Adjustment Index

Definition

An adjustment index is a benchmark interest rate used to calculate the interest rate of an Adjustable-Rate Mortgage (ARM) both at the origination time and over the life of the loan during adjustment periods. This index, combined with the loan’s margin, determines the new interest rate each adjustment period.

Examples

One-Year Treasury Bill Rate: Often used in ARMs that adjust yearly, this rate is based on the yield of a one-year Treasury bill auctioned by the U.S. government.
London Interbank Offered Rate (LIBOR): A common benchmark in international finance, especially in ARMs, derived from the rate at which banks lend to each other on the London interbank market.
Cost of Funds Index (COFI): This index is calculated based on the weighted average of interest rates paid by financial institutions for funds, often used in ARMs for their stability over long periods.

Frequently Asked Questions

1. What are the common indices used in ARMs? Common indices include the One-Year Treasury Bill Rate, LIBOR, and COFI. Others may include the Prime Rate and the 11th District Cost of Funds Index.

2. How does the adjustment index affect my ARM? The adjustment index, combined with the loan’s margin, determines your ARM’s interest rate at each adjustment period, impacting your monthly mortgage payments.

3. Can the adjustment index change over the life of my loan? Yes. The index can fluctuate over time based on market conditions, which means your interest rate and monthly mortgage payment can increase or decrease accordingly.

4. Is there a cap on how much my interest rate can change? Yes, most ARMs have interest rate caps that limit how much the rate can increase or decrease at each adjustment period and over the life of the loan.

Adjustable-Rate Mortgage (ARM): A type of mortgage loan where the interest rate changes periodically based on an index.
Margin: The fixed percentage added to the index rate to calculate the adjustable interest rate of an ARM.
Interest Rate Cap: A limit on the amount the interest rate can change per adjustment and over the loan’s term.
Initial Rate Period: The initial period during which the interest rate on an ARM is fixed before it starts to adjust.

Online Resources

References

“Mortgage Financing: ARM Index Types and Structure”, Journal of Real Estate Finance and Economics.
U.S. Treasury, Auction Results for All Securities.
“Global Financial Markets”, by Anthony Saunders and Marcia Millon Cornett.
Federal Home Loan Bank of San Francisco, “COFI Calculation and Use”.

Suggested Books for Further Studies

“The Mortgage Encyclopedia: The Authoritative Guide to Mortgage Programs, Practices, Prices and Pitfalls, Second Edition” by Jack Guttentag
“All About Mortgages: Insider Tips to Finance or Refinance Your Home, Second Edition” by Julie Garton-Good
“Mortgage Management for Dummies” by Eric Tyson
“Making Sense of mortgage rates & fees: a guide for real estate and financial professionals” by Michale P. Brownell

Real Estate Basics: Adjustment Index Fundamentals Quiz

### What is an Adjustment Index primarily used for in real estate? - [ ] Determining property value - [x] Calculating the interest rate of an ARM - [ ] Setting rental prices - [ ] Calculating property taxes > **Explanation:** An adjustment index is used to calculate the interest rate of an Adjustable-Rate Mortgage (ARM) when the rate adjusts. ### Which of the following is NOT a common adjustment index? - [ ] One-Year Treasury Bill Rate - [ ] LIBOR - [ ] Cost of Funds Index (COFI) - [x] Consumer Price Index (CPI) > **Explanation:** The Consumer Price Index (CPI) is not typically used as an adjustment index for ARMs. The One-Year Treasury Bill Rate, LIBOR, and COFI are common indices. ### When does the initial rate period in an ARM usually expire? - [x] At the end of the initial fixed-rate period - [ ] Every month - [ ] At the start of the loan - [ ] Every year regardless of term > **Explanation:** The initial rate period refers to the time when the ARM starts with a fixed interest rate before switching to an adjustable rate. ### What is added to an adjustment index to determine the new rate of an ARM during adjustment? - [ ] Principal amount - [x] Margin - [ ] Down payment - [ ] Property insurance > **Explanation:** The margin, a set percentage, is added to the adjustment index to determine the new interest rate for an ARM. ### If the One-Year Treasury Bill Rate is 1% and the margin is 2%, what would be the new ARM rate? - [ ] 1% - [ ] 2% - [x] 3% - [ ] Cannot be determined > **Explanation:** To calculate the ARM rate, add the adjustment index of 1% to the margin of 2%, resulting in a new ARM rate of 3%. ### Which index would likely make an ARM more susceptible to international market changes? - [ ] One-Year Treasury Bill Rate - [x] LIBOR - [ ] COFI - [ ] Prime Rate > **Explanation:** LIBOR is based on rates at which banks lend to each other on the London interbank market and is influenced by international market changes. ### Does an ARM with a COFI index generally show more stability over time when compared to one with a LIBOR index? - [x] Yes - [ ] No - [ ] Only during a recession - [ ] Only for residential loans > **Explanation:** ARMs using the COFI index tend to show more stability over time compared to those using the LIBOR index, which can be more volatile. ### Can an adjustment index impact monthly mortgage payments on an ARM? - [x] Yes - [ ] No - [ ] Only annually - [ ] Only due to missed payments > **Explanation:** An adjustment index can impact mortgage payments as it influences the interest rate, which, in turn, affects monthly payments. ### What is the primary reason ARM interest rates are adjusted? - [ ] Owner-occupied designation - [ ] Vacancy rates - [x] Fluctuations in the market-determined indices - [ ] Changes in property management > **Explanation:** ARM interest rates are adjusted due to fluctuations in the market-determined indices which affect the benchmark interest rate. ### For which of the following would an ARM with a one-year Treasury Bill Rate be most suitable? - [ ] A 30-year loan where stability is key - [ ] Short-term real estate investment - [x] Those expecting interest rates to fall - [ ] Homeowners against any rate changes > **Explanation:** An ARM with a one-year Treasury Bill Rate might be most suitable for those expecting interest rates to fall, thus benefiting from potentially lower monthly payments.