How is the rate on an adjustable-rate mortgage typically calculated at adjustment?

The rate on an adjustable-rate mortgage (ARM) is typically calculated at adjustment by adding the index to the margin. This method reflects how ARMs function, as their interest rates are designed to fluctuate based on changes in a specific benchmark, or index, such as the London Interbank Offered Rate (LIBOR) or another market-based rate. The margin is a fixed percentage added to the index, representing the lender's profit. Therefore, to determine the new interest rate at the time of adjustment, you take the current value of the index and add the margin agreed upon in the loan agreement.

This calculation directly impacts the borrower's monthly payment amount and reflects the true cost of borrowing as market rates change. Understanding this mechanism is crucial for borrowers to anticipate how their payments may vary over time and to assess their financial strategy for managing an ARM.