Usually simply called a “cap” or “periodic adjustment cap,” this limits the amount an adjustable rate mortgage (ARM) rate can rise during one adjustment period. It protects borrowers from payments that rise too quickly and become unaffordable. It’s the counterpart of the interest rate decrease cap, which protectors mortgage lenders from rates dropping too quickly.<./p>
When you get an adjustable rate mortgage, or ARM, your interest rates will change periodically based on a standard rate index. That means certain economic indicators can make your interest rate increase or decrease, causing you to pay more or less on your mortgage payments.
An interest rate increase cap is one manner in which you can protect yourself and your finances from a surge in interest rates. The interest rate increase cap sets a limit for how high your interest rate can be for a certain time period. So if the economy changes and interest rates drastically increase, you won’t find yourself paying an unexpected and outrageous amount of money.
On the other hand, there are ways that lenders protect themselves from dramatic dips in interest rates. Your ARM will also have an interest rate decrease cap, which is the maximum allowable decrease in your interest rate each time your rate is adjusted. It is usually 1 or 2 percentage points. If rates go down 4%, your rate may only go down 2% due to the decrease cap. This can help protect your lender from a considerable loss in profits due to a decrease in interest rates.
If you are unsure of how often the interest rate on your ARM is reset and what its interest rate caps are, contact your lender. That way you can prepare your finances in case of an increase. Working out the numbers and being an informed consumer is one of the best ways to stay out of a sticky financial situation.