A capped rate mortgage features a variation in interest repayments, intended to provide borrowers with the advantages of a fixed rate, and variable, mortgage. At the start of a mortgage term, interest will be charged at the “Standard Variable Rate”, or “SVR”, according to the lender – subject to fluctuations in the Bank of England Base Rate – but, from the outset, the maximum interest rate that can be charged is set, or “capped”, at a fixed level. This means that, during a capped rate period – typically two, or perhaps, three, years – if interest rates fall, borrowers pay the reduced rate, but if interest rates rise, the capped rate is the maximum rate that can apply. This type of mortgage can be useful for budgetary purposes, since borrowers know the maximum amount required for monthly mortgage repayments in a given period.
Introduction to Capped Rate Mortgages
Like any other mortgage, or financial product, a capped rate mortgage may be better suited – subject to personal circumstances and preferences – to one borrower than another. It provides the security of a “cushioned ceiling”, if you like, above which interest rates cannot rise, but still includes the attractive prospect – in common with a variable rate mortgage – of lower monthly repayments, if the Base Rate falls.
The obvious advantage of a capped rate mortgage is a “best of both worlds” scenario – if interest rates rise above the level of the cap, you, as a borrower, will benefit, and if interest rates fall, you will not be left at a disadvantage when compared to other borrowers.
The security and peace of mind provided by a capped rate mortgage does, however, come at a price. You are likely to find, more often than not, that the initial, variable interest rate for a capped rate mortgage is not quite as competitive as that for, for example, average fixed rate, or discounted rate, mortgage products. Lenders must insure themselves against a rise in interest rates, above the capped level, which could potentially be to their cost, so you effectively pay for the privilege of a capped rate. There are some lenders, nevertheless, who are prepared to offer interest rates that compare very favourably with fixed rate mortgages.
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In addition, capped rate mortgage loans are often subject to an administration, arrangement, or booking, fee – typically of between £100 and £200 – although you may find that this pales into insignificance, if you consider the cost of an interest rate rise above the capped level.
Furthermore, some capped rate mortgages are also subject to a lower limit, or “collar” – and, indeed, are often referred to as “cap and collar” mortgages – which represents the minimum rate of interest that you will pay, regardless of whether interest rates fall below that level.
The period for which a capped rate applies is usually fairly limited, although some long-term, capped rate mortgage deals are becoming available, and stiff penalties apply for early redemption, the period for which may extend beyond the actual capped rate period. At the end of the capped rate term, the interest rate will revert to the SVR, which may result in higher repayments, if interest rates have risen substantially in the interim. It is wise, therefore, to schedule a review of your requirements, with your mortgage lender, broker, or Independent Financial Advisor (IFA), if necessary, before the end of a capped rate period.
Capped Rate Mortgage Drawbacks
The main problem with a capped rate mortgage is nothing to do with mortgage product itself – it is simply that there are very few competitive capped rate mortgage deals available, from very few lenders. The Chancellor of the Exchequer, however, is apparently keen to explore the possibility of using capped rate mortgages as a means of creating stability in the housing market, so it may well be that more products of this type become available in the future.
If you are attracted by the advantages of a variable rate mortgage – not least, a reduction in monthly mortgage repayments, if and when interest rates fall – but with protection against rocketing interest rates, some excellent capped rate mortgages are, nevertheless, available. A properly qualified, and truly independent, IFA will be able to provide you with unbiased advice regarding the availability, and relative merits, of suitable mortgage products.
Other Capped Rate Mortgage Considerations
Before you commit to a mortgage agreement, a mortgage lender must disclose the APR, or “Annual Percentage Rate”, as well as the maximum, and minimum (if applicable), interest rates that will apply. APR incorporates, amongst other things, the length of the mortgage term, the interest rate, and associated fees and insurance premiums, and provides a “yardstick” for comparing one mortgage deal with another. Generally speaking, the lower the APR, the better.
A mortgage loan, for most people, will represent, by far, the largest financial commitment that they will make during their lifetime. A mortgage debt is also classified as “non-negotiable” – that is to say that it must, without exception, be paid off in full – and, as such, you should protect yourself against factors that may limit, or remove completely, your ability to make repayments. Mortgage lenders will usually insist that a suitable life insurance policy is in place, before the commencement of a mortgage term, but it is also worth insuring yourself against illness – critical or otherwise – accident, or loss of employment, all of which can have a severe detrimental effect on your financial stability. Insurance policies may be available from your mortgage lender, but it is preferable, once again, to contact an IFA, who can advise you on the policy, or policies, most appropriate to, and cost-effective in, your individual circumstances.
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