What is a payment cap in an ARM?

A payment cap in an Adjustable Rate Mortgage (ARM) refers to a limit on how much the payment can increase during an adjustment period. This feature is particularly important for borrowers as it helps to manage and predict monthly expenses, especially when interest rates fluctuate. By imposing a ceiling on payment changes, a payment cap safeguards borrowers from drastic increases in payment amounts that could occur if interest rates rise significantly.

This mechanism allows borrowers to have a certain level of financial stability, preventing overwhelming jumps in monthly payments even when the underlying interest rate adjusts. It does not, however, limit the actual interest rate itself, and while it can help manage payments, it does not address the potential for negative amortization or cap loan amounts. Hence, the focus on controlling the payment change aligns correctly with the definition of a payment cap in the context of ARMs.