What is the purpose of a periodic rate cap in an adjustable-rate mortgage (ARM)?

The purpose of a periodic rate cap in an adjustable-rate mortgage (ARM) is to limit the change in interest rates during adjustment periods. This cap regulates how much the interest rate can increase or decrease at each adjustment interval, providing a level of predictability in the borrower's monthly payment. By placing a limit on the interest rate fluctuations, borrowers can better plan their financial commitments without facing sudden or excessive increases in their payments that could arise from changes in market interest rates.

This mechanism is particularly important in an ARM because it ties the interest rate to a specific index, which can vary over time. The periodic rate cap protects the borrower by ensuring that the adjustments to the interest rate (and consequently the payments) remain within a manageable range, safeguarding against the financial strain that could result from drastic interest rate hikes.