In one sentence
A hedge limiting the interest rate on a floating-rate loan, required by lenders on transitional debt.
The longer version
A rate cap protects both borrower and lender from rising rates on a floating loan by capping the effective rate. Bridge and construction lenders typically require a cap, purchased at closing and often collaterally assigned.
The cap agreement, its term, strike, and assignment, is a closing item on floating-rate deals, and its replacement at extension is a servicing event.
Common questions
- What is an interest rate cap on a commercial loan?
- A hedge that limits how high a floating-rate loan's interest can rise, paying the borrower when the index exceeds a strike rate.
- Why do lenders require rate caps?
- To protect the borrower's ability to pay debt service if rates rise, especially on bridge and transitional loans with thin coverage.
- What do lenders specify about the cap?
- The strike rate, term, notional amount, an acceptable counterparty rating, and a collateral assignment of the cap to the lender.
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