Capped Rate Loans

A compromise between fixed and variable-rate mortgages.

In a Nutshell...

• A capped-rate mortgage has a variable rate with a fixed upper limit.
• The cap can last five years or more and you benefit from any fall in interest rates.
• Worthwhile if you think rates will fall and want to play safe should they rise.
• Good for first-time buyers looking for security in the first years and anyone on a budget.
• Rates are not as competitive as for fixed or discounted products.

What is it?

Capped-rate mortgages have a variable interest rate but include a fixed upper limit to the interest charged. If the base rate remains stable or falls, the interest does the same. Capped mortgages offer the most attractive parts of fixed and variable-rate mortgages.

The cap won't last the entire mortgage but can last five years or even more, should you want to commit for that long. They're generally worth considering when interest rates are either rising rapidly or when there is uncertainty over which way they'll go.

Who does it suit?

A capped mortgage is most likely to suit you if:

• You think interest rates may go down - you want to benefit but you're still on a budget and need to know your payments won't rise above a certain point.
• You are borrowing a large amount - your interest payments will be high anyway and you need some security with the possible advantage of them falling.
• You are on a tight budget now but expect your income to increase over the next few years - so by the time it does, you can remortgage to a different kind of product.
• You are a first-time buyer looking for security in your first few years in your new home.

Advantages

Capped mortgages are a very safe choice for protection against rates rising. For customers on a tight budget they can be as attractive as fixed rates. Plus, you benefit if rates fall, unlike a fixed product. For example, if you have a five-year capped-rate mortgage at 6%, and your lender increases its standard variable rate by 0.5%, your repayments won't change. But if your lender lowers its standard variable rate by 0.5%, however, the interest rate on your mortgage will fall to 5.5%. There are capped products with introductory discount periods for you to pay less initially.

Disadvantages

Capped mortgages are a safe bet, and thus the rates are not as competitive as fixed-rate or discounted mortgages. Lenders do this to make sure their losses are minimal if the base rate rises sharply. If rates go as high as or above the level of your original cap, fixed rates tend to be a better deal. If rates drop below the cap and stay there, a discounted rate would probably be a cheaper option.

When the capped period is over, your rate will revert to the lender's SVR. There will be a tie-in period, like with fixed and discount mortgages, to prevent you from remortgaging for a set period of time. Upfront arrangement fees are common so watch out for high charges.

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