Rate cap
A limit on how much an ARM's rate can rise — an initial cap at the first reset, a periodic cap per adjustment, and a lifetime cap over the loan.
What does rate cap mean?
Caps are the guardrails on an adjustable-rate mortgage, often written like 2/2/5: an initial cap on the first adjustment, a periodic cap on each later one, and a lifetime cap on how far the rate can ever climb above the start. Caps define your worst-case payment, so they matter as much as the teaser rate when weighing an ARM.
Reading a cap structure
ARM caps are written as three numbers. A 5/6 ARM with 2/1/5 caps means:
- 2 — the first adjustment can raise the rate by no more than 2 percentage points.
- 1 — each later adjustment is limited to 1 percentage point.
- 5 — the rate can never rise more than 5 percentage points above the starting rate over the life of the loan.
Worst case, in numbers
Start at 6% with 2/1/5 caps and the rate can reach 8% at the first reset, 9% at the next, and never exceed 11%. On a $300,000, 30-year loan the payment starts near $1,799. If the rate jumps to 8% after five years, the payment on the remaining balance of about $279,000 rises to roughly $2,155 — about $356 more a month.
Some ARMs also have a payment cap, which limits the payment rather than the rate and can let unpaid interest add to the balance. Ask which kind of cap your loan has and run the worst case before you sign.
Frequently asked
What do ARM caps like 2/2/5 mean?
The first number caps the initial adjustment, the second caps each later adjustment, and the third is the lifetime cap over the starting rate.
So 2/2/5 means the rate can rise at most 2% at first reset, 2% per adjustment after, and 5% total over the loan.
Put it to use
Related terms
All glossary terms