Life Cap refers to the maximum change allowed to the interest rate of an adjustable rate loan over the life of the loan.
There are two ways in which a life cap can be defined. The first is as a maximum rate, in which a certain percentage is established as the absolute highest rate at which interest on the loan can be charged. This is often referred to as the interest rate ceiling of the loan.
The second way a life cap is defined is as a maximum percentage change allowable (either an increase or a decrease) in the interest rate of the loan relative to the loan's initial interest rate.
Interest Rate Ceiling: A man receives a $100,000 loan with a life cap of 15% and an initial interest rate of 8%. This means that the most that the loan provider will be able to increase the interest rate over the loan's life is 7%. Since the 15% is the maximum percentage to which the interest rate can be raised, it is referred to as the loan's "interest rate ceiling."
Relatively-Defined Life Cap: A man receives a $100,000 loan at an initial interest rate of 10% and a relative life cap of 5%. This means that, depending on the man's repayment behavior, the loan's interest rate could decrease to as low as 5% (if all payments are made on-time and in-full), or could increase to a total of 15% (if there are repeated non- or below-minimum-payments).