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

An interest rate cap in an adjustable-rate mortgage (ARM) serves to protect borrowers from excessive interest rate increases. When borrowers choose an ARM, the interest rate can fluctuate based on changes in a benchmark index, which could lead to significantly higher payments if interest rates rise steeply. An interest rate cap limits how much the interest rate can increase during a specific time frame, such as annually or over the life of the loan. This feature provides borrowers with a degree of predictability and financial safety, ensuring they are not subject to potentially unmanageable monthly payments due to sudden spikes in interest rates.

The other options do not align with the primary function of an interest rate cap. Ensuring a fixed profit for lenders or setting a minimum interest rate does not directly protect borrowers from risks associated with rate fluctuations. Similarly, while an interest rate cap might indirectly help manage payments, its main intent is not to reduce the total payment amount but to limit the rate at which those payments can increase. Overall, the primary purpose of an interest rate cap is to safeguard borrowers against high costs associated with rising interest rates.