Interest rate cap
What is an interest rate cap, and how is it different from a swap?
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BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED
// THE SHORT ANSWER
An interest rate cap limits the base rate a floating-rate borrower pays to an agreed ceiling for an agreed period, in return for a premium paid upfront. Unlike a swap it removes only the upside of rates: if rates fall, the borrower keeps the benefit, and the most it can lose is the premium. That makes a cap simpler to hold — it never owes the bank money — and dearer to buy; the choice turns on whether the business needs certainty or only protection.
BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.
// WHAT IT IS NOT
An interest rate cap is not a swap: a swap fixes the rate in both directions and can owe the bank money; a cap is paid for once and only ever pays out.
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