Cap(Banking) Law and Legal Definition

In adjustable rate mortgages, the maximum allowable interest rate fluctuates. Cap is the highest point to which an adjustable rate mortgage can rise in a given time period. Caps embedded in mortgage agreements limit the amount of upward change in the rate of interest at each adjustment period. The agreement provides a fixed maximum over which the rate cannot rise during the life of a loan. The amount by which the percentage rate on a loan can increase in a given period is capped at a certain rate. The issuer sets the cap at the time the contract is issued. This is a safeguard for homeowners in case interest rates rise dramatically in a short period of time.