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The annual cap is a term contained in a mortgage loan contract in which even though the lender reserves the discretion to increase interest rates, the cap clearly states the maximum ceiling that can be increased.
Understandably, these types of terms only have a presence in adjustable rate mortgages as fixed rate home loans would not have interest rates that float with economic indicators.
It must be noted that there various types of annual caps for mortgages. And what they are should be clearly stated in the contract between lender and borrower.
Some of which include:
- Adjustment cap
- Maximum rate cap
- Lower cap
It is also possible for annual caps to be enforced on an annual basis.
Many borrowers make the mistake of assuming that these annual caps are set for the whole lifetime of the mortgage.
For example, if the maximum interest adjustment cap is 2%, the lender could very well increase the loan interest by 2% each year. So do ask a lender about their terms before signing on the dotted line.
When the cost of funds is increasing caused by a booming economy, lenders can be expect to do whatever in their power to adjust interest rates of all their loan products upwards.
Annual caps are usually only found in residential mortgages and seldom in commercial property loans.