Rate cap on ARM? An adjustable-rate mortgage cap sets the maximum rate increase per adjustment period and the maximum rate over the life of the loan. These caps protect you from extreme rate spikes that could make your payment unaffordable.
Periodic Cap
The periodic cap limits how much the interest rate can increase at each scheduled adjustment. For a 5/1 ARM, that means the rate cannot go up more than 2% on the first adjustment and 1% at each subsequent adjustment. If your initial rate is 5% and the index jumps sharply, the periodic cap keeps your first adjustment from exceeding 7% and each yearly adjustment after that limited to 1%.
Lifetime Cap
The lifetime cap sets the maximum interest rate your ARM can reach over the entire loan term. A typical lifetime cap is 5% to 6% above your initial rate. So if your loan starts at 5% with a 5% lifetime cap, your rate can never exceed 10% no matter how high the index goes. This provides long-term protection against extreme market conditions.
Always review both the periodic and lifetime caps when comparing ARM loan offers. A lower lifetime cap provides more protection but may come with a slightly higher initial rate. Patrick Kevin Fagan recommends understanding these caps thoroughly before committing to an ARM.
