This can be defined as an exact rate, for example 9.0 percent, or it can be expressed as a percentage over the loan’s initial interest rate. If the initial rate is 2.5 percent, and the rate has a six point ceiling or cap, the interest rate can’t exceed 8.5 percent.
This is a safeguard put in place to make ARM loans a little safer for borrowers. A borrower who knows what the worst-case scenario is can be more confident of being able to afford his mortgage payments even if interest rates rise in the future.
The interest rate ceiling is the highest interest rate possible under an adjustable-rate mortgage (ARM). You may hear this called the lifetime cap, and it is based on the number of percentage points your rate can increase from your initial rate.
This can be intimidating because it seems as though your interest rate could drastically increase, but that is where interest rate ceilings come in. When you sign the papers for your adjustable-rate mortgage, your lender will have specified the maximum that your interest rates could reach. That way, you don’t have to worry about your interest rate jumping from 6.75 percent to a whopping 40 percent.
On the other end of the spectrum, your ARM may also have an interest rate floor. The interest rate floor is the lowest interest rate possible for an ARM loan.
While an interest rate ceiling is a good way to protect yourself from paying a great deal of money in interest, an interest rate floor is how your lender is protected from a significant drop in interest rates. After all, if you were not paying interest on your mortgage, your lender would have no incentive for doing business with you.
If you have questions about ARMs and interest rate ceilings, you should contact your lender and see what the terms of your mortgage really mean. You may also be able to work out the numbers to see what your maximum monthly mortgage payment would be if you hit your interest rate ceiling. You can then plan your finances accordingly so that in case you reach your interest rate ceiling, you will be prepared.