Definition:
A lifetime cap is the maximum amount an interest rate can increase over the life of an adjustable-rate mortgage (ARM), regardless of changes in the market. It protects borrowers from extreme increases in monthly payments.
Example:
Sandra gets a 5/1 ARM with a starting interest rate of 4% and a lifetime cap of 5%. This means her rate can never go above 9%, even if interest rates in the market climb higher.
Explanation:
Adjustable-rate mortgages (ARMs) start with a fixed interest rate for a set number of years, such as 3, 5, or 7 years. After that, the rate adjusts periodically based on a market index (like SOFR) plus a margin set by the lender.
To limit how high these adjustments can go, lenders include rate caps in the loan agreement. There are three common types:
- Initial cap – Limits how much the interest rate can increase after the first adjustment.
- Periodic cap – Limits how much the rate can rise during each adjustment period.
- Lifetime cap – The interest rate can rise from the original rate over the entire life of the loan.
For example, with a 5% lifetime cap and a starting rate of 4%, the interest rate can never exceed 9% during the life of the loan.
Why is Lifetime Cap Important in Real Estate Transactions?
The lifetime cap is important because it protects borrowers from skyrocketing payments if interest rates rise sharply in the future. For buyers, it offers peace of mind when choosing an ARM by setting a ceiling on how much their payments could ever increase. For sellers and real estate professionals, explaining this feature can make ARMs more appealing and less risky for potential buyers.