An index is an economic or statistical indicator to measure changes in the economy as a whole or specific industries.
The total interest rate of home loans consisting of index plus margin is know as the fully indexed rate.
While the general purpose of these indices are for research and economic tracking, the adoption of them by lenders to determine interest rates on mortgages have made consumers aware of their existence.
Some of the common indices used for mortgages include:
- Interbank rates like LIBOR and EURIBOR
- Treasury bills
- Fed fund rate
- Cost of Funds Index (COFI)
- Certificate of Deposit (CD Index)
- Federal discount rate
- Wall Street Journal prime
- Other prime rates
Incorporating publicly-available indices into home loans can give borrowers more confidence in the system as they are usually calculated with many variables that no one single party will be able to manipulate.
This is as opposed as to a bank’s internal board rate where they can decide as and when to increase it for whatever reasons they like.
This is why I never recommend ARMs with index rates that are fully controlled by the lender itself.
He would have to either incur the wrath of penalty fees to refinance, or suck it up and pay the lender whatever they quote as the interest rate.