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The Index

February 22, 2012

Two factors determine how often the rate can change. Both the frequency of payment and rate adjustments figure into just how often the rate changes. Thus, the interest rate changes are a function of the index added to the margin. Using the index determines the future rate changes of an ARM. The borrower should look for the index to:

  • Be regularly published in a source accessible to the public
  • Be beyond the lender’s control. If the index is linked to the lender’s performance, or risk experience, the lender could theoretically increase the index whenever they needed to make more money

Numerous indices are used to determine how interest rates can change on adjustable-rate mortgages. Some of the more common and popular indices and how often they adjust can be found in the table below:

 

Index

Adjusted

Definition

LIBOR: London Interbank Offered Rate

One month, six months, 12 months (depending on loan program)

Average interest rate charged to banks in the London Interbank System when borrowing money from one another with ranging maturities

COFI: 11th District Cost of Funds Index

Monthly/Once a year (depending on loan program)

Weighted index of the cost member banks (in Arizona, California, and Nevada) pay on money borrowed such as customer checking and savings accounts

COSI: Cost of Savings Index

Monthly

A stable index that is the weighted average of interest rates on deposit accounts (savings) at federally insured depository institutions

CMT: Constant Maturity Treasury

Once a year

Follow the weekly or monthly fluctuations in the yield on one-year Treasury bills

MAT/MTA: 12-Month Treasury Average

Monthly

Average yield on U.S. constant-maturity one-year Treasury bill adjusted every month by the U.S. Treasury that reacts slowly to short-term fluctuations

Prime Rate: The Fed (U.S.) Prime Rate

Various

Short term interest rate used in the banking system of the United States used by various lending institutions and is the basis for rates on most short-term loans/lending instruments (Fed Funds Target Rate + 3)

 

The index is one component used when figuring the new rate of an adjustable-rate mortgage loan. The other key piece that must be factored in when figuring the new rate is the margin (discussed below). Using the two variables, the new rate is determined by the following equation:

INDEX + MARGIN = NEW RATE

 

The variables of each index are a factor in analyzing the future performance of an adjustable-rate mortgage. For instance, if the index is stable, future interest rate increases may not be dramatic, but there is less likelihood for an improvement in the event of future interest rate decreases.

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