Definition
Interest Rate Ceiling (cap)
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An interest rate ceiling on a housing loan refers to an upper limit imposed on the maximum interest rate that a borrower will be charged by the bank.
Because all bank home loans are floating rate mortgages, borrowers are always under the risk of rising interest rates causing excessive monthly payments that might be unaffordable.
Even fixed rate home loans will float with an index rate once the initial period of fixed rates expire.
To counter this risk of overly high interest rates being a burden to borrowers, some banks do introduce an interest rate ceiling feature for their housing loans so that mortgage interest rates will never get out of hand to a point of being unaffordable to the consumer.
Such a feature on a credit facility will prevent interest from going above a specified rate.
For example, if a home loan is SIBOR + 1.75% and adds up to 3.75%, an interest rate ceiling of 4% would mean that 4% is the maximum that a borrower will be charged for the loan even if SIBOR rises to 3%. Technically speaking that would result in 4.75% (3% + 1.75%).
But since the interest rate ceiling (sometimes referred to as the interest rate cap) is 4%, then that is the maximum that the borrower would pay according to the terms of the agreement.
Interest rate ceilings offer a regular borrower a little extra peace of mind when he is afraid of interest rate spikes. It will offer protection when there is uncertainty in the market.
When the general trend is that interest rates are rising, such limits become very popular with borrowers.
However, if the general trend is one of declining interest rates, an interest rate ceiling will add little value to the mortgage from the perspective of the borrower since it will not trigger unless in the event of an extraordinary and sudden rise in interest rates.
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