Margin is the fixed percentage added to the index rate in an adjustable-rate mortgage (ARM) to determine the interest rate charged to the borrower. The index rate is a benchmark interest rate, which fluctuates over time and depends on market conditions. Examples of such rates include the London Interbank Offered Rate (LIBOR) or the U.S. Prime Rate.
When you have an ARM, your interest rate is not fixed for the entire loan term. Instead, it adjusts periodically, typically annually. It depends on changes in the index rate. The margin is a constant value specified in the loan agreement, representing the lender’s profit margin and covering their cost of doing business.
To calculate the interest rate charged to the borrower, add the margin to the current index rate at the time of adjustment. For example, if the index rate is 3% and the margin is 2%, the interest rate on the ARM would be 5%.
It’s important to note that the margin determines how much your interest rate can change over the life of the loan. Other factors include the index rate and any adjustment caps or limits. Together, they are specified in the loan agreement. They provide transparency and allow borrowers to understand the potential adjustments to their interest rates.
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