A limit on how much the interest rate or the monthly payment can change, either at each adjustment or during the life of the mortgage. Most ARMs have an interest rate caps to protect you from enormous increases in monthly payments.

A lifetime cap limits the interest rate increase over the life of the loan. Lifetime caps can vary by lender, but most ARMs have caps of 5% or 6%. A periodic or adjustment cap limits how much your interest rate can rise at one time. Generally, a 6 month ARM will have a cap of 1% while a 1 year ARM will have a 2% cap.

Periodic and lifetime caps are quoted as two numbers as in 2/6 which would mean that periodic cap is 2% and the lifetime cap is 6%. Examples:

1. The initial interest rate is 4.5%, the index is 7%, and the margin is 3%,
then the new interest rate = 7% + 3% = 10%.
If the lifetime cap is 5% then
the actual new interest rate will be 4.5% + 5% = 9.5%.

2. The initial interest rate is 6%, the index is 5%, and the margin is 3%,
then the new interest rate = 5% + 3% = 8%.
If the periodic cap is 1% then
the actual new interest rate will be 6% + 1% = 7%.

ARMs which have an initial fixed period -- 30/3/1, 30/5/1, 30/7/1 and 30/10/1 -- can have also first adjustment cap. It limits the interest rate you will pay the first time your rate is adjusted. These ARMs are quoted as three numbers as in 5/2/5 which would mean that the first adjustment cap is 5%, adjustment cap thereafter is 2%, and the lifetime cap is 5%.