Just as there are rate adjustment caps to protect borrowers from ARM rates going too high, too fast, the decrease cap is there to protect the lender from the ARM rate dropping too quickly. An interest rate decrease cap is the maximum allowable decrease in your interest rate (on an ARM) each time your rate is adjusted. It is usually 1 or 2 percentage points. If interest rates go down 4 percent, your rate may only go down 2 percent due to the cap.
When you get an adjustable-rate mortgage, or ARM, your interest rate changes periodically based on a standard rate index. Your interest rate decrease cap ensures that the amount you pay in interest doesn’t drop below a certain percentage. That protects your lender from suffering a significant loss of profit.
On the other hand, your ARM also has an interest increase cap, which ensures that your interest rate doesn’t soar beyond a certain point. That way you know the maximum amount your interest rate can rise.
If you have an ARM and aren’t sure about where you stand with your interest rate decrease cap or interest rate ceiling, contact your lender for clarification. You should know what each of the caps mean for your finances, should they be reached, so you can properly prepare for either. You should also learn how often your interest rates on your ARM can change. For instance, one variation is the 5/1 ARM in which you have a fixed interest rate for the first five years of your mortgage. After that, your interest rate can reset once a year.