DEFINITION of 'Indexed Rate'

An interest rate charged on loans to borrowers that is calculated by taking the sum of a benchmark index interest rate and a specified margin. The indexed rate is used to calculate the interest rate on an adjustable-rate mortgage (ARM). The benchmark index rate is a variable rate, while the specified margin remains fixed.

On an ARM with an initial fixed interest rate, commonly known as a "hybrid ARM" or "fixed-period ARM", the term "indexed rate" is most often called the "fully indexed rate".

BREAKING DOWN 'Indexed Rate'

A borrower may or may not have a choice of indexes for a particular ARM. More frequently the borrower has some negotiating ability on the margin. Remember, the margin is a constant value added to the index level to arrive at the indexed rate. The lower the margin, the cheaper the interest on the loan will be. In addition, some indexes are better choices than others depending on the expected future interest rate environment.

For example, one popular mortgage index known as the MTA index is a moving average of another popular mortgage index, which is called the CMT index. In a rising interest rate environment, the lag effect of a moving average calculation is beneficial to the borrower. The opposite would be true in a falling interest rate environment.

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