Limitations on charges (caps)

Any mortgage where payments made by the borrower may increase over time brings with it the risk of financial hardship to the borrower. To limit this risk, limitations on charges—known as caps in the industry—are a common feature of adjustable rate mortgages.[1] Caps typically apply to three characteristics of the mortgage:
frequency of the interest rate change
periodic change in interest rate
total change in interest rate over the life of the loan, sometimes called life cap
For example, a given ARM might have the following types of caps:
Interest rate adjustment caps:
interest adjustments made every 6 months, typically 1% per adjustment, 2% total per year
interest adjustments made only once a year, typically 2% maximum
interest rate may adjust no more than 1% in a year
Mortgage payment adjustment caps:
maximum mortgage payment adjustments, usually 7.5% annually on pay-option/negative amortization loans
Life of loan interest rate adjustment caps:
total interest rate adjustment limited to 5% or 6% for the life of the loan.
Caps on the periodic change in interest rate may be broken up into one limit on the first periodic change and a separate limit on subsequent periodic change, for example 5% on the initial adjustment and 2% on subsequent adjustments.
Although uncommon, a cap may limit the maximum monthly payment in absolute terms (for example, $1000 a month), rather than in relative terms.
ARMs that allow negative amortization will typically have payment adjustments that occur less frequently than the interest rate adjustment. For example, the interest rate may be adjusted every month, but the payment amount only once every 12 months.
Cap structure is sometimes expressed as initial adjustment cap / subsequent adjustment cap / life cap, for example 2/2/5 for a loan with a 2% cap on the initial adjustment, a 2% cap on subsequent adjustments, and a 5% cap on total interest rate adjustments. When only two values are given, this indicates that the initial change cap and periodic cap are the same. For example, a 2/2/5 cap structure may sometimes be written simply 2/5.