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One of the components used to calculate the interest rate for an adjustable rate mortgage (ARM). The other is called the index.

Margin is one of the components used to calculate the interest rate for an adjustable rate mortgage (ARM). The other is called the index.

The margin is an amount (expressed as a percentage) that a mortgage lender adds to a published index to calculate an ARM rate.

The index is a benchmark rate, determined by market forces and published by a neutral third party. For example, the London Interbank Offered Rate, or LIBOR, is a common index managed by the ICE Benchmark Administration (IBA), and is based on five currencies: U.S. dollar (USD), Euro (EUR), pound sterling (GBP), Japanese yen (JPY) and Swiss franc (CHF).

Setting ARM rates

When setting ARM rates, mortgage lenders add the index to a margin, which is defined in the loan’s documents and agreed to by the lender and borrower. If the current LIBOR index rate is .71 percent, and a loan’s margin is 3.00 percent, the ARM interest rate would be 3.71 percent.

The index moves in response to economic changes; it is not under the control of the borrower or lender. The margin, however, is negotiated between the borrower and lender. It represents income to the lender.

The index is a published interest rate which lenders use to measure the difference between the current interest rate on an ARM and that earned by other investments.  Those investments include one- three-, and five-year U.S. Treasury Security yields, the monthly average interest rate on loans closed by savings and loan institutions and the monthly average Costs-of-Funds incurred by savings and loans.  This difference is then used to adjust the interest rate up or down on an ARM.

Margins and indices establish the final interest rate on a loan.  For example, if you have a mortgage and the index is 4 percent and the margin is 2.75 percent, your final interest rate will be 6.75 percent.

Fixed Rate VS ARM

Before you even look at margins and indices on mortgages, you will first need to decide between a fixed-rate mortgage and an ARM.  If interest rates are low, you might want to go with a fixed-rate mortgage because it helps protect you against future increases in interest rates.  But if interest rates are high, an ARM might give you the opportunity to take advantage of lower interest rates, should they occur in the future.  An ARM might also be right for you if you only plan on keeping your home for a short amount of time. 

If you have decided that an ARM is right for you, shop around for the loan program with the best features.  Margins and indices are just two components to consider when you are looking at ARMs.  You will also need to look at other factors including initial interest rates, closing costs and caps.

The margin on a mortgage is just one way that lenders profit from doing business with you, so finding the lowest margin can help you save money when you buy a home.