What is a life cap?
A life cap, or lifetime cap or rate cap, is the maximum amount that a borrower’s interest rate can increase over the term of the loan. The life cap represents either a total absolute rate or percentage change in the rate.
Adjustable-rate mortgages (ARMs) usually come with a series of caps that limit how much interest can be charged to the borrower after the fixed-interest period ends. The initial adjustment cap limits the change in interest for the first time rates are adjusted, and there are subsequent, or periodic, interest caps to cover upcoming changes in the interest rate.
Life caps limit how much interest the lender can charge over the term of the entire term. Usually expressed as an absolute percentage, or a change in percentage, life caps may differ between lenders but should be spelled out in the loan agreement.
Lifetime caps represent the highest rate at which interest can be charged. However, ARM interest rates can actually decrease after the fixed-interest period. Additionally, lifetime caps don’t affect other costs like transaction and late fees, which are factored along with the interest rate into the annual percentage rate (APR).
Wondering how a life cap will affect your payments? Use Bankrate’s mortgage calculator to find out how much you’ll owe.
Life cap example
James acquired a loan from a bank with 7 percent as the initial interest rate. The bank allows adjustments every three months, but has a life cap of 3 percent. Therefore, the maximum interest rate Jack will ever have to pay is 10 percent.