What Is an Interest Rate Cap?

An interest rate cap is a limit to the amount of interest that a lender can charge on an adjustable-rate loan. Adjustable-rate mortgages have an interest rate cap to provide a maximum payment amount, regardless of what happens with the underlying financial index. Interest rate caps can come in a few different varieties.

Periodic Interest Cap

The periodic interest rate cap limits the amount of interest that can be charged for a particular period in the loan. For example, the interest rate might only be able to increase by a certain amount every year. 

Lifetime Interest Rate Cap

In some cases, mortgages will also have a lifetime interest rate cap attached to them. This means that after a certain interest rate has been reached, it cannot go up for the remainder of the loan.

As a borrower, interest rate caps provide much-needed protection with an adjustable-rate loan. Without this type of feature, you could have a mortgage payment that continues to grow indefinitely. A limit on the amount of interest that can be charged offers a borrower a worst case scenario in order to plan for loan payments.

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