What Is A Capped Mortgage?

The pure variety of mortgages available to home borrowers these days can be overwhelming. In this article, we focus on defining a capped mortgage.

What Is A Capped Mortgage?

When it comes to home loans, mortgages can be categorized in a wide variety of ways. One of the easiest methods is to focus on interest rates. There are generally two interest rate terms offered with mortgages. Fixed rate mortgages are exactly what they sound like, to wit, the interest rate remains the same throughout the repayment period. Adjustable rate mortgages, as the name suggests, have interest rates that are tied to financial indicators such as LIBOR and can go up or down as those indicators move. When discussing a capped mortgage, we are really talking about an element of an adjustable mortgage.

Adjustable rate mortgages are by far the most popular home loan program available to buyers. Why? For the last 10 years or so, the interest rates on these loans have been lower than those found with fixed rate home loans. This allows borrowers to either borrow more money than they would with a fixed or get the same amount of money with lower monthly payments. Given this, one might wonder why everyone wouldn't go with an adjustable rate mortgage.

Unlike fixed rate mortgages, there is a risk with adjustable mortgages. The risk is simply that the interest rate will rise quickly. Such an event can occur where the borrowing cost of money becomes high, inflation occurs or the financial markets react quickly to some event such as war or skyrocketing oil prices. In any of these situations, the interest rate on an adjustable mortgage will go up, up, up.

The problem with these fluctuations is an increased interest rate results in an increase monthly mortgage payment. A jump of a $500 or more can really strain the finances of most homeowners. If things move to quickly, a significant percentage of the real estate market could go into default. Imagine opening your mortgage payment mail and finding the amount due has gone up $500!

To stop this crippling scenario, most adjustable home loans are what is known as a capped mortgage. The cap refers to two things. First, the loan agreement contains language stating that the interest rate can only be adjusted so many times in a year, often only two or four times. Second, the agreement contains language indicating the maximum cap for the interest rate. The maximum cap is simply the highest point the interest rate can be raised to regardless of financial indicators. If the cost of borrowing money goes to 19 percent and your loan has a cap of 12 percent, you are charged 12 percent and no more. The lender may go bankrupt, but that is another issue.

What is a capped mortgage? It is an adjustable rate mortgage with a safety mechanism built into to it to keep you and much of the real estate market from being wiped out if interest rates climb dramatically.

Get A Free, No-Obligation Consultation with a Mortgage Professional

<< Back to Mortgage Loans