Payment Cap

Clause in an Adjustable Rate Mortgage (ARM) limiting monthly payment adjustments, usually restricting the increase to a percentage of the previous payment. An ARM with a 71⁄2% payment cap and monthly payments of $100 can increase to no more than $107.50 in the first adjustment period, and $115.56 in the second. See also Annual Cap; Life of Loan Cap.

A contractual limit on the percentage amount of adjustment allowed in the monthly payment for an adjustable rate mortgage at any one adjustment period. Generally it does not affect the interest rate charged. If the allowable payment does not cover interest due on the principal at the adjusted rate of interest, Negative Amortization will occur.
Example: An adjustable rate mortgage has a payment cap of 7% a year. The monthly payment in year 1 is $500. When the interest rate is adjusted in year 2, the new payment would be $550 to pay interest and amortize the principal. However, due to the payment cap, the maximum payment for year 2 is $535.