Annual Cap

AAA

DEFINITION of 'Annual Cap'

A clause found in the contract of an adjustable-rate mortgage (ARM) that limits the possible increase in the loan's interest rate to a certain amount each year. The cap is usually defined in terms of rate, but the dollar amount of the principal and interest payment can be capped as well. Annual caps are designed to protect borrowers against a sudden and excessive increase in the amount of their monthly payments when rates rise sharply over a short period of time.

INVESTOPEDIA EXPLAINS 'Annual Cap'

A loan with an annual rate cap will only increase by so much in terms of percentage points regardless of how much rates actually rise. A 5% ARM with a 2% cap can only adjust to 7%, even if rates increase by 4% over the initial fixed term of the loan. A loan with a dollar cap can only increase by so much as well, although this type of cap can lead to negative amortization in some cases.

RELATED TERMS
  1. Annuity

    A financial product that pays out a fixed stream of payments ...
  2. Payment Shock

    The risk that a loan's scheduled future periodic payments may ...
  3. Lifetime Cap

    The maximum interest rate on an adjustable-rate mortgage (ARM) ...
  4. Insurance

    A contract (policy) in which an individual or entity receives ...
  5. Cap

    The highest point to which an adjustable rate mortgage (ARM) ...
  6. Adjustable-Rate Mortgage - ARM

    A type of mortgage in which the interest rate paid on the outstanding ...
Related Articles
  1. Insurance

    ARMed And Dangerous

    In a climate of rising interest rates, having an adjustable-rate mortgage can be risky.
  2. Credit & Loans

    Mortgages: Fixed-Rate Versus Adjustable-Rate

    Both of these have advantages and disadvantages depending on your financial needs and prospects.
  3. Options & Futures

    This ARM Has Teeth

    Find out how to avoid getting bitten when your mortgage rate resets.
  4. Options & Futures

    Subprime Is Often Subpar

    Proceed with caution when considering these short-term, high-interest mortgages.
  5. Credit & Loans

    Getting A Mortgage After Bankruptcy Or Foreclosure

    Millions of Americans had homes foreclosed and millions more went into bankruptcy. Here are the necessary qualifying steps to buying a home again.
  6. Taxes

    Will Itemized Deductions Get You A Bigger Refund?

    April and taxes are due soon. If you need to file your return, you might have to decide if itemizing your deductions this year will net you a better deal.
  7. Home & Auto

    Save $30,000 For A Home Down Payment In 5 Months

    Before tackling mortgage rates, home maintenance costs and utilities, every home buyer must first gather the funds for a mortgage loan down payment.
  8. Credit & Loans

    Getting A Mortgage When Building Your Own Home

    It's much harder to get a loan when you're building a home, not moving into one. Here's where to look and what to expect.
  9. Credit & Loans

    Understanding Loan-to-Value Ratio

    Loan-to-value ratio (LVR) is a tool used to evaluate the risk in a collateralized loan, usually a mortgage loan.
  10. Credit & Loans

    Surprising Ways A Mortgage Affects A Credit Score

    It takes a good credit score to get favorable mortgage rates. Then, how you pay a mortgage will shape your score – just having one can lower it at first.

You May Also Like

Hot Definitions
  1. Asset Class

    A group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same ...
  2. Fiat Money

    Currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat ...
  3. Interest Rate Risk

    The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between ...
  4. Income Effect

    In the context of economic theory, the income effect is the change in an individual's or economy's income and how that change ...
  5. Price-To-Sales Ratio - PSR

    A valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the ...
  6. Hurdle Rate

    The minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, ...
Trading Center