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A Cap is an interest rate hedge protecting borrowers against rising short term rates above a set Cap rate.  When a variable rate rises above the maximum rate (or Cap Rate), the Cap owner is compensated for the difference between the market variable rate and the Cap strike price.

Features:

  • Caps normally require a one time, upfront fee paid by the borrower.
  • A Cap does not require credit approval.
  • The borrower pays a variable rate until the loan rate moves above the Cap rate when the rate is fixed for the period.

Benefits:

  • A Cap provides protection if rates rise above the Cap rate, and allows borrowers to pay the lower rate if rates decline.
  • A Cap agreement has value prior to maturity and may be resold at any time for its market value.
  • There is no prepayment risk associated with Caps.

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