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The Pitfalls Of A Capped Mortgage

What sounds like a win/win situation for the borrower, having a low initial interest rate and a maximum too, may not necessarily be worth the effort.  A capped mortgage applies to a variable rate loan in which the rate changes as the market changes, but the higher end is limited to the cap.  The rate cannot exceed that point.

With this type of mortgage, there is a lower introductory rate in order to entice or more appropriately, qualify a borrower who otherwise would have difficulty meeting the obligation.  If the interest rates go up, a limit is placed on the total amount so the rate cannot exceed the cap.  If the interest rates go down, then the borrower will pay less interest during that period.

Variable rate mortgages are similar to Adjustable Rate Mortgages in that neither has a fixed rate, but the same problem that exists with an ARM also exists with a variable rate mortgage only a bit more intense.

Since the rate of a variables fluctuate with interest rates and change accordingly, there is very little consistency in the amount of payments made each period, monthly, quarterly etc.  This can be problematic for a borrower who has a fixed income, even though the loan is capped.  Before getting into such a loan, be aware of the maximum amount of the cap and the equivalent payments.  Base your ability to pay the mortgage on the higher amount so as not to be caught short when the interest reaches the cap.

The second problem with this type of mortgage is that in general, they are more costly than a fixed rate or adjustable rate mortgage.  But if you know that you are going to in the property for just a short time, then it may behoove you to secure a capped mortgage.

The third problem which is directly related to the above is that many of these mortgage carry either a pre-payment penalty or a redemption charge if you choose to move the mortgage to another provider.

This type of loan is right in between a fixed rate mortgage and an adjustable rate mortgage.  Be mindful of all the advantages as well as the disadvantages.