Capped Rate Mortgage

A mortgage agreement is available with a variety of options, one of which is a capped rate. A “Capped Rate Mortgage” as the words are used places a cap on the maximum interest that can be levied by the lender on you.

Therefore the standard variable rate is used as the reference rate for levying interest. However a cap rate is fixed at the commencement of the mortgage; say the cap rate is 6% per annum. In case the variable rate exceeds the cap rate, you are obligated to pay on the cap rate. Therefore you have hedged your interest rate risk.

The capped rate option is available for a specific period of the total loan term usually 1 to 5 years. After this period the interest rate reverts back to the variable rate. Therefore it does not matter after this period if the standard variable interest rate is higher than the capped rate.

Some Capped Rate Mortgages also have a “Collar” attached to it. The collar sets a lower limit on the interest rate. If the market interest rate falls below the cap rate then you have to pay the collar rate. This option protects the lender against interest rate falls.

Advantages of a Capped Rate Mortgage

• Easy for you to budget your monthly expenses as you are aware of the maximum interest cost
• Benefits even when rates are increasing and when rates are falling as you pay the lower rate when rates are increasing and benefit when market rates fall
• Peace of mind
• Interesting option if you expect the market rates to rise in the short term

Disadvantages of a Capped Rate Mortgage

• Available for a limited period only after which the terms switch back to variable rate
• The capped rate mortgages are usually more expensive than fixed rate mortgages