What You Should Know About Indexes
Homebuyers commonly ask how lenders set their rates on adjustable rate mortgage (ARM) loans, and what causes a rate to fluctuate. Here's what you can tell them:
Whether a loan starts with an initial fixed rate, or is adjustable from the beginning, lenders set adjustable rates using indexes, because indexes are good indicators of variations in economic conditions. As those conditions fluctuate, so, too, does a loan's adjustable rate. Here are two commonly used indexes:
The London Interbank Offered Rate (LIBOR), based in London and used globally, is one of the most widely used indexes to adjust ARMs. Published by the British Bankers Association, the LIBOR tracks the rate by which banks in London's wholesale money markets exchange money between one another. The LIBOR was traditionally used to benchmark interest rates for corporate financial transactions. However, it grew to be such a reliable economic barometer, without wide fluctuations, that it was adopted by mortgage lenders to gauge ARM interest rates.
The Monthly Treasury Average (MTA) index is based on the 12-month "rolling" average of returns on U.S. Treasury Bills (T-Bills). Each month, the MTA totals up the sum of returns on those T-Bills for the past 12 months, divides that sum by 12 and the yield is the 12-month MTA rate. The MTA is a commonly used index for two key reasons: It does not widely fluctuate, seeing monthly fluctuations of no more than 0.26 percent over the past decade. Also, because the MTA's rate reflects historical activity, it takes longer for the MTA rate to change, while others might rise or drop more quickly.
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