An interest rate cap structure is a key feature of adjustable-rate mortgages (ARMs) that controls how much the interest rate can increase over the life of the loan. This structure generally consists of three types of caps:
- Initial Adjustment Cap: Limits the increase in interest rate at the first adjustment after the fixed-rate period.
- Periodic Adjustment Cap: Caps how much the rate can rise during each subsequent adjustment, usually annually.
- Lifetime Cap: Sets the maximum interest rate increase allowed over the loan’s entire term, measured from the original rate.
These caps work together to protect borrowers from sudden and significant increases in their mortgage payments, providing a safeguard against market volatility.
The cap structure is often represented as a series of three numbers such as 5/2/5 or 2/2/5. For example, in a 5/2/5 structure:
- The initial adjustment cap (5) means the interest rate can’t rise more than 5 percentage points at the first adjustment.
- The periodic cap (2) limits the annual increase after the first adjustment to 2 percentage points.
- The lifetime cap (5) restricts the total increase over the life of the loan to 5 percentage points above the initial rate.
For instance, if your ARM starts at 4%, the interest rate could rise to no more than 9% (4% + 5%) over the loan’s lifetime, regardless of market trends. Even if the periodic cap suggests a higher increase in a given year, the lifetime cap overrides to keep the rate within limits.
Understanding your loan’s interest rate cap structure can help you anticipate changes in your monthly payment and manage financial risk. Borrowers can typically find these caps detailed in their loan documents, including the Loan Estimate and Closing Disclosure.
For more information, see our detailed Adjustable-Rate Mortgage (ARM) glossary entry.
Reliable sources:
- Consumer Financial Protection Bureau: What is an Adjustable-Rate Mortgage (ARM)?
- Investopedia: ARM Cap Structure (accessed 2025)
By understanding these caps, homeowners can make better informed decisions and avoid surprising payment hikes associated with adjustable-rate loans.
