What is a Fully Indexed Interest Rate?
A fully indexed interest rate is a variable interest rate that is being calculated by adding a margin to a specified index interest rate. This interest rate equals an adjustable-rate mortgage’s (ARM) interest rate benchmark plus a spread. A fully indexed interest rate can differ broadly depending on the assigned margin above that baseline rate or what maturity term that the underlying index is measured at.
How Does a Fully Indexed Interest Rate Work?
The interest rate on an ARM tally to a particular benchmark (most times prime rate, but sometimes LIBOR, the one-year constant-maturity Treasury, or other benchmarks) plus a spread (which is also known as margin, and its size is mostly based on the borrower’s credit score). The benchmark plus the spread equals the interest rate on the loan which is known as the fully indexed rate. Some ARMs also offer a discounted index rate, which is known also as a teaser rate, probably during the first year.
Does a Fully Indexed Interest Rate Matter?
Sometimes, ARMs have caps which are limits on how high and sometimes how low the interest rate can go, as well as how much they can move in a year, month or quarter. However, in some cases, the interest rate will only adjust up, where borrowers get no benefit if interest rates fall. Note also, that because of its risk arrangement, ARMs often carry lower interest rates than fixed-rate mortgages. This in turn may allow borrowers to borrow more than they could under fixed-rate mortgages.
Difference Between InterestRate &FullyIndexed Interest Rate
In order not to be trapped in a bad ARM. It is important to understand the basic difference between the interest rate and the fully indexed rate (FIR).
The ARM interest rate is the rate you can see. It is a rate quoted by the loan provider and the rate shown in the media. It is also the same as the rate on a fixed-rate mortgage. With one difference. The ARM rate holds only for a specified initial period. Which can be as short as a month, and as long as 10 years. At the end of that period, the rate is adjusted.
FIR, on the other hand, is the rate you don’t see. It is never quoted, never shown in the media. And is not a required disclosure. However, it is the major indicator of what will happen to the rate at the end of the initial rate period.
If the initial rate period is long. And the borrower expects confidently to be out of the house before the initial period is over, then the FIR is unimportant. On the other hand, if the initial rate period is short. Or if there is a reasonable probability that the borrower will still have the mortgage when it ends. Then the FIR is critically important to the borrower.