Capped Rate Mortgages
A capped rate mortgage is a cross between a variable rate and fixed rate mortgage. Much like a fixed rate mortgage it offers a simple solution to the problem of rising interest rates by setting a threshold for the maximum level of interest that you have to repay. This upper limit is known as a "cap" and is usually set for a fixed period of time, typically one to five years. For the duration of this capped period your mortgage interest rate will rise and fall in-line with your lenders standard variable rate. If there is a drop in interest rates then your monthly repayments will likely drop. On the other hand should the interest rates rise, your monthly repayments will never exceed the pre-set capped rate.
On the surface a capped rate mortgage would seem impossible to beat, however like most things they also have their drawbacks.
There aren't as many capped rate loans on offer for one, and those that are tend to be more expensive to set up than a fixed or tracker rate mortgage. Some capped rate mortgages have what's known as a "collar" which is the minimum level to which the interest on the loan can fall. This kind of defeats the object of a capped rate mortgage so it's important for borrowers to ensure they know exactly what this lower limit is.
What are the benefits of a capped rate mortgage?
The main benefit of a capped rate mortgage is the knowledge of knowing the maximum your monthly loan repayments can reach during the capped rate period, which makes budgeting possible. If there is no collar set on your loan when the interest rates fall you can benefit from having lower monthly repayments and therefore more cash in your pocket.
What are the disadvantages of a capped rate mortgage?
- The administration fees for setting up a capped rate mortgage are generally higher than other types of mortgage.
- There aren't many capped rate mortgages to be found on the market.
- If there is a collar or lower level set to which interest payments on your loan cannot fall, any benefits received from falling interest rates will be limited.
- The lowest rates on the market aren't usually offered with capped mortgages, short term fixed rate mortgages usually offer a better deal.
- There is usually little flexibility of early repayments for capped rate mortgages, any change to the mortgage before the capped rate ends will usually result in a heavy redemption penalty.
- Once your capped rate period has finished your mortgage payments will switch to the lenders higher standard variable rate.