What is a Capped Rate Mortgage?
Capped rate mortgages combine features of both variable rate and fixed rate mortgages. These loans offer the consumer quite a few benefits, but also have aspects that may be considered disadvantages.
Capped rate mortgages are classified as repayment mortgages. A portion of the capital, or loan amount, is paid with each monthly payment, along with interest charges. At the end of the mortgage term, the borrower owns the previously mortgaged property.
Base lending rates in the UK are determined by the Bank of England. The current base lending rate is reviewed monthly by the Bank of England’s Monetary Policy Committee, and a new base lending rate is established. Financial institutions base their standard variable rate, or SVR, on the approved base lending rate. Most banks and other traditional lending facilities offer a standard variable rate of two percent above the most recent base lending rate.
The interest rate for a capped rate mortgage fluctuates with the Bank of England’s adjustments to the base lending rate, similar to a variable rate mortgage. The interest rate and monthly mortgage payment will normally increase as well as decrease over the life of the mortgage. Potentially declining interest rates are a benefit of capped rate mortgages. Some lenders adjust interest rates to reflect a decreased base lending
rate several times a year, while others make this adjustment only once a year. A lender may also set a minimum interest rate for the loan, which could result in the borrower paying more than the base lending rate at some point during the mortgage term.
Just as the interest rate for a capped rate mortgage can decrease, the interest rate can also increase, leading to larger monthly payments. Capped rate mortgages have an interest cap, or limit, that is determined at the origination of the loan. This feature is similar to a fixed rate mortgage. The interest rate for a capped rate mortgage can increase, but only up to a certain amount. Once the cap is agreed upon, the loan’s interest rate will never surpass that limit, even if the Bank of England’s base lending rate becomes higher than the loan’s cap.
Capped rate mortgages have several advantages, and borrowers must be prepared to pay extra for them. The starting SVR of a capped mortgage is typically higher than interest rates of other types of mortgages. Since a capped rate mortgage’s interest rate may decline during the course of the mortgage term, financial institutions protect themselves against potential loss of income from falling interest rates. This is accomplished by charging a higher starting interest rate for capped rate mortgages.