What is a Life Cap?

A life cap is a limit put in place on an adjustable rate mortgage to confine interest rate increases. On a mortgage with a life cap, the interest rate cannot go beyond the amount stipulated in the loan paperwork. This ensures that customers cannot face endless interest rate increases or very large and sudden increases on their loans, two things that might make repayment difficult for the customer. The life cap is sometimes embedded in the form of a quote that includes an initial cap, adjustment cap, and life cap, as seen in a 5/2/5 loan.

There are two different ways of expressing a life cap on interest rate increases. One method establishes a rate ceiling, an interest rate the loan cannot exceed. This method assures people with adjustable rate mortgages that they will never be charged more than this ceiling in interest on the loan. The other option is a maximum percentage change, looking usually at percentage over base when the loan was originated. Percentage change caps also limit interest reductions, as the rate cannot drop below the percentage change.

When people apply for adjustable rate mortgages, they will be provided with a quote providing information about the life cap on the loan. It is important to read this documentation carefully for information on when rates can be raised, by how much, and how much notice will be provided. Although some people obtain such loans with the goal of selling or refinancing before the rates increase, it is advisable to remember that sometimes economic circumstances intervene, and it may be necessary to pay increased interest for several months or years before conditions will be favorable for sales or refinancing.

It is sometimes possible to negotiate the life cap. The better someone's credit, the better the terms of a loan will be, in most cases. A person with a strong credit history who is not satisfied with a life cap may be able to renegotiate it to a more reasonable level while working out the details of a loan. It can be helpful to have a quote from a competing lender, allowing the borrower more latitude for walking away from negotiations, if necessary.

People with poor credit usually have less success when it comes to negotiating the terms of a loan. It is important to carry out all negotiations before paperwork is signed, and to structure real estate contracts so people can back out of the deal if they cannot get a loan, or if loans are only available on extremely unfavorable terms. If the contract compels people to purchase regardless of financing, they can be left holding a bill they cannot pay.