What Does Interest Rate Cap Mean?
An interest rate cap is a limit imposed on the interest rate on adjustable-rate loans. While the interest rate on the loan can increase along with inflation or otherwise fluctuate, the cap prevents it from exceeding a certain amount. In this way, the interest rate cap acts as a kind of insurance against the loan ballooning to an excessively high rate or amount.
Insuranceopedia Explains Interest Rate Cap
There are multiple structures for interest rate caps, including initial, periodic, and lifetime. The initial interest cap dictates how much the interest can be adjusted at the first interest rate adjustment date. The periodic cap delimits how much the interest can fluctuate at each interest rate adjustment date. The lifetime interest rate cap, as the name implies, puts a limit on how much the interest rate can increase over the entire course of the loan.
Interest rate floors are the counterparts of these caps. While they both attempt to rein in interest rate fluctuation, the interest rate floor does so by guaranteeing that the interest will not dip below a certain rate.