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Capped rate mortgages explained

Capped tracker mortgages are basically tracker mortgages with an upper limit to their interest rate.

This means they usually follow the Bank of England Base Rate with either a percentage added on top or deducted off.

There is an upper limit to the monthly payments which is set as the "cap", your interest rate cannot go above the cap but will vary so long as the interest rate changes are below the cap rate.

Some capped products also have what is known as collar of floor rate, which is an interest which the mortgage cannot below.

For example a capped product may have a cap rate of 6% and a floor or collar rate of 2%. In this case the payable interest rate would not go above 6% and would not go below an interest rate of 2%.

For example a rate may be quoted as BBR (Bank Base Rate) +2.49% with a Cap of 6%. Changes in the BBR would affect your interest rate and your payments would either increase or decrease in line with the BBR.

However when bank base rate increased to the point where your mortgage interest rate hit the cap in this case Bank Base Rate of 3.51% or more, your mortgage payments would cease increasing and your payments would become fixed at the capped rate until the BBR dropped below the cap again at which point your payments would decrease and start to vary once again.

It's important to consider when choosing between a tracker rate mortgage, a fixed rate and a capped tracker mortgage what the likely changes to bank base rate may be over the term of the mortgage.

In a rising interest rate environment a capped rate may underperform against both fixed rates and trackers if the capped rate is a lot higher than fixed interest rate, and if the margin over base rate is considerably higher than a tracker product.

Conversely in a falling interest rate environment the capped product may underperform against a similar tracker again if the extra margin is considerably higher and also if the floor rate is quite high.

Care should be taken when arranging a Capped rate that it really offers true value money.

You tend to see the release of capped rate mortgage products when fears of interest rate rises are high with dubiously high capped rates which outweigh any benefit over fixed rates widely available.

The pros and cons of capped tracker mortgages

Pros:

  • Upper limit on interest rates and payments
  • Good for budgeting and avoiding big interest rate rises
  • Tracker element can allow you to benefit from rate reductions

Cons:

  • May be less competitive than similar tracker or fixed rates
  • Floor rate may restrict reductions in interest payments
  • Tracker element will allow some increases in mortgage payments and interest rates

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