When the rate on an adjustable rate mortgage (ARM) adjusts, there are limitations on how much it can increase or decrease. These limitations, called "caps" include the "initial cap", the "periodic cap", and the "lifetime cap".
- The lifetime cap is the limit on how much the rate can adjust over the life of the loan.
Different ARMs carry different caps, depending on the program.
Example: An ARM with caps of 5/2/5 means the first five is the initial cap; the second number is the periodic cap; and the third number is the lifetime cap. If your rate is 6.5 percent, then the initial cap says the first adjustment is your rate plus or minus five percent--so it can go as high 11.5 percent or as low as 1.5 percent (though it's pretty unlikely that rates would change that significantly). The periodic cap says the second and subsequent adjustments are your rate (6.5 percent) plus or minus two percent--so no higher than 8.5 percent and no lower than 4.5 percent. The lifetime cap says the rate can never go higher or lower than your rate (6.5 percent) plus or minus five percent.