What is the Mortgage Interest Rate Index?

Feb 2, 2022 | Interest Rates and Regulations

The mortgage interest rate index is a benchmark that adjustable-rate mortgages (ARMs) base their fully indexed interest rates on. The fully indexed rate is the interest that borrowers will pay for their loan. To get this, the ARM index is added to the margin. There are several well-known indices that lenders can use to determine the rate for ARM loans.

Key takeaways

  • The mortgage rate index reflects the actual conditions of the market and is a benchmark for ARMs.
  • To establish the mortgage rate on variable-rate loans, the index and margin are often added together.
  • Various factors, including industry trends, inflation rate, and the economic growth rate, can influence how much the mortgage rate spikes or drops.

What is a mortgage interest rate index?

Before diving into the mortgage interest rate index, it’s best to have an understanding of what an index is. In short, it’s a way to track and measure financial information, such as inflation and interest rates. So, a mortgage interest rate index is a benchmark to determine the interest rate for variable-rate loans, including ARMs. These are based on the current market conditions and can include popular indices such as the 11th District Cost of Funds Index (COFI) and the Treasury Constant Maturities index.

ARMs use the mortgage interest rate index and margin to establish a new interest rate when the initial rate for the loan expires. The two are added together periodically to adjust the interest rate according to the market.

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How do these types of mortgage rates work?

When you’re approved for a mortgage loan, you’re expected to pay it back in full over a determined timeframe or by a specific date. On top of paying back what you borrowed, you also have to pay interest that typically accrues monthly. The rate you receive can be influenced by your credit score and debt-to-income ratio. 

For ARMs, you’ll pay the same amount of interest until a rate adjustment takes place. When this happens, either yearly or every few years, the lender will recalculate the interest by getting the sum of the index and margin. Borrowers may not see an adjustment until after the teaser rate is over. 

Mortgage rate trends

Mortgage interest rates significantly affect how much interest is paid over the course of a loan. A low mortgage rate could mean paying less in interest in the long run compared to a high one. Over the years, interest rates will continue to rise and fall, so knowing what factors affect mortgage rate trends can be beneficial. 

  • Inflation: Inflation occurs when prices increase, but the purchasing power of a currency decreases. Mortgage lenders will monitor the rate of inflation closely and adjust their rates accordingly.  
  • Economic growth rate: Economic growth indicators, such as the nation’s employment rate, can affect mortgage rates. This is because higher employment rates can increase spending, especially in the real estate industry. In contrast, when the employment rate plummets, less individuals are looking to make major long-term purchases. 
  • Market conditions: The conditions of certain markets have an impact on interest rates. For example, if there’s a higher demand to own a home and not enough homes are being built to sustain this demand, mortgage rates can increase. 

If you’re interested in the interest rates for reverse mortgages, take a look at our reverse mortgage rate guide. This comprehensive article provides insight into the different types of interest rates available. You can also refer to our reverse mortgage calculator to receive an estimate for your loan, whether it’s a lump sum at a fixed rate or variable rate. 

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