All adjustable rate mortgages have an adjusting interest rate tied to an index.[1]
In Western Europe, the index may be the ECB Refi rate (where the mortgage is called a tracker mortgage), TIBOR or Euro Interbank Offered Rate (EURIBOR).
Six common indices in the United States are:
11th District Cost of Funds Index (COFI)
London Interbank Offered Rate (LIBOR)
12-month Treasury Average Index (MTA)
Constant Maturity Treasury (CMT)
National Average Contract Mortgage Rate
Bank Bill Swap Rate (BBSW)
In some countries, banks may publish a prime lending rate which is used as the index. The index may be applied in one of three ways: directly, on a rate plus margin basis, or based on index movement.
A directly applied index means that the interest rate changes exactly with the index. In other words, the interest rate on the note exactly equals the index. Of the above indices, only the contract rate index is applied directly.[1]
To apply an index on a rate plus margin basis means that the interest rate will equal the underlying index plus a margin. The margin is specified in the note and remains fixed over the life of the loan.[1] For example, a mortgage interest rate may be specified in the note as being LIBOR plus 2%, 2% being the margin and LIBOR being the index.
The final way to apply an index is on a movement basis. In this scheme, the mortgage is originated at an agreed upon rate, then adjusted based on the movement of the index.[1] Unlike direct or index plus margin, the initial rate is not explicitly tied to any index; the adjustments are tied to an index.
In Western Europe, the index may be the ECB Refi rate (where the mortgage is called a tracker mortgage), TIBOR or Euro Interbank Offered Rate (EURIBOR).
Six common indices in the United States are:
11th District Cost of Funds Index (COFI)
London Interbank Offered Rate (LIBOR)
12-month Treasury Average Index (MTA)
Constant Maturity Treasury (CMT)
National Average Contract Mortgage Rate
Bank Bill Swap Rate (BBSW)
In some countries, banks may publish a prime lending rate which is used as the index. The index may be applied in one of three ways: directly, on a rate plus margin basis, or based on index movement.
A directly applied index means that the interest rate changes exactly with the index. In other words, the interest rate on the note exactly equals the index. Of the above indices, only the contract rate index is applied directly.[1]
To apply an index on a rate plus margin basis means that the interest rate will equal the underlying index plus a margin. The margin is specified in the note and remains fixed over the life of the loan.[1] For example, a mortgage interest rate may be specified in the note as being LIBOR plus 2%, 2% being the margin and LIBOR being the index.
The final way to apply an index is on a movement basis. In this scheme, the mortgage is originated at an agreed upon rate, then adjusted based on the movement of the index.[1] Unlike direct or index plus margin, the initial rate is not explicitly tied to any index; the adjustments are tied to an index.
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