Definition of Mortgage Cap Rate
A mortgage cap rate is the maximum allowable interest rate a lender can charge on a pre-existing mortgage contract. Cap rates on mortgages are typically only used in variable rate mortgage contracts and in convertible mortgage contracts (where borrowers can opt to switch from a variable to a fixed rate within the mortgage contract term).
Why is this term important?
The mortgage cap rate is the highest interest rate that can be charged by your lender on a variable-rate or hybrid mortgage loan. The inclusion of a cap rate in the mortgage contract allows you to reduce the risk of potentially rising rates, as it prevents your mortgage rate from rising above this specified rate. It’s a cap as it restricts how high a lender can raise your rate during the active mortgage contract term.
Examples of term
Historically, convertible mortgage allows a borrower to start off with a slightly higher mortgage rate than variable mortgages, but slightly lower than fixed mortgage rates. When negotiating the terms of a convertible mortgage, the lender would offer a mortgage cap rate—the highest rate that could be charged to the borrower should they opt to convert from a variable to a fixed rate.
Convertible mortgages and any mortgage with a cap rate help borrowers who are unsure as to whether or not mortgage rates will rise in the near future, but still want to take advantage of low mortgage rates.