Rate Cap sets the limit on how much the rate can change/adjust in an Adjustable-rate mortgage (ARM).
There are three kinds of rate caps:
- Initial adjustment cap: how much the interest rate can increase the first time it adjusts after the fixed-rate period expires. It’s typically 2% or 5% – meaning that at the first rate change, the new rate can’t be more than 2% (or 5%) higher than the initial rate during the fixed-rate period.
- Subsequent adjustment cap. This cap says how much the interest rate can increase in the adjustment periods that follow. This cap is typically 2%: i.e. the new rate can’t be more than 2% higher than the previous rate.
- Lifetime adjustment cap. This cap says how much the interest rate can increase in total, over the life of the loan. This cap is typically 5%, i.e. the rate can never be 5% points higher than the initial rate. However, some lenders may have a higher cap.