Interest Rate Cap
A limit on how much the interest rate can increase on an adjustable-rate mortgage (ARM) during specific time periods. Caps typically include periodic caps (limiting increases per adjustment period) and lifetime caps (limiting total increases over the loan's life).
Example
“Our adjustable-rate mortgage has an interest rate cap of 2% per year, so even if market rates skyrocket, our rate can't increase by more than that annually.”
Memory Tip
Picture a baseball cap sitting on top of rising interest rates, preventing them from going higher than the cap allows.
Why It Matters
Rate caps protect borrowers from dramatic payment increases that could make their mortgage unaffordable if interest rates rise significantly. Without caps, ARM payments could become unmanageable during periods of rising rates.
Common Misconception
Some borrowers assume rate caps prevent any payment increases, but rates can still rise substantially within the cap limits.
In Practice
A 5/1 ARM might have a 2/2/5 cap structure, meaning rates can increase by 2% at the first adjustment, 2% per year thereafter, with a 5% lifetime maximum increase from the initial rate.
Etymology
Combines 'interest rate' with 'cap' from Latin 'caput' meaning head or top, literally putting a ceiling or top limit on rate increases.
Common Misspellings
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