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Capped rate mortgages
A Guide to Capped Rate Mortgages

If you like the idea of paying less when interest rates fall, but are concerned about the risks of payments going through the roof when interest rates rise, a capped mortgage or capped rate mortgage could be just what you are looking for.

Capped mortgages are tempting to many as they supposedly offer the best of both worlds. In other words, they offer a middle option between choosing a mortgage with a variable interest rate and one with a fixed interest rate. Regardless of what the Federal Reserve decides on interest rates, capped rate mortgages limit how high your mortgage interest rate can rise, but they do not stop your payments falling should interest rate falls.

How do capped rate mortgages work?

If you decide to embark on a capped mortgage, your lender will offer you two interest rates:

  • A starting interest rate, based on your lender’s standard variable rate at the time, from which you will begin your repayments

  • A maximum interest rate or capped rate which you can be required to pay if interest rates start to increase. Even if interest rates continue to rise, your personal interest rate will remain unchanged.

Here are some advantages:

  • A capped rate mortgage allows you to agree to have a ceiling—or a cap—on the maximum amount of interest you will pay over a particular period of time.

  • If the variable rate climbs higher than your agreed capped rate, you are only required to pay to that agreed limit.

  • However, should the variable interest rate fall below your agreed capped rate, you will pay out less.

  • In essence, you enjoy the benefits of falling interest rates but are protected from rising interest rates, at least for a period of time.

Here are some disadvantages:

  • Very few mortgage lenders out there are offering capped rate mortgages so you will not have a wide range from which to choose. Although there is not a huge choice, there can be a handful of good deals. If you are interested, it may be best to talk to an independent financial advisor who will know that capped mortgages are available, and which offer the best value.

  • Those lenders who offer capped mortgages generally make you pay for the safety of having a capped rate mortgage. They cleverly cover their potential losses by setting a starting interest rate that is not as competitive as it would be on a normal variable or fixed rate mortgage. Many capped rate mortgage lenders may also charge costly administrative fees to arrange these mortgages.

  • Sometimes lenders set a ‘collar’ on capped rate mortgages; this means there is a minimum level below which the rate you pay will not fall.

Some important considerations before taking out a capped rate mortgage

  • Some capped rate mortgage providers have set minimum and maximum amounts that they are prepared to put up for a mortgage loan.

  • Some capped rate mortgage providers have set limits to the mortgage loan- to-value ratio. For instance, if you want to borrow $90,000 on a property valued at $100,000, the loan-to-value you need is 90%.

  • Some capped rate mortgage providers charge mortgage high lending charges. If you want to borrow more than the value of the property or more than the lender is initially prepared to offer, the lender will use the high lending charges to buy insurance to protect itself. If anything should go wrong, remember that the insurance company will take action against the homeowner even though it is the lender that is compensated.

  • Make sure you shop around to find the best package for your capped rate mortgage. Rates can vary and this can make a considerable difference to your monthly repayments.

  • Be aware that many capped rate mortgages have early-payment penalties. If you pay off your loan at anytime before the end of the mortgage term, you may incur a fee.

  • Make sure that your capped mortgage is portable, which means that it can be kept with the same mortgage provider in the event that you have to move house.

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