The difference between a fixed rate and an adjustable rate mortgage is that, for fixed rates the interest rate is set when you take out the loan and will not change. With an adjustable rate mortgage, the interest rate may go up or down.
For an adjustable-rate mortgage, the index is a benchmark interest rate that reflects general market conditions and the margin is a number set by your lender when you apply for your loan. The index and margin are added together to become your interest rate when your initial rate expires.
With an adjustable-rate mortgage, the rate stays the same, generally for the first year or few years, and then it begins to adjust periodically. Once the rate begins to adjust, the changes to your interest rate are based on the market, not your personal financial situation.
To calculate your new interest rate when it’s time for it to adjust, lenders use two numbers: the index and the margin.
Index + Margin = Your Interest Rate
The index is a benchmark interest rate that reflects general market conditions. The index changes based on the market, and is determined or maintained by a third party. Changes in the index drive the changes to your interest rate.
The lender decides which index your loan will use when you apply for the loan, and this choice generally won’t change after closing. The most commonly used index for mortgages is the one-year LIBOR, which stands for the London Inter-Bank Offer Rate. You can look up the current LIBOR rates in major newspapers such as the Wall Street Journal .
The margin is the number of percentage points added to the index by the lender. The margin is set by the lender when you apply for a loan, and this amount generally won’t change after closing. The margin amount depends on the particular lender.
The fully indexed rate is equal to the margin plus the index.
