CAP loans – conditions compared
A cap loan works like a normal loan, but the mortgage lender is much more flexible with this instrument. There is no fixed interest rate for the cap loan, rather the interest rate is always adjusted to the currently valid interest rate level. So that the worst case does not happen and the cost of the loan suddenly shoots up, a certain upper limit is set when the contract is concluded – the so-called cap. This makes the financing instrument relatively safe, because due to the limitation, the monthly burdens can not go without limits. Special repayments are also possible by the borrower, but they are always permitted at every new adjustment date. Anyone who unexpectedly has a large amount of money (e.g. an inheritance or a life insurance sum) can also make a full repayment of their cap loan.
If major restructuring measures are planned within the loan term, the cap loan can easily be converted into a long-term fixed interest rate. Fixed interest rates are possible here for up to 20 years. However, cap loans are only suitable for real estate financiers when interest rates fall. However, if interest rates rise, the loan can quickly become more expensive, because the not inconsiderable costs for the processing fee make the overall financing relatively expensive. With this type of financing, borrowers can also expect the requirements regarding creditworthiness and reliability to be applied twice as strictly.
A cap loan is therefore of interest to all those who have instantly found an object of their choice and need to access it, because otherwise it is no longer available and who is certain that falling interest rates can be expected in the future. The same applies to those who have found their dream property again at the moment, but will only be able to expect larger assets (e.g. from life insurance) in the near future. Cap loans achieve the greatest advantage when it comes to financing, in which the home loan contract is only allocated later. This would normally require very expensive interim financing. With a cap loan, this interim period can be easily bridged until the maturity of allocation, since unlimited special repayments are also possible here. In this way, the remaining debt can be repaid quickly and easily.
Whoever decides on a cap interest rate should pay particular attention to the interest rate adjustment, as these vary from bank to bank. For example, it can be adjusted monthly or semi-annually. In many cases, no special repayments are possible. It is also important what the interest rate is set at. If the bank complies with the respective reference interest rate, borrowers are arbitrarily delivered to their bank. Knowledge of the financial market is a prerequisite for this.
How Cap Loans Work
With a cap loan, real estate financiers combine the benefits of variable financing with the security of a fixed-rate loan. The difference to a normal loan is, however, that the interest rate is not set for the agreed borrowing rate, but only for a few months. The interest rate will then be adjusted again. The banks base this variable interest rate on the Lite Lender for 6-month money. This rate in turn depends on developments in the capital markets.
One advantage is the adjustment to the current interest rate level. The high level of security that classic mortgage loans offer due to their long term (between ten and twenty years) is an important point in mortgage lending. Another equally important point is flexibility, and this cannot be given with such a long term. Only cap loans have this advantage because they can constantly adjust to the current interest rate. Example:
In this way, borrowers can always react extremely flexibly to the general current interest rate level. Because they receive a flexible loan without a fixed interest rate in order to benefit from the favorable developments on the interest market. With a cap loan, not only can favorable interest rates be used, but the built-in upper interest rate limit also prevents the risk of an increase in interest rates. Cap loans can be closed for periods of 3, 5, 10 or 15 years. The amount of the upper limit of interest then also depends on this loan term. Because the longer the term, the higher the cap on the interest rate.
On the other hand, every borrower also has the option of converting their cap loan into a loan with a fixed borrowing rate. In this way, he can then enjoy absolute interest rate security. Due to the possibility of special repayment, the loan can be redeemed early, especially in high-interest phases. There is also no prepayment fee (there may be exceptions!). Another advantage applies to borrowers who want to finance their property in a low interest rate phase. If you don’t want to be bound by long interest rates here, you can use a cap loan as a building loan – an ideal financing component. Anyone who is too unsure about this type of financing can, as a builder or property buyer, divide the required mortgage lending amount between various loan modules and thus also across various risks. This can be done, for example, by building your financing on partial loans with a long or short term or by combining partial loans with a long or short term with a cap loan.
The advantages and disadvantages of cap loans
The advantage of cap loans is that, in addition to exhausting the maximum possible repayment options, it is also possible to pay them off completely. All in all, optimal conditions for real estate financing. Nevertheless, despite these advantages, the respective offers should also be carefully examined and compared with each other. There are differences in particular in the interest caps, the adjustment dates, the reference interest rate and the special repayment agreements. Here it says: Compare conditions. Another advantage of a cap loan is the relatively short notice period, unlike loans with fixed interest rates, which can only be terminated without damage at the end of the loan term. In this way, borrowers can benefit from the consequences of a financial crisis.
Real estate owners or borrowers who are expecting a falling interest rate development have enough time with a cap loan to observe the interest rate development on the market, but at the same time they are already able to realize their purchase or new construction project. Once the interest rate has finally come to an end, the loan can easily be converted into a long-term fixed interest rate. The same applies to all those who want to repay their loan as quickly as possible. A cap loan is particularly suitable for this, since the borrower can convert their respective interest savings from the favorable interest rates of the cap loan into a correspondingly higher repayment rate compared to the capital market interest rates. Due to the even higher repayment (between 1 and 2 percent is common), the term of the loan is shortened accordingly.
Cap loans can be terminated at any time with 3 months’ notice. If there is an increase in the interest rate, the borrower is even entitled to terminate his loan contract with immediate effect within 4 weeks after notification of the change. Despite these many advantages, there are only a few providers who refer to this option on their own initiative. Rather, other types of financing predominate simply because they flow more commissions. This makes it difficult for the end consumer to make a corresponding comparison between the different cap providers. A condition comparison between cap loans and fixed-interest loans is also extremely difficult. Again, this is much easier when comparing annuity loans with each other.
The biggest disadvantage with cap loans is the commission and processing fees, which can be between 1 and 2.3 percent of the loan amount. This additional burden must also be taken into account in the amount of the total funding. Borrowers must therefore weigh up to what extent the additional financial burden on insurance premiums outweighs the flexibility of a cap loan. If you compare, you may even find that – despite all the advantages – real estate financing via a normal “combination loan” (e.g. mortgage, home loan and savings contract) is cheaper than with a cap loan despite an agreed interest rate cap.
Another disadvantage is the fact that a borrower benefits from low or falling money market interest rates, but on the other hand he has to pay more when interest rates rise.
Who are cap loans suitable for?
Overall, cap loans are suitable for all those who would like to benefit from the currently low interest rates, without foregoing the important safety factor. However, if the general interest rate rises, the loan is taxed accordingly up to the agreed upper limit. Another possibility to make flexible and calm decisions is the cap loan in the situation in which you want to switch from your previous property to a larger or more appropriate property. Should the previous property be sold or rented here? To bridge this time of decision, a cap loan is ideal.
Or you expect falling interest rates, but have already found your dream property. Now you have to act quickly before someone else wins the bid. If you do not want to commit yourself in the long term in such a situation, you not only remain flexible with a cap loan, but you can also wait and see in which direction the market moves. Because an exit is possible at any time, a conversion into a long-term fixed interest rate can be determined at any time. In addition, the building owner is currently (as of 03.2011) receiving a current interest rate for short-term loans, which is significantly below that of a long-term loan. Due to the lower monthly debit, the borrower can make the corresponding repayments.