ARM - Caps
Interest rate caps -limitations on charges- are a common feature of adjustable rate mortgages. Caps typically apply to mortgages in three ways:
- Cap how frequently the rate can change (ex: Adjustments may be made only once per year)
- Cap the amount the rate can change in specific periods (ex: Interest may only adjust by maximum of 1% every 12 months)
- Cap the total change in interest rate over the life of the loan (ex: Interest rate may only be adjusted a maximum of 5% in the lifetime of the loan)
Notes on Caps
- Mortgages may have different adjustment caps depending on the period (first year at 2% max, fifth year at 3% max, etc.)
- Rather than cap the interest rate, some mortgages may cap the total monthly payment in absolute terms. For example, a monthly payment may be capped at $1000. Beware of these mortgages though as a borrower may find that they end up paying nothing but interest on the loan.
- Cap structure is sometimes expressed as initial adjustment cap / subsequent adjustment cap / life cap. For example 1/2/6 for a mortgage loan would mean a 1% cap on the initial rate adjustment, a 2% cap on subsequent rate adjustments, and a 6% cap on total lifetime interest rate adjustments.