CAP

Definition

In the context of adjustable-rate mortgages (ARMs), a CAP is a safeguard that limits the extent to which the interest rate or mortgage payment may change during the adjustment periods. ARMs generally offer an initial period with a fixed interest rate, after which the rate adjusts periodically based on an index. The cap ensures that borrowers will not face abrupt and substantial increases in their payments. Here are the typical caps associated with ARMs:

• Annual Cap: This limits the rate of increase from one adjustment period to another within a single year.
• Life-of-Loan Cap: This places an absolute ceiling on how high the interest rate can go over the life of the loan.
• Payment Cap: This restricts the amount by which the monthly payment can increase at any one time or over the life of the loan.

Examples

1. Annual Cap: If an ARM has an annual cap of 2%, and the current rate is 4%, the rate cannot increase to more than 6% in one year, regardless of how much interest rates in the broader market have risen.

2. Life-of-Loan Cap: Consider an ARM with a life-of-loan cap of 6%. If the initial rate is 4%, the rate cannot increase above 10% over the entire term of the mortgage.

3. Payment Cap: With a payment cap of 7.5%, if your initial monthly mortgage payment is $1,000, it cannot increase by more than $75 (7.5% of $1,000) at an adjustment, regardless of how high interest rates rise.

Frequently Asked Questions (FAQs)

How does an ARM’s cap affect my mortgage payments?

• Caps protect borrowers from experiencing sharp increases in their monthly payments, providing a level of predictability and financial planning.

What happens if interest rates drop significantly?

• While caps limit increases, they do not prevent decreases. Thus, if market rates fall, your interest rate may also decrease within the limits set by the ARM terms.

Are there any downsides to having a cap on my ARM?

• Caps primarily benefit borrowers, but keep in mind they might also mean slightly higher initial interest rates compared to ARMs without caps.

Can my ARM have multiple types of caps?

• Yes, ARMs can have a combination of annual caps, life-of-loan caps, and payment caps to limit both periodic and lifetime interest rate increases.

What type of cap is the most beneficial?

• It largely depends on your financial situation and risk tolerance. A life-of-loan cap provides long-term predictability, while annual caps offer more immediate annual protection.

Related Terms

• Annual Cap: The maximum rate of increase in interest rates that can occur in a year.

• Life-of-Loan Cap: The maximum rate that can increase over the life of the ARM loan.

• Payment Cap: A limit on how much your monthly payment can increase, which can sometimes lead to negative amortization.

• Cap Rate (Capitalization Rate): A rate that helps in valuing a property by dividing the annual income by the property price.

Online Resources

• Bankrate: Understanding Adjustable Rate Mortgages
• Consumer Financial Protection Bureau: ARM Mortgages Explained
• Investopedia: Adjustable Rate Mortgage Cap

References

• Consumer Financial Protection Bureau (CFPB). “What is an adjustable-rate mortgage (ARM)?” Retrieved from CFPB.gov
• Bankrate. “Adjustable-rate mortgage vs. fixed-rate mortgage.” Retrieved from Bankrate.com
• Investopedia. “Interest Rate Cap Definition and Example.” Retrieved from Investopedia.com

Suggested Books for Further Studies

1. Mortgage Management for Dummies by Eric Tyson and Ray Brown
2. The Real Estate Investor’s Handbook: The Complete Guide for the Individual Investor by Steven D. Fisher
3. Investing in Apartment Buildings: Create a Reliable Stream of Income and Build Long-Term Wealth by Matthew A. Martinez
4. Mortgage Ripoffs and Money Savers: An Industry Insider Explains How to Save Thousands on Your Mortgage or Refinance by Carolyn Warren

Real Estate Basics: CAP Fundamentals Quiz