Lesson 6 of 25 · 7 min

ARM caps: initial, periodic, lifetime

Three caps bound a reset: the first step, each later step, and a ceiling that does not move.

A cap is a scheduled limit on a reset. The uncapped rate from lesson 5 is 6.65 percent. That figure is allowed to become the new rate only if it also sits inside the caps. Three numbers do that work. An initial cap limits the first reset relative to the start rate. A periodic cap limits each later reset relative to the rate then in force. A lifetime cap limits the rate relative to the start rate for as long as the loan runs.

Cairn Street Lending's start is 5.40 percent. Initial cap 2.00 points, so the first reset cannot exceed 5.40 + 2.00 = 7.40 percent. Periodic cap 2.00 points, so no later reset can jump more than 2.00 points from the rate then in force. Lifetime cap 5.00 points, so the ceiling is 5.40 + 5.00 = 10.40 percent. The uncapped 6.65 percent sits below the 7.40 percent initial cap, so 6.65 percent binds. The cap did not trim it. It would have trimmed a 7.80 percent uncapped print down to 7.40 percent.

Track 1 lesson 5's maintenance rate is a number the loan-to-value ratio is not allowed to cross. A cap is that role applied to a rate: a ceiling the reset is not allowed to cross, written in points rather than in a ratio. Both are thresholds. Both are in the agreement before the event. Neither is a decision made on the day.

Three ceilings, three different bases:

Initial cap: measured from the start rate, used once, at the first reset.
Periodic cap: measured from the rate then in force, used at every later reset.
Lifetime cap: measured from the start rate, used for the life of the loan.

The uncapped sum is a candidate. The cap is a test. The new rate is whichever of those two is smaller.

Key terms

Initial cap: The largest first-reset move, measured from the start rate. Here, 2.00 points above 5.40 percent, so 7.40 percent.
Periodic cap: The largest move at a later reset, measured from the rate then in force.
Lifetime cap: The highest rate the loan is allowed to carry, measured from the start rate. Here, 10.40 percent.

Worked example

6.65 percent against 7.40 percent

Cairn Street Lending. Start 5.40 percent. Initial cap 2.00, periodic cap 2.00, lifetime cap 5.00. Uncapped first reset 6.65 percent.

Initial-cap ceiling: 7.40%
Lifetime-cap ceiling: 10.40%
Uncapped rate: 6.65%
Rate that binds: 6.65%
If uncapped had been 7.80%: 7.40% would bind

A cap is a test, not a discount. On this print the test passed, so 6.65 percent is the new rate.

Check yourself

Start 4.90 percent, initial cap 2.00 points, lifetime cap 5.00 points. Uncapped first reset is 7.20 percent. What is the initial-cap ceiling, what is the lifetime ceiling, and which rate binds?

A cap is a scheduled limit on a reset, the everyday version of a maintenance threshold: a number the rate is not allowed to cross, the role Track 1 lesson 5 gives the maintenance rate. Open The maintenance rate, and how it differs from the advance rate →

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.