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Financial Dictionary - Mortgage CAP
Mortgage CAP
The mortgage CAP (or Interest and rate hedging contract) is a way of limiting the interest rate of a mortgage from going up.
When you take out a CAP, you will pay a single premium calculated based on the interest rates at the time of arrangement, and in return a limit percentage will be set on the rise of the Euribor (the stock index to which variable rate mortgage loans are normally referenced). This cap is called the strike price. If this index exceeds the CAP, the bank must return the difference to the customer. This means that ultimately, the price of the mortgage will not rise.
Now you know which house you want and how much you need, calculate your mortgage.
A term (for example, five years) will also be established, since this contract has a specific duration, much less than the duration of the mortgage. When this expires, the credit institution will offer you the option of entering into another mortgage CAP adapted to the new situation and current interest rates. And thirdly, you will agree on a nominal amount, the maximum of which will be the total of the mortgage loan.
Another aspect to take into account is that the CAP is not beneficial when interest rates go down; we can say that it only works as a ceiling.
When is a mortgage CAP profitable?
Before taking one out you should analyse market performance and interest rates, because if they are low, you would be losing money and it would not be profitable. More so: to be beneficial, rates will need to rise enough to offset the premium payment. In any case, the bank is obliged by law to offer it to the customer as long as it is suitable for said customer, and not if it anticipates a drop in interest rates.
You will know if this product has been profitable once it matures. You received more money from the bank than you paid you as a single premium.
CAP, insurance and mortgages
It must be made clear that a CAP is not insurance. That is to say, it is not structured like an insurance, nor is it managed by an insurance company, although it may seem so; rather, it is a financial derivative. It is also not part of the mortgage. Although it can be taken out at the same time, they are two independent products. And if, for example, you carry out a subrogation or cancellation of your mortgage before the CAP expires, it will remain in force.