Definition
An interest rate cap is a limit on how high or low the interest rate on an adjustable-rate mortgage can go. It protects you from extreme rate fluctuations.
Understanding Interest Rate Caps
Interest rate caps come into play with adjustable-rate mortgages (ARMs). They limit how much the interest rate can increase. Think of it as a safety net for your rate. It’s designed to protect against steep increases. Example: If your initial rate is 3% and the cap is 2%, your rate won’t exceed 5% in a period. This cap applies during adjustment periods and over the loan's life. It's not a fixed rate, so rates can still change within set limits. A common misconception is that the cap means the rate will never rise, but it just limits how much it can increase.
