DEFINITION of 'Life Cap'
The maximum amount that the interest rate on an adjustable rate loan can increase over the term of the loan.
A life cap can be expressed as an absolute interest rate - such as a maximum lifetime rate of 12%, which is called an interest rate ceiling - or as a maximum percentage change in the interest rate from the initial interest rate on the loan. When the life cap is expressed as a maximum percentage change from the initial interest rate, it can also apply to interest rate decreases.
BREAKING DOWN 'Life Cap'
The life cap on a loan is used frequently as part of an interest rate cap structure. For example, a fixed period or hybrid ARM frequently has initial, periodic and life caps. On a 5-1 hybrid ARM, this might be expressed as a 5-2-5 cap structure, meaning there is a 5% initial cap, 2% periodic cap and 5% life cap. This means that at the first interest rate change date, the rate could change by a maximum of 5%, and at each subsequent change date the rate could change by a maximum of 2%. The maximum lifetime change in this example is 5%.