Disadvantages of a Capped Rate Mortgage

Capped rate mortgages give the borrower several advantages, but there are also some disadvantages to be considered. The consumer must understand all aspects of the mortgage loan before making a commitment to any type of mortgage agreement.

Declining interest rates can be a benefit to the owner of a capped rate mortgage, but rising interest rates can be a drawback. If the Bank of England’s base lending rate is increased, interest rates for capped rate mortgages will follow suit. The effect of an increased interest rate is a higher monthly mortgage payment for the borrower. There is a limit, or cap, on the interest amount allowed for a capped rate mortgage, but the consumer needs to be aware that it is likely that the monthly payment will rise at some point during the mortgage term.

The possibility of a declining interest rate is attractive to most borrowers. Some lenders, however, only adjust interest rates to reflect a decline in the Bank of England’s base interest rate once a year. It is the responsibility of the consumer to ask what the lender’s practice is for decreasing interest rates.

Capped rate mortgages are attractive mortgages for the consumer, but the financial institutions are aware that they could potentially lose money with these loans because of declining interest rates. To lower the risk of losing money, the institutions impose a higher standard variable interest rate for capped mortgages than for conventional fixed or variable mortgage loans. An individual may very well benefit from declining interest rates during the term of the mortgage, but his or her loan will start out with a higher interest rate than other types of loans.

Capped rate mortgages typically come with additional fees. One of these fees is an arrangement fee. Arrangement fees are charges made for the origination of the loan. Many consumers seek out capped rate mortgages, but there are few of these loans available. An arrangement fee is an added cost for the privilege of securing this preferred loan.

Another fee common to capped rate mortgages is the early repayment charge. This is sometimes referred to as the early redemption penalty. When a loan is paid off in advance, the financial institution loses the business of the borrower, which also results in loss of money for the institution. An early repayment charge not only discourages the borrower from paying off a loan in advance, but also insures that the financial institution will recover at least part of the money lost if the borrower’s business is discontinued.