Capped rate mortgages are often seen as offering the best of both worlds, sitting somewhere between standard variable rate mortgages and fixed rate mortgages. Capped rate mortgages will closely follow the standard rate just as variable rate mortgages do, but they come with the security of not going over a pre-agreed level of interest and therefore not being permitted to raise payment levels to worryingly high levels. Capped rate mortgages offer an element of security against interest rates rising out of control.
As an example, suppose that the interest rate at the beginning of the mortgage was 2% and there was an agreed cap put in place at 4% for the first three years of the mortgage. What this means is that if during that first three years the lender increased the variable rate for all of their customers to 4.5%, those borrowers with capped mortgages would still only have to pay 4%. Simultaneously however, the lender will often also put in place a ‘collar’ that sets a minimum lower limit. To carry on the above example, a collar might be put in place that is set at 1%, so that if interest rates actually drop during the capped rate period, say down as far as 0.5%, whilst standard variable rate customers would only be paying 0.5% interest on their mortgages, borrowers with the capped rate and collar would be paying 1%.
Advantages of Capped Rate Mortgages – As mentioned above, capped rate mortgages offer all the flexibility of standard variable rate mortgages with an element of security thrown in. It is this element of security – whereby you are protected for an initial period from shocking rises in interest rates – that makes such mortgages appealing to people who are looking for flexibility in the long term but whom would also appreciate some security and lower payments in the first couple of years when they first move into their new home. They are also particularly useful when the interest rate drops and gives the borrower potentially a significant reduction in their interest rate, despite the use of caps and collars.
Disadvantages of Capped Rate Mortgages – Clearly the imposition of a ‘collar’ offers no advantage whatsoever to a borrower and if it kicks in, puts them at a distinct disadvantage to other borrowers with the same lender. If rates do drop significantly then the collar will be of benefit only to the lender. Similarly, capped rate mortgages offer the same potential downsides as all variations of the standard variable rate mortgage – that those interest rates can shoot up and if you are not within the protected ‘capped’ period, you might well face a massive increase in your monthly payments.