Adjustable Rate Mortgages – Talking About Interest Rate Caps

Many people have opted for adjustable rate mortgages (ARMs) to benefit from the historically low interest rates in recent years. However, with rates now on the rise, it's crucial to understand interest rate caps associated with these mortgages.

An adjustable rate mortgage allows the interest rate to be adjusted according to certain interest rate benchmarks. The primary advantage of an ARM is that it can significantly reduce monthly mortgage payments when interest rates are low. However, as rates increase, it's essential to comprehend how this affects your mortgage.

With the adjustable nature of your loan's interest rate, rising rates can be concerning. Fortunately, most ARMs include rate caps to prevent drastic rate increases. There are two main types of rate caps, each offering different forms of protection.

A lifetime rate cap sets the maximum interest rate the lender can charge over the life of the loan. For example, if you secure an ARM at an initial rate of 4% with a lifetime cap of 9%, your interest rate will never exceed 9%, even if market rates soar to 10%. This cap provides a safeguard against unmanageable rate hikes, ensuring you won't be subject to exorbitantly high interest rates.

Periodic rate caps offer protection by limiting how much the interest rate can increase within a specific period. The shorter the period, the more frequently adjustments can be made, but the smaller each potential increase will be. For instance, if your ARM allows for adjustments every six months with a periodic cap of 1%, the lender can only increase your rate by 1% per adjustment period, regardless of broader market rates.

ARMs are advantageous when interest rates are low. However, as rates begin to climb, it's vital to review your rate caps carefully to understand how they will influence your mortgage payments.