Interest Rate Cap
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.
- 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.
- 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.