*interest cap escrow requirements* are about to blindside some real estate owners

Imagine having a $4,000/mo. expense jump to a $125,000 -A MONTH- expense

How?

Let’s talk about what *interest cap escrow reqs* are & why some borrowers may have an unforeseen bill coming due.

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First, lets explain *interest rate caps*

When you buy real estate with a *floating rate loan*, most lenders require that you buy an *interest rate cap*.

What’s this?

Paying money today to “cap” yourself & the lender from interest rates rising on your floating rate debt

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These caps are hedging costs.

You’re paying today to hedge against future interest rate volatility.

Here’s the thing:

When rates are low and going lower, these caps are cheap.

When rates skyrocket, so do your *cap costs*.

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Now, in come the *interest cap escrow requirements*

Turns out your lender was ok with you only buying a *12-month interest rate cap* on a 5, 7, or 10-year floating rate loan..

..as long as you escrow money EVERY MONTH for the cost of a *replacement cap*

Said differently:

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Your lender was ok with you only protecting yourself for the next 12 months on a 7 year loan, as long as you put money aside to buy the next interest rate cap in 12 months, i.e. *the replacement cap*

So what happens when your next cap goes from costing $50,000 to $1,500,000?

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Well, now the borrower has to go from putting $4166 a month aside in escrow for the next interest rate cap to $125,000 A MONTH aside.

($50K replacement cap cost / 12 months) = $4.1K/mo

($2M replacement cap cost / 12 months) = $125K/mo

So, what now?

6/fin

If you own a property with a floating rate loan, double check the terms of your interest rate cap.

Fannie & Freddie typically include *cap escrow requirements* - some lenders do not.

Don’t let these costs creep up on you when your lender recalculates your cap costs!

Follow up questions / concerns should go to the legend @mattnihan who gave me the heads up that this was around the corner for floating rate borrowers !