What's an Index?
Adjustable Rate Mortgage rates are tied to an index, and borrowers need to know what that means. But fasten your seatbelt — it can get complicated.
The interest rate of an ARM is determined by an index, which adjusts periodically, plus a pre-set margin (e.g., Prime plus 2). In general, you want to understand this because some indexes change faster than others. The more change, the more fluctuation in the ARM. Most buyers want to choose an ARM based on a stable index (especially if you suspect the economy is less than booming), or at least consider it along with all the other aspects of the loan.
Some popular indices include:
- T-Bills, the federal government's treasury bill index; the most commonly used
- LIBOR (London Interbank Offered Rate Index), based on international rates
- COFI (11th District Cost of Funds Index), based on a moving average of rates
- Prime Lending Rate
You can find current index rates by asking your lender. You need to look at your original mortgage contract to find the date your index rate adjusts, then you can figure out what will happen to your payments as a result. But you also need to know the fees and margins that are added to the index rate to make up the total payment.