What is the main component used to adjust the interest rate in an adjustable-rate mortgage?

In an adjustable-rate mortgage (ARM), the interest rate is primarily influenced by an index. The index is a benchmark interest rate that reflects the general trend of interest rates in the economy, such as the LIBOR (London Interbank Offered Rate) or the yield on U.S. Treasury securities. The lender adds a margin to this index, which is a fixed percentage that covers the lender's costs and profit. Together, the index and the margin determine the actual interest rate that the borrower will pay throughout the life of the mortgage.

The choice of the index is crucial because it is subject to market fluctuations, which means the interest rate on an ARM can change at specified intervals, leading to potentially higher or lower monthly payments over time. This mechanism allows borrowers to benefit from lower rates in a declining interest rate environment, while also exposing them to increased costs if rates rise.

Other components, such as the margin or calculating rate, play roles in the ARM structure but do not serve as the primary variable that dictates the rate adjustments; rather, they complement the index in setting the final interest rate for the borrower.