What are interest rate caps in relation to floating rate commercial property loans?
An interest rate cap is used to limit the risk on a floating rate commercial property loan. A floating rate property loan has a variable interest rate, borrowers usually opt for this type of loan during periods of low-interest rates, because if the interest rate decreases further than the borrower benefits. A floating interest rate can also increase and that may be a huge financial risk if it increases rapidly or by too much. For this reason, borrowers try to cap the amount by which interest on the loan increases.
The interest rate cap may apply during a specific period of the loan or its entire lifetime. An interest cap gives the benefits of potentially lowered rates should they decrease and the security of a ceiling should they increase. For example, a borrower can get a 10-year commercial property loan which charges 4% interest with an interest rate cap of 7%. The interest rate can go up or down but will not go above 7%.