Money & Finance › Commercial real estate lending › Fixed vs. floating rates on property loans
Interest-rate caps on floating-rate loans
· Asset or instrument
Fact, law or dataA rule, statute, definition or measured number.
A contract a floating-rate borrower buys for a one-time fee that pays out whenever the benchmark rate rises above a set level.
See it on the Money & Finance map →How it works
Example: a $20 million bridge loan floats at SOFR plus 3.5%. The owner pays a bank an upfront premium for a two-year cap with a 4% strike. If SOFR averages 5% in a month, the cap pays 1% a year on $20 million for that month, about $16,700, so the owner's net rate stops at 7.5%. The premium depends on strike, term and expected rates. Lenders often require caps from A-rated providers, pledged to the lender, and new ones at each extension.
Why it matters
A cap limits the worst case without giving up savings if rates fall, unlike a swap, but its price swings with rate expectations.
Think of it like
Like insurance with a deductible: pay a premium, carry rate rises up to the strike, and the policy covers the rest.
Facts, rules and data
Cap requirements in loan agreements, ISDA cap confirmations, and hedging advisers' published cap pricing before and after 2022.
Debates and risks
Whether lenders were right to demand costly new caps at extension in 2023, which pushed some borrowers into default, is debated.
Connections (3)
▸Bridge loans: short-term, floating-rate transition financing usually require Interest-rate caps on floating-rate loansFact, law or data
The connection
A bridge loan floats over SOFR, and the property often barely covers debt service during lease-up. To keep rising rates from sinking it, the lender requires the borrower to buy a cap, typically at a strike that keeps DSCR near 1.0x, for the initial term, and a new cap for each extension.
When and why
Standard in US bridge, debt-fund and CRE CLO loans; a major issue in 2022–24 when caps on many 2021 loans expired.
How we know
Bridge loan agreements and CRE CLO deal documents, which spell out cap requirements, and mortgage REIT filings.
Debates and risks
Whether lenders should waive or help fund replacement caps for struggling borrowers, as some did in 2023, is negotiated loan by loan.
▸Interest-rate caps on floating-rate loans are a type of Options and other derivativesFact, law or data
The connection
A rate cap is a string of call options on a benchmark rate, one for each period: if SOFR sets above the strike, that option pays the difference. Like any option, its price depends on the strike, time, the expected path of rates and volatility, and the buyer can lose only the premium.
When and why
Traded privately between dealers and borrowers since the 1980s, usually documented as ISDA confirmations.
How we know
Standard option-pricing models, such as Black's model for caps, used by dealers and hedging advisers; ISDA cap confirmations.
Debates and risks
How fairly dealers price caps for small borrowers, who rarely compare quotes, is hard to know.
▸Interest-rate caps on floating-rate loans soared in cost during 2022–23 hikes in The federal funds rateMainstream view
The connection
From March 2022 to July 2023 the Fed raised its target from 0–0.25% to 5.25–5.50%, and SOFR followed. Caps bought cheaply at 1–3% strikes went deep in the money, and replacement caps cost far more because expected rates and volatility were higher: by many reports, ten times or more their 2021 price.
When and why
In US floating-rate CRE lending, 2022–24, as bridge loans written in 2021 reached extension dates that required new caps.
How solid is the link?
The Fed's rate history, cap pricing from hedging advisers, and mortgage REIT disclosures of borrowers' cap costs and loan modifications.
Debates and risks
With the Fed hiking again in September 2026, whether cap costs climb as in 2022–23 depends on how far markets expect rates to go.