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.

BREAKING DOWN '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. Interest Rate Cap Structure

    Limits to the interest rate on an adjustable-rate loan - frequently ...
  2. Capped Rate

    An interest rate that is allowed to fluctuate, but which cannot ...
  3. Initial Interest Rate Cap

    The maximum amount the interest rate on an adjustable-rate loan ...
  4. Periodic Interest Rate Cap

    A part of an interest rate cap structure on loans and mortgages. ...
  5. Lifetime Cap

    The maximum interest rate on an adjustable-rate mortgage (ARM) ...
  6. Adjustable-Rate Mortgage - ARM

    An adjustable rate mortgage is a type of mortgage in which the ...
Related Articles
  1. Investing

    An Introduction To Small Cap Stocks

    When it comes to a company's size, bigger isn't always better for investors. Find out more here.
  2. Investing

    Market Capitalization Defined

    Find out the differences between mega-, large-, mid- and small-cap stocks and how each suits different investing styles.
  3. Investing

    1Q Small Cap Earnings Preview: The Tide Has Turned

    Earnings growth for small caps should trail large caps badly in the first quarter.
  4. Personal Finance

    Mortgages: Fixed-Rate Versus Adjustable-Rate

    Both of these have advantages and disadvantages depending on your financial needs and prospects.
  5. Investing

    Mortgages: Fixed Rate Versus Adjustable Rate

    Choosing the right mortgage can help homebuyers avoid costly mistakes. Learn the difference between fixed- and adjustable-rate loans.
  6. Investing

    Small Cap Vs. Mid Cap Vs. Large Cap Stocks in 2016

    Find out what to expect from small-, mid- and large-cap stocks in 2016, learn and why markets might not perform much better than 2015.
  7. Investing

    Why You Need to Watch Small Caps (IWM)

    Small cap performance impacts broad market tone and direction while revealing important details about market psychology.
  8. Small Business

    Capitalization Rate

    Capitalization Rate is a financial term most commonly used in the real estate investment industry. It is often simply called the Cap Rate.
  9. Investing

    Market Cap

    Learn more about how market cap represents the "price tag" of a company.
  10. Personal Finance

    How Interest Rates Work On A Mortgage

    A step-by-step explanation of the interest calculations, mortgage types, and how the loan is eventually "retired" – which means paid off.
RELATED FAQS
  1. Are small cap companies a safer investment than large cap companies?

    Learn about the safety of small caps compared to large caps. Find out which key measures they differ on and which to pick ... Read Answer >>
  2. Are small cap companies more risky investments than large cap companies?

    Learn about the risk of small cap companies compared to large cap companies. Compare the volatility of both and learn how ... Read Answer >>
  3. How can I use market capitalization to evaluate a stock?

    Find out how market capitalization affects valuation in fundamental analysis, which valuation ratios use market cap and how ... Read Answer >>
  4. Which is better, a fixed or variable rate loan?

    Interest on variable interest rate loans vary as market interest rates change. Interest on fixed interest rate loans will ... Read Answer >>
  5. Is there such a thing as a nano cap or micro cap index?

    While there are indexes that track micro cap stocks, there are few indexes tracking nano caps. Although definitions vary, ... Read Answer >>
Hot Definitions
  1. Ex-Dividend

    A classification of trading shares when a declared dividend belongs to the seller rather than the buyer. A stock will be ...
  2. Debt Security

    Any debt instrument that can be bought or sold between two parties and has basic terms defined, such as notional amount (amount ...
  3. Taxable Income

    Taxable income is described as gross income or adjusted gross income minus any deductions, exemptions or other adjustments ...
  4. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly AIMR) that measures the competence and integrity of financial ...
  5. Initial Coin Offering (ICO)

    An Initial Coin Offering (ICO) is an unregulated means by which funds are raised for a new cryptocurrency venture.
  6. The Bernie Madoff Story

    Bernie Madoff ran a multibillion-dollar Ponzi scheme that is considered the largest financial fraud of all time.
Trading Center