**Cap premium pricing (2025 market)**: For a **$5M loan with 5-year term**, cap strike at **5% SOFR** (current rate 3.5%, 20% volatility): Premium = **$87,000-$125,000** (1.74-2.50% of loan amount, 174-250 basis points).

Amortized cost: **$17,400-$25,000/year**. **5 key pricing factors**: **(1) Strike rate vs current rate (moneyness)**: Strike 2% above current (5% vs 3.5%) = "out of the money" = cheaper ($87K).

Strike at current (3.5% vs 3.5%) = "at the money" = expensive ($185K, 2x cost).

Strike 1% below current = "in the money" = very expensive ($285K, 3x cost). **Rule**: Each 1% lower strike adds 50-100 bps premium. **(2) Loan term (time value)**: 3-year term = $52K (1.04%), 5-year = $87K (1.74%), 7-year = $142K (2.84%), 10-year = $225K (4.50%). **Premium increases ~30-40% per additional 2 years**. **(3) Rate volatility**: Low volatility 15% = $68K, Medium 20% = $87K, High 30% = $128K (50% higher premium). **Volatility measures rate uncertainty**; higher = more protection needed = higher cost. **(4) Loan amount (linear scaling)**: $2.5M loan = $43.5K premium (half of $5M), $10M = $174K (double), $25M = $435K (5x).

Premium scales directly with notional. **(5) Forward rate curve**: If market expects rates to rise (steep curve), premiums increase 10-25%.

Flat curve = lower premiums. **Comparison to fixed rate**: 5% cap on $5M for 5 years costs $87K upfront ($17.4K/year amortized).

Fixed rate alternative at 5% (1.5% above current floating 3.5%) costs extra **$75K/year** ($375K over 5 years). **Cap saves $293K if rates stay below 5%**, costs extra $87K if rates never rise. **Break-even**: If floating rate averages 4.65% or higher over 5 years, cap pays for itself. **Best use case**: Cap when expecting moderate rate increases (1-2%) but want protection against severe rises (3%+).

**Buy cap + floating rate when**: (1) **Rates expected to stay flat or decline** (save 0.5-1.5% vs fixed rate, current 2025: SOFR 3.5% vs 5% fixed = $75K/year savings on $5M loan). (2) **Loan term <5 years** (shorter exposure to rate risk, lower cap premium 1-2% vs 3-4% for 7-10 years). (3) **High confidence rates stay below cap** (5% cap, expect rates peak at 4.5% = cap never triggered, paid $87K premium but saved $293K vs fixed). (4) **Lender requires cap** (many commercial real estate lenders mandate caps for LTV >65% to protect their collateral). (5) **Ability to prepay without penalty** (floating loans allow prepayment, fixed charge 1-5% penalty). **Choose fixed rate when**: (1) **Rates expected to rise significantly** (if SOFR going to 6-7%, 5% fixed rate locks in savings, floating+cap at 5% = breakeven). (2) **Long loan term (7-10 years)** (cap premium 3-5% makes fixed rate competitive, plus eliminates refinancing risk). (3) **Budget certainty critical** (property management, HOAs need predictable payments). (4) **Cap premium unaffordable** (startups, tight cash flow can't pay $87K-$225K upfront, prefer higher monthly fixed payment). (5) **Forward curve steep** (market pricing in 2-3% rate increases = expensive cap, fixed rate better value). **Hybrid strategy (best of both)**: Start with floating+cap for years 1-3 (rates declining or flat, save $50K-150K), refinance to fixed in year 4-5 if rates rising (lock in before peak). **$5M loan example** (5-year term): **Floating+cap cost**: Year 1-3 at 3.5-4% = $175K-$200K interest, Cap premium $87K, Total = **$262K-$287K**. **Fixed rate cost**: 5 years at 5% = **$375K** interest. **Savings with cap**: **$88K-$113K** over 5 years if rates stay below 5%. **Break-even rate**: 4.65% average floating rate.

If SOFR averages 4.7%+ over 5 years, fixed would have been cheaper. **2025 recommendation**: With Fed expected to hold rates 3-4% through 2025-2026, then cut to 2.5-3% by 2027, **floating+cap superior** to 5% fixed for 3-5 year loans.

Use 5-5.5% cap strike (well above 4% peak expectation), premium 1.5-2%. **Risk**: Unexpected inflation spike pushes rates to 6-7% (your 5% cap still protects but floating+cap total cost equals fixed). **Worst case**: Overpay $87K cap premium if rates never rise above 3.5% (opportunity cost vs fixed-rate discount negotiation).