Rate Cap
Definition and meaning of Rate Cap in real estate.
A rate cap is a limit on how much the interest rate can increase or decrease on an adjustable-rate mortgage during a specific timeframe or over the life of the loan.
In more detail
These caps protect borrowers from extreme payment shocks when market interest rates rise. Typically, adjustable-rate mortgages feature three distinct types of caps, which are the initial adjustment cap, the periodic adjustment cap, and the lifetime cap. The initial cap limits the first rate change, the periodic cap restricts subsequent adjustments, and the lifetime cap sets the maximum rate the borrower will ever pay.
Understanding these limits helps home buyers budget for the worst-case scenario over the life of their home loan.
Key facts
| Category | Mortgages & Financing |
|---|---|
| Also known as | Interest rate cap |
| Applies to | Adjustable-rate mortgages |
| Watch out for | Payment shock from rate increases |
A buyer takes out an adjustable-rate mortgage with a lifetime rate cap of six percent above the initial five percent rate, meaning their interest rate can never exceed eleven percent regardless of how high market index rates climb.
Frequently asked questions
What are the typical cap structures on an adjustable-rate mortgage?
Most adjustable loans use a three-number structure, such as 2/2/5, which represents the maximum percentage the rate can change at the first adjustment, each subsequent adjustment, and over the life of the loan, respectively.
Can a rate cap cause my monthly payments to decrease?
Yes, rate caps can also apply to downward adjustments, limiting how much your interest rate and monthly payment can drop during a single adjustment period.