Interest rate cap

Definition

A contract that limits how high a variable rate can climb.

Why It Matters

Most SBA 7(a) acquisition loans float against prime, so the payment you modeled is not the payment you will be making in year six. A cap is bought separately, from a bank or a dealer, and pays you the difference whenever the index rises past a strike you choose. It costs money up front, priced on how far away the strike sits and how long the term runs, so the honest comparison is against simply underwriting the deal at a higher rate and seeing whether it still works without one.

In numbers: On a $1.5M loan, every 1% the rate rises costs roughly $15,000 a year before amortization, which is what a cap is priced against.