Cap (Interest Rate)

The cap, in the context of interest rates, refers to a limit on the amount an interest rate can increase on a variable or adjustable-rate loan or mortgage. This ceiling is designed to protect borrowers by setting a maximum rate that can be charged, regardless of market fluctuations.

Caps are commonly found in adjustable-rate mortgages (ARMs), where they serve to limit the interest rate adjustment during a particular period (the periodic cap) and over the life of the loan (the lifetime cap).

Interest rate caps are crucial for borrowers to manage their future financial exposure and risk. While ARMs, with their lower initial rates, can be attractive, caps provide a safeguard against escalating payments, ensuring that borrowers are not overwhelmed by sudden and steep increases in interest rates.