Interest rate type

Capped rates

Capped-rate mortgages are a compromise between fixed and variable-rate mortgages

These mortgages have a variable interest rate but there is a fixed upper limit to the amount of interest that will be charged. If the base rate remains stable or falls, the interest remains in line with it and falls too. In this way, capped mortgages combine the most attractive aspects of fixed and variable-rate mortgages.
The cap will not last the entire life of your mortgage but can last as long as five years or even more, should you want to commit for that long. They are generally worth considering when interest rates are either rising rapidly or when there is uncertainty over which way they will go.

Advantages
Capped mortgages are very much a safe choice as they offer protection against rates rising. For customers on a tight budget they can be as attractive an option as fixed rates. The bonus is that unlike a fixed product, you benefit from any fall in rates.
If you have a five-year capped-rate mortgage at 6%, for example, and your lender increases its SVR by 0.5%, your repayments will not change. If your lender lowers its SVR by 0.5%, however, the interest rate on your mortgage will fall to 5.5%
Capped products are increasingly sophisticated and there are products available with introductory discount periods if you want to pay less initially.

Disadvantages
Capped mortgages are a cautious but secure choice, and inevitably the rates are not as competitive as comparable fixed-rate or discounted products. Lenders do this to ensure their losses will be minimised 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 and 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 lenderís standard variable rate (SVR). As with fixed and discount products, there will be a tie-in period to prevent you remortgaging away from this rate for a set period of time. Upfront arrangement fees are also common so watch out for high charges.

Cap and collar
A further development of the capped mortgage is the cap and collar. This is where you have a cap limiting the maximum you pay and a collar limiting the minimum. The advantage of this is there is marginally less risk in it for the lender so the rate will be slightly cheaper than a normal capped one and of course your pay rate will still not go above a certain point.
However, you lose out if interest rates go below your collar as your pay rate will stick at that point for the duration of the mortgage period.

Suitability
A capped mortgage is most likely to suit you if:

  • You think interest rates may go down and you want to benefit but you are still on a budget and need to know  your payments wonít rise above a certain point
  • You are borrowing a large amount Ė again because 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 Ė 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

Need to know

  • A capped-rate mortgage has a variable rate with a fixed upper limit 
  • The cap can last up to five years or more
  • You benefit from any fall in interest rates
  • Worthwhile if you think rates will fall but you donít want to be exposed to the risk that they could rise
  • Good for first-time buyers who want security during the first few years and anyone on a budget
  • Rates are not as competitive as for fixed or discounted products

Information source:  Mortgage Advisor & Home Buyer publication
http://www.mortgageadvisormag.co.uk/