What is the purpose of the rate cap in an adjustable-rate mortgage?

The purpose of the rate cap in an adjustable-rate mortgage (ARM) is to protect the borrower from excessive increases in interest rates. A rate cap limits how much the interest rate can increase during a specific adjustment period or over the life of the loan. This provides borrowers with a level of financial predictability, as they will not face drastically higher payments if market interest rates rise significantly. By establishing a maximum interest rate, the cap ensures that borrowers can manage their financial responsibilities and avoid payment shock, making the loan more affordable in the long term.

In contrast, the other options do not accurately reflect the role of a rate cap. While it’s important for lenders to be aware of market conditions, the cap is fundamentally designed to safeguard borrowers. A fixed rate is not guaranteed in an adjustable-rate mortgage; rather, it is the adjustable nature that distinguishes them from fixed-rate mortgages. Lastly, the purpose of the cap is not to increase monthly payments, but rather to prevent them from becoming unmanageable due to sharp rate increases.