What is the role of an interest rate cap?

An interest rate cap plays a critical role in financial products, particularly variable-rate loans. It functions as a mechanism that limits how much the interest rate on a loan can increase over a specified period. This means if the market interest rates increase significantly, the borrower will not face a corresponding hike in their own interest rate beyond the predetermined limit set by the cap. This feature protects borrowers from excessive interest rate fluctuations, helping them manage their financial obligations and budget more effectively.

Understanding this can help borrowers make informed decisions about their loan options, particularly when contemplating loans with variable interest rates. The other choices do not accurately represent the function of an interest rate cap; for instance, determining loan amounts, securing loans against default, and specifying payment schedules relate to different aspects of loan agreements and are not influenced by interest rate caps.