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For an adjustable-rate mortgage (ARM), what are the index and margin, and how do they work?

For an adjustable-rate mortgage, the index is an interest rate that fluctuates periodically based on general market conditions. The margin is a number set by your lender when you apply for your loan. When your initial teaser rate expires, the index and margin are added together to become your new interest rate, subject to any rate caps.

With an adjustable-rate mortgage, the initial teaser rate is generally only for the first few years, and then it begins to adjust periodically. Once the rate begins to adjust, the changes to your interest rate (and payments) 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 (subject to any rate caps)

The index is an interest rate that fluctuates with general market conditions. Changes in the index, along with your loan’s margin, determine the changes to the interest rate and your payments for an adjustable-rate mortgage loan. If interest rates go up, your payments will go up, so these loans have future risks that other loans do not. 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 margin is the number of percentage points added to the index by the mortgage lender to set your interest rate on an adjustable-rate mortgage (ARM) after the initial rate period ends. The margin is set in your loan agreement and won't change after closing. The margin amount depends on the particular lender and loan.

The fully indexed rate is equal to the margin plus the index.

Margins and indexes are two of many terms that determine your monthly payment for an adjustable-rate mortgage. It’s also important to understand caps, carryover, and other terms. If you’re considering an adjustable rate mortgage, read the Consumer Handbook on Adjustable Rate Mortgages (CHARM) booklet .