Interest rate caps are important features of adjustable rate mortgages (ARMs). They limit how much the interest rate can increase over the life of the loan or during specific periods. Understanding these caps helps borrowers anticipate potential payment changes and manage financial planning.
Types of Interest Rate Caps
There are primarily two types of caps associated with ARMs: periodic caps and lifetime caps. Periodic caps restrict how much the interest rate can increase from one adjustment period to the next. Lifetime caps limit the total increase over the entire term of the loan.
How Caps Affect Borrowers
Interest rate caps provide protection against significant rate increases. They help borrowers understand the maximum possible payment increase, which can aid in financial planning. However, caps do not prevent rates from rising; they only limit the extent of increases.
Key Terms to Know
- Initial Rate: The starting interest rate of the ARM.
- Adjustment Period: The interval at which the interest rate can change.
- Periodic Cap: The maximum increase allowed at each adjustment.
- Lifetime Cap: The maximum interest rate increase over the loan's duration.