As with all variable mortgages, the interest rate on a capped mortgage follows the lender's SVR up and down. The difference with this type of mortgage is that the rate is guaranteed not to go above the level at which it is 'capped'. This cap will not last the entire life of the mortgage, but it is common to find rates that are capped for five years or more.

Advantages

This type of mortgage is particularly popular in times where interest rates may be likely to rise, since they offer protection against repayments going above a certain level. This makes capped rate mortgages almost as attractive as fixed rate mortgages to those borrowers who are keen to set their repayment budget for a specific period of time.

While capped rates prevent repayments rising above a certain level, they still allow you to enjoy the benefits of any cuts that the lender makes to its SVR. A capped rate mortgage does not deny you the savings that arise from falling rates. Furthermore, it is possible to find capped rate mortgages that also come with an initial discount in addition to the cap.

Disadvantages

Despite the availability of discounts in conjunction with a cap on the interest rate, the rate is usually higher than comparable fixed rate or pure discounted products. So although they are a safe choice of mortgage, they are a fairly conservative one, as you will never have the cheapest rate available on the market. If rates go as high as, or above the level of your cap, you would have been better with a rate fixed at a lower level. If rates drop or stay below the cap, a discounted rate will normally be better value than a capped rate.

This type of mortgage also often has redemption penalties, sometimes with an overhang beyond the capped rate period.

Cap and Collar

This is the same as a capped mortgage, but with a lower limit as well, meaning that your bets are hedged in both directions. The mortgage rate is therefore guaranteed to be within a set margin for the duration of the cap and collar period.

Like a capped rate product, this is a safe and risk-free type of mortgage. Although the rate may be marginally cheaper than a capped rate (but still less competitive than an equivalent fixed or discounted product), you are losing some of the potential gains if interest rates drop, since the rate you pay will not go below the collar rate.