In an ARM, what does the index represent and what is the margin?

• A. Margin alone determines rate.
• B. Index is a market benchmark rate; margin is the lender’s fixed markup; sum determines rate after adjustments.
• C. Index is fixed; margin is prepaid points.
• D. Index is credit score; margin is loan-to-value.

Answer: (B)

In an ARM, the interest rate is built from two pieces: the index and the margin. The index is a market benchmark rate that changes with conditions in the broader financial markets. The margin is a fixed markup added by the lender and stays the same for the life of the loan. On each adjustment date, you take the current index value and add the fixed margin to determine the new rate, subject to any caps or floors in the loan terms. So the rate you pay is the sum of the index and the margin (with any applicable adjustments).

That combination is why the correct description is that the index is a market benchmark rate, the margin is the lender’s fixed markup, and the rate after adjustments is the sum of those two. The other statements don’t fit because the rate isn’t determined by the margin alone, the index isn’t fixed or described as prepaid points, and the index isn’t a credit score while the margin isn’t based on loan-to-value.