Interest Rate Cap Structure


DEFINITION of 'Interest Rate Cap Structure'

Limits to the interest rate on an adjustable-rate loan - frequently associated with a mortgage. There are several different types of interest rate cap structures including an initial, periodic and lifetime interest rate cap structure. The initial cap is a value that limits by what amount the interest can adjust at the mortgage's first interest rate adjustment date. The period cap is a value that limits by what amount the interest rate can adjust at each subsequent adjustment date. The lifetime cap limits the total amount by which the interest rate can adjust over the life of the mortgage.

BREAKING DOWN 'Interest Rate Cap Structure'

The interest rate cap structure of a mortgage gives holders protection from large interest rate increases. For example, 5-1 fixed period ARMs usually offer the borrower a choice between a 2-2-6 or a 5-2-5 interest rate cap structure. (The first number refers to the initial cap, the second number to the periodic cap, and the third number to the lifetime cap.) If the fully indexed interest rate on the mortgage were to increase substantially before the first interest rate adjustment date, but stay below a 5% lifetime cap value, the borrower would be better off choosing the 2-2-6 interest rate cap structure. However, the dilemma to this is that borrowers can never truly be certain where interest rates will head next.

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