Capped home loans
A capped home loan is a variable rate that can go up or down, but there's a limit on how high it can go. It gives you some of the benefits of both a fixed and variable rate.
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Capped home loans differ from fixed rate home loans in that their interest rates are semi-variable. Interest rates on a capped loan have a ceiling that will protect you from any unexpected increase in mortgage rates above the cap rate, while at the same time allowing you to benefit from any reduction in interest rates. This makes capped home loans cheaper than fixed rate mortgages, offering borrowers peace of mind in times when home loan interest rates are constantly fluctuating.
What is a capped home loan?
A capped home loan is a loan with a cap on the interest rate. The cap prevents interest on the loan from rising above a certain specified rate, but also allows for the borrower to benefit from any decrease in interest rates in the market. Lenders offer capped home loans with a specific term which can vary from one to three years.
Capped home loans are suited for borrowers who do not want their borrowing costs to increase but who are also keen to benefit from a decrease in home loan interest rates. Customers who dislike the uncertainty of rising interest rates or the finality of a fixed rate home loan can also opt for this type of loan.
How do they work?
Capped home loans are similar to any other regular home loan, meaning that they have a loan term, monthly repayments and charge regular home loan fees. The major difference that capped home loans have from other mortgage types is that their interest rate is capped at a certain rate. This simply means that the interest cannot go higher than the capped rate in the event interest rates go up during the interest rate cap period, while it can come down if market rates reduce.
This mechanism protects you from having to pay higher interest on your home loan in times of fluctuating mortgage rates, while also allowing you to save on mortgage interest payments when rates go down. Capped home loans may be capped for anywhere between 12 months and three years, though this depends on the lender and the terms of the mortgage.
How to compare capped home loans
Like fixed and variable home loans, capped home loans have certain features that you can use to compare different products from lenders so as to determine the loan that best suits your needs.
- Capped rate period. Capped rate home loans have a period within which an interest ceiling is set, mainly to protect customers from a spike in interest rates. Different lenders will provide home loans with varying cap periods, mostly between one and three years. While comparing capped home loans, look at the cap period that will most suit your finances and help you save more in times of fluctuating mortgage rates. Lenders can also allow you to recap, fix the rate on your mortgage or even switch to a variable rate home loan. Go for the loan product with more flexibility and options because of the uncertainty surrounding interest rates at any given time.
- Repayment options. Like any standard home loan, a capped home loan will have its repayment options detailed in its terms and conditions. Some lenders will offer you a deferred first repayment option, allowing you to skip monthly payments for a month or two after your loan application is finalised.
- Lump sum repayments. Most capped home loans allow you to make extra payments on your principal amount at any given time, enabling you to pay off your home loan faster and save on interest charges. If you are likely to get a lump sum amount in the future which you want to use to clear your mortgage, taking up a capped home loan could be ideal for you. Go for a lender that allows you to make additional payments for no charge.
- Loan charges. Capped home loans are normal loans, meaning they attract charges such as application fees, stamp duty, settlement fees, legal costs and other charges. Comparing different products from lenders in Australia with the help of a mortgage broker can help you reduce your home loan amount by finding a lender who offers better terms.
Pros and cons of a capped home loan
- Save on interest. Capped home loans save you money by allowing you to benefit from any drop in interest rates during your capped rate period.
- Flexibility. Capped home loans also offer you flexibility that is not provided by fixed rate home loans by allowing you to make additional repayments to your mortgage without having to pay any penalties.
- Rate ceiling. With capped rate home loans, you are protected from unexpected increases in the interest rate due to the interest rate ceiling.
- Higher rate. Although they may be beneficial when interest rates are expected to go up, capped home loans will generally have an interest rate that is higher than the standard variable rate in the market.
Things to watch out for with capped home loans
Careful consideration and consultations with a mortgage broker are always important when taking out any home loan. Most customers make the mistake of failing to read the fine print on their home loan application, so they end up paying unexpected fees such as valuation, settlement and other fees.
In addition, getting a capped home loan with no redraw facility can lock up your extra repayments until the end of the capped term, denying you access to your extra funds if you need them.
If the comparison rate is higher than a fixed rate home loan for the same period, or if interest rates drop rather than rise, a capped home loan may not be as competitive.
Frequently asked questions about capped home loans
Why choose a capped home loan?
This type of loan will offer you the flexibility to make extra payments on your principal amount at any time and it will protect you from unexpected increases in home loan interest rates.
Is a capped home loan a cheaper option?
It can be. With a capped home loan, you might end up paying less for your home than you would with a fixed rate home loan. This is mainly because the capped rate will allow you to benefit from any decrease in interest rates during the repayment period.
When is the best time to lock my rate?
The best time to lock your rate is when there is a trend of rising interest rates on mortgages. If you get your timing right, you will be able to lock the rate when it is at its lowest so as to save money. A financial adviser can help you determine the best time to fix your rate, or figure out whether you should recap or switch to a different home loan after the capped term expires.
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