Definition and Example of Current Indexed Value
The current indexed value is the value your lender uses to determine how much you pay for a variable rate loan. If you’ve recently taken out a variable-rate loan, the indexed rate is one of the factors that determines your interest rate. The indexed rate is set by your lender and can be based on the following indexes:
Federal Funds RatePrime RateThe London Interbank Offer Rate (LIBOR)The Cost of Savings Index (COSI)
Your lender will calculate your interest rate using the indexed rate and the margin. The margin is based on your credit score and financial information. The amount you’re required to pay is known as the fully indexed rate.
How Current Indexed Value Works
When you take out an adjustable-rate mortgage, your rate will stay the same for the first couple of years. After that, it will adjust annually with the market.That means your interest rate is based on market conditions, not your credit score or financial situation. When it’s time for your interest rate to adjust, your lender will use the margin and index to determine your new rate. The index is a benchmark interest rate that changes based on current market conditions. The indexed rate can be based on several different factors, including the London Interbank Offer Rate (LIBOR), the Cost of Savings Index (COSI), or the lender’s prime rate. This index is usually determined when you first take out the mortgage and shouldn’t change after closing. For instance, if you take out an adjustable-rate mortgage through Wells Fargo, your interest rate is determined using the Wells Fargo Cost of Savings Index (Wells COSI). This index is calculated monthly and uses a weighted average of the interest rates paid on CDs by individual deposit holders. From there, your lender will add a certain number of percentage points to the index to determine your interest rate. These percentage points are known as the margin. The margin is also set before closing on the loan, and it won’t change. The total margin amount can vary depending on your lender. Once you add the margin and the index together, you get your fully indexed rate.
Pros and Cons of Adjustable-Rate Mortgages
Pros Explained
Low introductory rate: Some people like ARMs because they come with a low introductory rate. That means your mortgage payments could be more affordable for the first few years you own the home. For instance, if you take out a 5/1 ARM, your interest rate is locked in for the first five years before adjusting annually. Flexible terms: If you don’t plan to stay in the house for long, an ARM could be a good option. You can enjoy a few years of low interest rates and then either sell the house or refinance to a fixed-rate loan. Rate cap: ARMs come with a rate cap, which means your interest rate cannot rise beyond a certain point. This can provide some peace of mind to borrowers.
Cons Explained
Rate will change over time: After the initial loan period, your interest rate will adjust annually. If interest rates are rising, that means your payments will go up. It can be quite a shock to some borrowers when they see their interest rate start to adjust.Unexpected hurdles: You may take out an ARM assuming you’ll sell the house in a few years, but things don’t always go as planned. You could find yourself unable to sell the home and unable to make your mortgage payments after the interest rate adjusts.
