DEFINITION of 'Indexed ARM'
An adjustable-rate mortgage on which the interest rate adjusts periodically according to an underlying benchmark index plus a margin. An adjustable-rate mortgage contract states which index will be used, how often the interest rate will adjust and usually sets a limit on the maximum amount the interest rate can adjust upward over the life of the mortgage. Some adjustable-rate mortgages also have limits on the amount the interest rate can adjust at each interest rate adjustment date.
BREAKING DOWN 'Indexed ARM'
The index used is variable while the margin on the mortgage is constant. There are several different indexes used for different adjustable-rate mortgages. Indexed ARMs are the only type of adjustable-rate mortgages offered in the United States.
In Europe, a type of ARM known as a discretionary ARM is popular. Discretionary ARMs allow lenders to adjust the interest rate at any time for any reason, contingent only upon giving advanced notice to the borrower. Indexed ARMs provide more protection to the borrower.