Capped mortgages explained

At a glance

• An interest rate ceiling or “cap” means the rate you pay won’t go above a certain level, even if your lender increases their standard variable rate.
• These mortgages typically have higher rates than other products.
• Capped mortgages are variable rate deals, and there aren’t many available.

Capped rate mortgages are a type of variable rate mortgage, but with one important difference: they have an interest rate ceiling, or cap, beyond which your payments can't rise. Let’s take a closer look at what these mortgages are and whether you can benefit.

What is a capped mortgage?

Capped mortgages put an upper limit on the mortgage rate you’re charged. This makes them the only rate type, other than fixed rates, that will offer a certain measure of payment security – they guarantee that your mortgage payment won't go above a certain level, but because they’re variable rate, they also let you benefit from lower payments when rates go down.

This can make them the ideal compromise between flexibility and payment certainty, but they are also the rarest of all mortgage types – most of the time there are only a handful of capped rate products available across the market.

How do capped mortgages work?

Capped mortgages work by offering a variable rate with an upper limit. This means the rate can move up or down in line with the lender’s standard variable rate (SVR) or external measures (such as base rate), but it will never go higher than the cap – even if the SVR rises above it.

The cap is normally set for an introductory period, typically anything from two to five years, after which your mortgage will go onto your lender's SVR or a tracker rate for the remaining term, although at this point you can remortgage to a new deal if you wish.

Example

You’ve taken a mortgage with a variable rate of 4.75%, capped at 6%. A year into the mortgage your lender increases their SVR to 6.75%, but because your rate is capped, you’ll only ever pay a maximum of 6%.

A few months later the SVR is reduced to 5.75%; at this point your rate will go down, and so will your mortgage payments.

Essentially, capped rate mortgages are a kind of halfway house between variable and fixed rate mortgage deals. They’re still variable rate, which means your payment can change month-to-month, but like with fixed rates they offer the security that those payments will never go above a certain level.

Bear in mind though that they tend to have higher rates than the best tracker and discounted rates available, simply because you’re paying for the security that the interest cap provides.

Like most mortgages with an introductory term you’ll be tied in for that initial period as well, and will usually face an Early Repayment Charge if you want to remortgage or pay off the mortgage in full before the term comes to an end (although you’ll usually be allowed to make overpayments).

What is a collar rate?

A collar rate is the opposite to a capped rate – it’s a minimum level that your rate will never fall below. Lenders may impose a collar to protect themselves from dramatic interest rate drops, so while it’s still a variable rate that can fluctuate, your payments will only ever go so low.

Is a capped mortgage right for me?

A capped mortgage may be right for you if you want the flexibility that a variable rate can offer, without the fear that the payments will become unaffordable – and crucially, are happy to pay a bit more for that peace of mind. They can be particularly suitable if you think rates might increase during the term of your mortgage deal.

Yet it’s important to remember that interest rates can still go up on a capped mortgage, albeit only up to a point. Therefore, you still need to check you can cope with any rise in rates up to your cap. For example, an increase of just 1% could add up to an extra £83 a month to your repayments for a £100,000 mortgage. You can use our mortgage calculator for a more tailored look at your potential repayments.

Alternatives to capped mortgages

Not sure if a capped mortgage is right for you? Here are a few alternatives you can consider:

• Tracker rate mortgage. These variable mortgages “track” an external interest rate – typically the Bank of England base rate – and your mortgage rate can fluctuate in line with that. As such this mortgage type can be a good option when base rate is expected to fall, as it means you could benefit from lower monthly payments.
• Discounted variable rate mortgages. With a discounted mortgage your lender offers a discount on their SVR (it can be other interest rates but SVR is the most common) for a set term, which again means your rate can fluctuate.
• Fixed rate mortgage. If you want complete certainty that your mortgage rate – and therefore your repayments – will remain unchanged for the term of your deal, your best bet is a fixed rate mortgage. There’s the chance that you could end up paying more if interest rates fall, but for many the certainty in knowing that their rate won’t increase can outweigh that.

If you’re unsure which type of mortgage to choose, it’s important to seek advice. You can do this by speaking to an independent mortgage broker, who will discuss the options with you to help you decide which kind of mortgage will suit your circumstances and, crucially, your budget.

Speak to our preferred adviser, Mortgage Advice Bureau, for a no-obligation chat.

Should I speak to a mortgage broker?

Mortgage brokers remove a lot of the paperwork and hassle of getting a mortgage, as well as helping you access exclusive products and rates that aren’t available to the public. Mortgage brokers are regulated by the Financial Conduct Authority (FCA) and are required to pass specific qualifications before they can give you advice.

Speak to a mortgage broker today