Rate Cap - Maximum Rise or Fall in ARM Rate

Sam

Rate Cap is a limit by which the interest rate on an adjustable rate mortgage (ARM) can increase or decrease with respect to an adjustment period or throughout the life of the loan.

For example, Joseph takes a 1 year adjustable rate mortgage of $600,000 for a period of 24 years at the interest rate of 6%. Now if a cap of 2/6 is applied, it implies that the rate increases or decreases by 2% during each annually adjusted period with the maximum increase or decrease being 6% during the entire term of the loan.

Caps applied on an adjustable rate mortgage help to determine the interest rates with respect to different adjustment periods. These are as follows:

Initial adjustment rate cap: It determines the limit by which the interest rate changes during the first adjustment period of the mortgage.
Periodic adjustment rate cap: This indicates the limit by which the interest rate changes from one adjustment period to another.
Lifetime rate cap: This cap indicates the value by which the interest rate increases or decreases throughout the entire term of the mortgage.

The GSCU (Granite State Credit Union) offers different caps on various ARM programs. These include:

Cap on 1 year adjustable rate mortgage - 2/6: This means that the interest rate changes by 2% every year and it should increase or decrease by 6% throughout the entire life of the loan.
Cap on 3 year adjustable rate mortgage - 2/6: Here the interest rate is adjusted after every 3 years during which it increases or decreases by 2%. The rate should increase or decrease by 6% during the entire loan term.
Cap on 5/1 or 7/1 year adjustable rate mortgage - 2/5: The interest rate is fixed for the first 5 and 7 years respectively after which it varies annually by 2%. However it should increase or decrease by 5% throughout the life of the loan.

Adjustable Rate Mortgage

Related Forum Discussion

Use of lifetime cap

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