Which type of loan uses an index and margin to determine the interest rate?

An adjustable-rate mortgage (ARM) uses an index and a margin to determine its interest rate, making it distinct from fixed-rate mortgages or other loan types. In an ARM, the interest rate is not fixed for the entire term of the loan; instead, it fluctuates based on a specific benchmark interest rate, known as the index.

The margin is a set percentage added to the index rate. For example, if the chosen index is at 3% and the margin is 2%, the resulting interest rate would be 5%. This means that the payment amounts can change periodically, usually in line with the terms outlined in the mortgage agreement. This structure can lead to lower initial rates compared to fixed-rate mortgages, but also carries the risk of increased payments if interest rates rise.

In contrast, a fixed-rate mortgage maintains the same interest rate throughout the life of the loan, providing stability but often at a higher initial rate. A graduated payment mortgage includes a payment schedule that starts low and increases over time but does not depend on an index or margin. Lastly, a conventional mortgage may or may not be fixed-rate, but it does not utilize the index and margin structure that characterizes adjustable-rate mortgages. Understanding this distinction is key to selecting the appropriate