Components of an ARM

(a) Index The interest rate on an ARM is tied to an economic indicator called an "index." The index is a published financial benchmark that reflects the general cost of money in the economy (such as the U.S. Treasury yield). The lender does not control the index; it fluctuates with the market. If the index goes up, the borrower’s interest rate generally goes up; if it goes down, the rate may decrease.(b) Margin & Calculated Interest Rate. Because the index is just a raw economic number, the lender adds a profit percentage to it called the "margin." The margin is fixed at the time the loan is originated and does not change. To determine the borrower’s actual interest rate (the "calculated interest rate"), the lender adds the current index value to the fixed margin. For example, if the index is 3% and the margin is 2.5%, the borrower’s interest rate is 5.5%.