Cap loan

A cap loan is a loan with a variable interest rate, but the interest rate does not exceed an interest rate cap (the cap ). In economic terms, it is a combination product of a fixed-rate loan and two interest rate derivatives (an interest rate swap and an interest rate cap ). The corresponding security is a cap floater .

The cap loan differs from a "normal" loan in that the interest rate is not fixed for a period of years, but only for a few months, and then adjusted again using a short-term interest rate (e.g. according to the EURIBOR ) becomes. The loan is secured against a significant rise in interest rates by agreeing an upper interest rate limit. Floor loans, on the other hand, define a lower interest rate limit.

This is how a cap loan works

For example, a five-year loan with a variable interest rate is taken out. An interest rate of 5 percent is agreed as the upper interest limit . If the general interest rate exceeds the agreed five percent in the five years of the loan term, this increase is no longer applicable to the loan due to the agreement on the upper limit. However, if the general interest rate falls, the interest rate on the cap loan adjusts itself to the lower interest rates.

Effect of a cap loan when interest rates rise

The borrower's interest rate risk is limited due to the agreed upper interest rate limit. However, since the cap reaches only above the current market rate for variable loans, the cap loans in the event of rising interest rates is only available while cheaper than a fixed-rate loans, while valid at the conclusion of the loan fixed interest rate is higher than the agreed CAP-interest.

Effect of a cap loan with constant or falling interest rates

When interest rates fall, a variable loan without a cap is always cheaper than a cap loan. The reason is that the bank sets a so-called cap premium, a type of insurance premium, to protect against the rise in the general interest rate. Its amount is based on the term of the cap loan and the difference between the general interest rate and the agreed upper interest rate limit.

Other Features of a Cap Loan

• As with a variable loan, a cap loan does not incur any early repayment penalties .
• While the interest rates for "normal" loans are very comparable due to many providers, only a few banks offer cap loans aggressively. A comparison of conditions is therefore difficult.