What Is a Ceiling?
In finance, a ceiling is the maximum permitted level in a financial transaction. The term can be applied to a variety of factors, such as interest rates, loan balances, amortization periods, and purchase prices.
Ceilings are often used to control risks, by imposing an upper limit to the size or cost that is possible for a given transaction.
- Ceilings are upper limits which can be applied to various aspects of a financial transaction.
- They are commonly applied to factors such as interest rates, amortization periods, or the principal balance of loans.
- Ceilings are used to control risks. From the perspective of lenders, for instance, they can be used to control the risk of default by debtors.
How Ceilings Work
There are many kinds of ceilings used across the modern financial markets. A common example is rent control, which imposes an upper limit, or “ceiling”, on the rent that landlords can charge to their tenants. Other common examples include the upper limits imposed by banks on the size or frequency of electronic fund transfers; the maximum interest rates permitted under law for consumer loans; or the highest allowable price for a regulated utility.
Ceilings are also commonly used in the research reports and projections of financial analysts. For instance, financial models seeking to estimate the present value and future growth prospects of a company will often contain value ranges with a ceiling that specifies the upper limit of the company’s estimated value. Similarly, they are often included as an ‘optimistic’ or ‘best-case’ scenario in analysts’ projections regarding closely-followed metrics such as stock prices and estimated earnings per share (EPS).
Credit products with variable interest rates will often also include interest rate ceilings in their loan provisions. Under these provisions, interest rates are permitted to rise throughout the life of the loan, but only up to a predetermined maximum level. Similarly, these agreements may also contain a minimum interest level, or “floor,” which acts to protect the lender against an uncontrolled decline in their interest income.
Another consequential example of a ceiling in finance is the United States debt ceiling, which is the legally-mandated limit to the total size of the national debt. Congress has had to raise the debt ceiling on several occasions in recent decades, in order to prevent the nation from potentially defaulting or becoming delinquent on its sovereign debt obligations.
Real World Example of a Ceiling
Similar but less high-profile examples can be found in the commercial credit market, where credit limits on borrowing can also be used to mitigate broad ranging credit risks. States and federal governments, for example, may have debt ceilings that are implemented based on credit quality requirements.
In certain situations, individual borrowers may also face ceilings on the amount of money they can borrow. One such example is reverse mortgages, which have regulated ceilings on the lifetime principal allowances for borrowers aged 62 or older.