Fully Indexed Rate: Detailed Definition
In adjustable-rate mortgages (ARMs), the fully indexed rate is crucial for determining future mortgage payments. It is calculated by adding the current value of a specific index to a predetermined margin. This combination reflects the interest rate that borrowers will pay once the initial rate period ends and in the absence of any interest rate caps (limits on rate adjustments).
Examples
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Example 1: Basic Calculation
- Initial Scenario: An ARM is linked to the one-year Treasury bill rate.
- Index Value: The current value of the Treasury bill rate is 3%.
- Margin: The loan has a margin of 2.5%.
- Initial Interest Rate: The initial rate for the first year is 4.0%.
- Fully Indexed Rate: After the first year, the fully indexed rate becomes 5.5% (3% index + 2.5% margin).
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Example 2: Rate Adjustment with Caps
- Index Changes: Suppose in the second year, the index value increases to 4%.
- New Fully Indexed Rate: The new fully indexed rate would be 6.5% (4% index + 2.5% margin).
- Cap Application: However, if there’s a cap that limits rate increases to 2 percentage points yearly, the actual interest rate would only adjust to 6.0%.
Frequently Asked Questions (FAQs)
What is the fully indexed rate?
- The fully indexed rate is the rate determined by adding the current value of an index to the loan’s margin. It informs the interest rate charged once any initial rates or caps are no longer applicable.
How often does the fully indexed rate change?
- The frequency of change in the fully indexed rate depends on the type of index used and the loan agreement. Commonly, indices used can change annually, semi-annually, or at different intervals prescribed by the mortgage terms.
What indices are commonly used for calculating the fully indexed rate?
- Commonly used indices include the London Inter-Bank Offered Rate (LIBOR), Prime Rate, the Cost of Funds Index (COFI), and U.S. Treasury bill rates.
Do caps affect the fully indexed rate?
- Caps do not affect the fully indexed rate itself but can limit how much the interest rate can increase or decrease at adjustment intervals.
Why are margins applied to the index value?
- Margins are lender-specific percentages added to the index rate to determine the fully indexed rate. They account for the lender’s cost and desired profit margin.
Related Terms with Definitions
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Adjustable-Rate Mortgage (ARM): A mortgage with an interest rate that adjusts periodically based on changes in a corresponding financial index associated with the loan.
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Initial Rate: The starting interest rate of an ARM, often lower than the fully indexed rate, and usually set for a specific period (e.g., 1 year, 5 years).
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Caps: Limits on the amount the interest rate of an ARM can increase or decrease at each adjustment period or over the life of the loan.
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Teaser Rate: A temporarily low introductory rate charged at the beginning of an ARM’s term, before the fully indexed rate kicks in.
Online Resources
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Investopedia: Adjustable Rate Mortgage (ARM)
- Link: Investopedia ARM Guide
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Consumer Finance Protection Bureau (CFPB): Adjustable-rate mortgages (ARMs)
- Link: CFPB ARM Guide
References
- Freddie Mac: “Enhanced looks at ARM Plans” - Freddie Mac ARM Guide
- Federal Reserve: “Buying a Home: Understanding ARMs” - Federal Reserve ARM Guide
Suggested Books for Further Studies
- “The Real Estate Wholesaling Bible” by Than Merrill
- “How to Invest in Real Estate” by Brandon Turner
- “The Book on Rental Property Investing” by Brandon Turner
