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Capped Rate Mortgages

Fixed rate mortgages offer a sense of security in that you are assured that the interest rate you pay will always be in your range of affordability. But what if current mortgage rates go down? Could you be getting a better deal, at least for some of the duration of your mortgage term?

Capped Rate mortgages offer flexibility in mortgage interest payments, whilst customers remain safely within their affordability limits.

Read on to find out more about how Capped Rate Mortgages work.

What is a Capped Rate Mortgage?

Capped Rate Mortgages have an interest rate ‘ceiling’ or benchmark. This means that the interest rate charged cannot succeed a certain benchmark percentage, for a fixed period.  

They work much in the same way as a standard variable rate mortgage, in the sense that your mortgage interest payments every month will fluctuate in line with your lender’s SVR and the Bank of England’s base interest rate. 

Many capped mortgage deals last for two, three or five years. However, it is possible to get a mortgage that is ‘capped for life’ (i.e. the entirety of the mortgage term).

‘Collar’ is another term you may see in relation to capped rate mortgages. This is the agreed minimum rate of interest to pay in a capped mortgage plan. Those who opt for a mortgage with a collar rate may find that mortgage interest rates fall below the margin. If this is the case, you may not benefit from the lower rates. However, lenders who offer mortgages with both a cap and a collar may pass on slightly more competitive rates than those offering caps on just the upper limits. This is because they see collared mortgages as being a slightly lower risk investment.

Am I Eligible for a Capped Rate Mortgage?

• Capped Rate mortgages may be perfect for people who would like to benefit from low-interest rates, but need a secure upper limit for their monthly mortgage repayments.
• These can also be suitable for people who may expect their income to rise in the next few years and who may then wish to switch to another mortgage rate.

How is a Capped Rate Mortgage Repaid?

Capped Rate mortgages are repaid in the same way as many other mortgage types, where a certain amount of your loan’s capital, plus a certain percentage of interest, is charged each month.

A capped mortgage can also be tied to the bank of England base rate, tracking its fluctuations instead of the lender’s standard variable rate. You will be notified within 14 days if your rate is set to change if you choose a tracker mortgage with a capped rate.

It is worth noting that these types of mortgages often come with charges for exiting early or, in some cases, making overpayments. It is for this reason that those seeking a capped mortgage should consider only capping their rate for a short time (e.g. two years) and reconsidering your mortgage options when the period ends.

What are the Benefits of Capped Rate Mortgages?

• Access to Lower Rates - Choosing a capped rate mortgage can give you access to lower interest rates (in line with your lender’s SVR) and similarly give you security, as you know that you will never be charged above a certain amount, as interest, on your mortgage.
• Protection from Higher Rates - In times where interest rates are high, people who are on capped rate mortgage plans are protected and will not pay over their agreed amount.

Let’s Look at a Capped Rate Mortgage Example:

Sally has a capped rate mortgage at 6%, as she is on a tight budget. Six months into her mortgage, her bank raised their SVR by 0.5%. As this was over Sally’s agreed cap, her rate remained at 6%. Some months later, the lender switched their SVR again, this time they reduced it to 5.5%. This means Sally mortgage interest rate also reduced to 5.5%. She benefitted from the fall in interest rates.

What are the Pitfalls of Capped Rate Mortgages?

• Less Choice - There are fewer Capped Rate mortgages on the market, which means there are fewer plans to choose from.
• You May Not Need a Cap - A cap on mortgage interest rates can offer security, but it is possible that the maximum limit may never be reached, over the two, three or five-year period.  For this reason, you may be able to find a cheaper tracker or even fixed mortgage deal. You may be paying over-the-odds for the security of having a capped rate mortgage.  
• The Cost of Protection - The initial interest rate offered at the start of a capped mortgage agreement may be comparatively high, given that you have the extra security of an interest rate cap on your mortgage.
• Exit Fees and Extra Charges - It may be expensive to switch mortgages, if you have a deal which charges you for early repayment, or if you decide to exit the deal before the capped rate ends.  
• Pay for Security – The set-up costs for capped rate mortgages, in some cases, can be higher than other mortgage types. Many will find themselves paying a premium for the security a capped rate mortgage offers.

What are the Alternatives to Capped Rate Mortgages?

Fixed-Rate Mortgages – These mortgages offer security in that you will always know what you are paying for your mortgage every month. You may be able to find a better deal at a fixed interest rate.

Tracker Mortgages – It may also be possible to find a good tracker mortgage plan, where the interest rates follow the BoE base rate, with a small percentage added on top. This way you can take full advantage of falls in interest rates.

If you are interested in taking out a capped rate mortgage and you would like to see a free quote for your needs, get in touch with an independent mortgage advisor now.