Lenders have set caps to help protect borrowers from significant interest rate fluctuations. However, your monthly payment can still go up or down, even with interest rate caps.
Some variable-rate loans such as adjustable-rate mortgages have an initial period where the interest rate is fixed. After that, it follows the benchmark rate.
There are three different caps:
- The initial cap, which decides how much interest rates can change during the first adjustment period.
- The periodic cap, which determines how much the rate can change between subsequent adjustment periods.
- The lifetime cap, which determines how high the interest rate can go during the entire duration of the loan.
Even though these rates protect the borrowers, your payment can still increase. For instance, let’s say a fixed-rate loan has an interest rate of six percent; the cap for a variable-rate loan is set somewhere around 12–13%, meaning you could potentially pay twice as much interest.
The bigger the risk, the bigger the reward. There is no risk with fixed rates, but also no reward. You know how much you have to pay, which is why most borrowers choose this option.
With variable-rate loans, your monthly payment can go up or down. Sometimes borrowers with a variable-rate loan will end up paying less over time than they would have with a fixed-rate loan. However, it is hard to predict whether these trends will remain the same.
That’s why it’s best to familiarize yourself with all options and see which one works best for you.