What do lenders establish to protect borrowers from unlimited increases in the interest rate?

Lenders establish rate caps to protect borrowers from unlimited increases in the interest rate. Rate caps are features built into adjustable-rate mortgages (ARMs) that limit how much the interest rate can increase at each adjustment period and over the life of the loan. This provides a safeguard for borrowers against excessive interest rate hikes, allowing for more predictable monthly payments. It ensures that while borrowers may benefit from lower rates when the market is favorable, they also have insurance against drastic increases that could lead to financial strain.

Payment caps, although related, specifically limit the amount of the monthly payment rather than the interest rate itself. Private mortgage insurance (PMI) is a form of insurance that protects lenders in the event of borrower default when a down payment is less than 20%, and conventional mortgages refer to loans that are not insured or guaranteed by the federal government but do not specifically offer interest rate protection.