Capped Rate Mortgages
A capped rate mortgage
is essentially a combination of a fixed rate mortgage and a
variable rate mortgage. As the name suggests, the interest rate
is capped (it has a ceiling on it) so that the borrower’s
monthly payments will be calculated using either the standard
variable rate or the capped rate, whichever is lower. This kind
of mortgage offers a limit to how high the interest rate can
rise, but the rate you pay can move up and down below that level.
Capped rate mortgages have a specified upper limit (also known
as the cap) above which the rate cannot go, but it will follow
interest rates downwards. This means you are guaranteed not
to pay above a fixed rate of interest on your mortgage but at
the same time you will benefit if interest rates fall below
this level.
For example, if the cap is set at say 10% then if interest
rates rise to say 15%, you will only have to pay the capped
amount of 10%, not matter how high interest rates rise. If
interest rates go down to say 5%, you will then pay this lower
interest rate. Capped rate mortgages are often seen as providing
you with the best of both worlds – if the variable rate
goes higher than your agreed capped rate then you’re
only paying up to the agreed capped rate. Whereas if it falls
below your capped rate then you pay less as well. Hence you
benefit from falling interest rates but are also protected
from rate rises. They are also fairly easy to plan your budget
around as you always know the maximum amount you will have
to pay. However the downside to capped rate mortgages is that
there are not many of these deals available on the market
and they’re not thought to be very competitive as the
rate on them is still usually higher than that available on
comparable fixed or discounted rate products. There may also
be an admin charge for taking out this type of mortgage and
you may also have to pay penalty charges if you want to pay
off your loan within the capped period.
Some capped rate mortgages also come with the option that
if interest rates drop, your mortgage will only drop so far.
This is known as a ‘collar’ – the minimum
pay rate. This product means you are always paying within
a margin; you pay less than the cap but more than the collar.
The downside to this type of arrangement is although you are
protecting yourself from high interest rises you are also
not going to benefit if interest rates fall below the collar
as you will still have to pay the minimum rate set.
Capped rate mortgages are worth considering when interest
rates are either rising rapidly or when there is uncertainty
as to which direction they are going. A capped rate mortgage
is usually capped for a set period of time between one year
and five years but it is possible to find capped rate mortgages
lasting for the entire life of the loan.
It would seem like you have the best of both worlds with
a capped rate mortgage, on the outside it would seem as if
the borrower wins, no matter what. But in reality the cap
is set at a level that the lender does not expect the variable
rate to exceed for too long – if they didn’t do
this they could end up losing out quite heavily.
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