DEFINITION of ARM Index
ARM (adjustable-rate mortgage) index is the benchmark interest rate to which an adjustable rate mortgage is tied. An adjustable-rate mortgage's interest rate consists of an index value plus a margin. The index underlying the adjustable-rate mortgage is variable, while the margin is constant. There are several popular indexes used for different types of adjustable-rate mortgages.
This is also referred to as the "fully indexed interest rate."
BREAKING DOWN ARM Index
The index to which an adjustable rate mortgage is tied can make a difference over the life of the mortgage. For example, one popular mortgage index is the MTA (Monthly Treasury Average) index. It is a moving average calculation, and therefore has a "lag effect." If interest rates are expected to rise, a mortgage tied to the MTA index might be more economical than a mortgage tied to an index without a moving average calculation, such as the one-month LIBOR index.
However, a borrower should consider more than the index when choosing an adjustable rate mortgage. Many other variables, such as the margin and the interest rate cap structure, are important considerations.
How Different ARM Indexes Are Applied
Each index has its own characteristics that set it apart. As a global index, the London InterBank Offered Rates (LIBOR) is a barometer for the worldwide economy and is used by investors who operate internationally. This index is based on the interest rate charged among London-based banks for borrowing transactions between them. The LIBOR index is often used as ARM index to cover intervals that can be one month, three months, six months, or one year.
The primate lending rate index is focused on the United States as a market tied the nation’s banking system. It is a short-term interest rate that sees common used by all forms of lenders, including credit unions, banks and other institutions. The prime rate is typically used in the pricing of short-term and medium-term loans, or for adjustments at set intervals on long-term loans.
This index is consistent throughout the country to allow for comparisons on loans regardless of where they are offered. For instance, the primate rate will be the same in California or Maine, which makes the specific aspects of adjustable-rate mortgages more the deciding factors in determining if a loan is competitive or not. The margins on the loan and whether or not the interest is set below the primate rate all become elements in comparing loan offers.