Payment cap

A limit on how much the monthly payments on an adjustablerate mortgage (ARM) can go up or down.

Some ARMs have a payment cap, which is normally around 7.5%. Caps on monthly payments are rare since they can cause negative amortization, a situation where your mortgage balance increases despite regular monthly payments.

Example: How can a payment cap cause negative amortization on a $200,000 loan at 6% interest with a 7.5% payment cap?

If your interest rate goes up to 8%, you now have to pay $712per month, up from $589. However, since you have a payment cap of 7.5%, the maximum that you have to pay is $634 ([$589X 7.5%] + $589). Who eats the $44 difference?
If the lender allows negative amortization, you have the choice to pay either the $634 or $712. If you opt to pay the lower amount, the$44 is added to your loan’s principal, increasing the size of your loan.