ARM loans, or Adjustable Rate Mortgages almost all have a feature which can greatly affect how much your monthly mortgage payment or mortgage rate may increase after the introductory fixed rate period of your loan expires, called the Index.

An ARMs Index is really just a guide that allows different lenders to measure and compare changes in interest rates to determine the basic cost of the money they are lending you.

A major increase in the value of an index from the time you purchased the home or last refinanced can cause a significant increase in your mortgage payment, because the ARMs index can be considered an underlying rate which affects, along with the margin, the final note rate which you are charged when your ARM loan begins adjusting at the end of its fixed introductory period.

Lenders and investors in Adjustable Rate Mortgages utilize a variety of indexes for ARM mortgages, including the performance, return or yield of 1 month, 1 year, 3 year, 5 year and even 10 year US Treasury securities (10 year note yield indices are rarely used in adjustable rate ARMs)


Popular ARM Indexes commonly used as benchmarks by lenders include:
>> Prime Rate (Bank Prime Loan)
>> MTA or MAT (12-Month Treasury Average)
>> COFI (11th District Cost of Funds Index)
>> LIBOR (London Inter Bank Offering Rates)
>> T-Bill (Treasury Bill)
>> CMT or TCM (Constant Maturity Treasury)
>> COSI (Cost of Savings Index)
>> CODI (Certificate of Deposit Index)
>> CD (Certificates of Deposit Indices)


Other indexes which may occasionally be used in Adjustable Rate ARM mortgages are highly varied, however homeowners may have an ARM mortgage with an index from the following list (although more rarely than those ARM indexes mentioned above):

>> Cost of Funds component indices:
- Federal Cost of Funds Index
- Semi-annual National Average Cost of Funds Index
- Quarterly Average Cost of Funds
- National Monthly Median Cost of Funds Index

- OR -

- RNY (Fannie Mae or Freddie Mac Required Net Yield)
- Semiannual Weighted Average Cost of Funds Index
- National Average Contract Mortgage Rate

The way an ARM index works in the calculation of your mortgage interest rate is that whatever Index your mortgage is based on, whether it is Prime, LIBOR, COSI, COFI, MTA, etc..., your index will be added to your rate margin to compute your actual rate. Most adjustable rate mortgages will be fixed at an introductory rate for a specified period of time such as 1, 3, 5, 7, or 10 years, these are very common fixed periods on ARM loans. After that introductory period is over, your rate will then become an adjustable rate mortgage and will adjust, usually either once every month, once every 6 months or once every year (while some may adjust at slightly different intervals). Once your rate starts adjusting, the only component of your rate that will adjust will be the Index. Whatever your margin is, this will remain a constant in the calculation of your interest rate. More often than not, the adjustable rate will increase, however, sometimes the rate will decrease as well. Here is an example of how an adjustable rate mortgage works.
Customer obtains a 3/1 ARM loan. This is a 30 year mortgage that will have a fixed introductory rate for the first 3 years, 36 months, of the loan. Thereafter, every year the rate will adjust once per year. That is what is meant by 3/1 ARM, 3 years fixed, 1 year adjustment periods. Let's say the rate on the 3/1 ARM was 5.5% and this rate was based on the index of LIBOR. This rate would remain 5.5% for the first 3 years of this loan and then thereafter it would adjust. If your margin is 2% and after 3 years LIBOR is 5% this would mean that your new interest rate would adjust to 7%. This is calculated by adding the 5% index, which is LIBOR, plus the 2% margin, which will remain the same throughout the life of the loan and you end up with 7%. In 12 more months let's say LIBOR increases up to 6%, then the new rate on this loan would be 6% index, plus 2% margin to give you an interest rate of 8%. With the preceding example you can see that your index changes and not your margin. Therefore, if you know what your margin is (it should be provided in the copy of all of your closing paperwork that you receive after closing on your mortgage loan) you should be able to provide yourself with a pretty good idea as to what your rate is going to be by simply looking into the current rates of the Index being used for your mortgage rate calculation.

With an adjustable-rate mortgage, on each interest rate change date, an ARM's interest rate adjustments are based on your loan program's Index plus a margin, as specified on your loan's Note.

Lenders use many indexes to calculate a borrowers ARM payment. These indexes usually have different values over time. Borrowers should ask a trusted mortgage advisor to determine an ARM loan is right for them. If so, which loan program and index will be the most beneficial to them.

If you're considering an adjustable rate mortgage or have been offered one, make sure that if for whatever reason you can not refinance the loan prior to the adjustment that you can afford the monthly payment after it adjusts. Many homeowners have been lulled into believing that no matter what, they will be able refinance before the loan adjusts and when they realize they can't, they find they may lose their homes because they can't afford the new higher payment.

Your Index plus your Margin will equal your Mortgage Payment.