DEFINITION of Mortgage Index
A mortgage index is the benchmark interest rate an adjustable-rate mortgage's fully indexed interest rate is based on. An adjustable-rate mortgage's interest rate, known as the fully indexed interest rate, consists of an index value plus a margin. The margin tends to be constant, but the index's value is variable. Several benchmark interest rates serve as mortgage indexes.
BREAKING DOWN Mortgage Index
Some common mortgage indexes include: the prime lending rate, the one-year constant maturity treasury (CMT) value, the one-month, six-month and 12-month LIBORs, as well as the MTA index, which is a 12-month moving average of the one-year CMT index.
The index that an adjustable-rate mortgage is tied to is an important factor in the choice of a mortgage. For example, if a borrower believes that interest rates are going to rise in the future, the MTA index would be a more economical choice than the one-month LIBOR index because the moving average calculation of the MTA index creates a lag effect.
Ways a Mortgage Index Influences Competition in Lending
The choice of mortgage index can have an effect on what a lender charges the borrower as mortgages are assessed at their designated intervals. The mortgage will specify when the adjustments to the interest rate will be made, which could be at six-month, one-year, or two-year intervals for example. At that time, the lender will make a recalculation of the interest using the index and the margin to determine the new figure.
Each index has its own characteristics that set it apart. For example, the prime lending rate 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 prime rate will be the same in California or Maine, which makes the specific aspects of the 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 prime rate all become elements in comparing loan offers. A borrower who has excellent credit might be offered a mortgage with an interest rate much lower than the prime rate index, which could reassure the customer that the loan is competitive.