A SOFR rate cap is an interest-rate hedge that pays the borrower if SOFR rises above a contractually specified strike rate. Required by most floating-rate bridge lenders, the cap is purchased upfront from a counterparty bank, runs for a defined term (typically matching the initial loan term), and protects the borrower from runaway interest cost.
How is the cap priced?
Cap pricing depends on three things: term (longer = more expensive), strike rate (lower strike = more expensive), and notional amount (the amount of debt being hedged). Cap cost also moves with implied volatility, when markets expect more rate movement, caps cost more.
Who is the counterparty?
Most caps are purchased from large bank counterparties, usually through a hedge advisor. The borrower assigns the cap proceeds to the lender for the life of the loan. The lender requires a minimum counterparty rating and may require collateral posting or a downgrade trigger.
What happens if the loan extends?
Bridge loans with extension options typically require a refreshed cap covering the extended period. The new cap is priced off then-current rate volatility, which can be a meaningful cost surprise if volatility has spiked. Borrowers should budget for cap renewal in their hold-period analysis.
Sources
- Secured Overnight Financing Rate (SOFR) · Federal Reserve Bank of New York · daily