What Is ARM Margin?

ARM Margin Explained in Less Than 4 Minutes

Definition

ARM margin is the number of percentage points of interest a lender adds to the index to determine the total interest rate on an adjustable-rate mortgage (ARM).

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Definition and Examples of ARM Margin

ARM margin is the number of percentage points you’ll pay on top of the index rate as part of your interest rate on an adjustable-rate mortgage. The index will change depending on market conditions, but the margin won’t change over the life of the loan. However, different lenders may offer different ARM margins.

  • Alternate name: Mortgage margin

As you’re shopping around for a mortgage, pay attention to both the index and the margin offered by each lender. Choosing a lender that offers a lower margin means you may pay less overall interest on your ARM.

For example, let’s say you’re looking to take out a 30-year ARM for $300,000. If the first lender you speak with offers a margin of 2% and an index of 5%, the fully indexed rate is 7%. But if you find a lender that offers a margin of 1.5% and an index of 5%, your total interest rate is only 6.5%.

How ARM Margin Works

When you have an ARM, your interest rate will change periodically over the life of the loan. Four components determine how much you’ll pay in interest: the index, the margin, the interest rate cap, and the initial rate period.

After you close on your mortgage, there is an initial period where you’ll have a low interest rate. During this period, your interest rate may be lower than what you would have received on a fixed-rate mortgage.

Once that initial rate period is over, your interest rate will adjust to a new level calculated by adding the margin to the index. Your lender will disclose the ARM margin during the initial loan application process. The margin won’t change over the life of the loan, but the index rate will vary based on what’s happening in the market.

As the index goes up or down, your interest rate will follow it. However, your interest rate will never surpass the interest rate cap, which protects you from excessive interest rate changes.

Some lenders offer an annual interest rate cap that limits how much your interest rate can go up or down in a given year. Other lenders provide a lifetime cap, which specifies the minimum and maximum interest rates you’ll ever pay on the loan.

Index vs. Margin

Index Rate ARM Margin
A benchmark interest rate that reflects the market A percentage determined by your lender and added to the index rate
Changes periodically based on market conditions Stays the same for the life of the loan

The index and the margin are two critical components of an ARM. The index is a benchmark interest rate that is usually based on the Constant Maturity Treasury (CMT) index or the one-year London Interbank Offered Rate (LIBOR). The index rate changes periodically depending on what’s happening in the market.

In comparison, ARM margin is the number of percentage points added to the index rate. When you apply for an ARM, your lender will disclose the margin; once you close on the mortgage, the margin will stay the same for the life of the loan.

By adding the margin to the index rate, you’ll get the fully indexed rate, which determines the amount of interest you’ll pay on an ARM.

Key Takeaways

  • ARM margin is the number of percentage points added to the index rate on an adjustable-rate mortgage.
  • When you add the margin and index together, you get the fully indexed rate, which is your total interest rate.
  • The index will change depending on market conditions, but the margin will stay the same over the life of the loan.
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Sources
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  1. U.S. Department of Housing and Urban Development. "Adjustable-Rate Mortgages (ARM)." Accessed Sept. 9, 2021.

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