Interest rate cap
A cap can compensate a borrower when the covered reference rate exceeds the cap rate during specified periods. The borrower normally retains the benefit of lower rates but pays a premium. The all-in borrowing cost can exceed the stated cap because the loan margin, premium and any mismatch may sit outside it. The cap must match the relevant amount, dates and benchmark to provide the intended protection. It differs from fixing the rate with a swap, where favourable downward rate movements are usually exchanged away.
Worked example
A loan charges a benchmark plus 1.5%. A cap protects the benchmark at 5%. If it rises to 7%, the cap offsets the covered excess 2 percentage points, leaving approximately 6.5% borrowing cost before premium and other effects, rather than an all-in 5% ceiling.
Common mistake
Treating the cap on a reference rate as a ceiling on total borrowing cost including margin and premium.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Direct | September 2026–June 2027 |
| ACCA | FM | Direct | September 2026–June 2027 |