Massachusetts Real Estate License Practice Test

In the context of an adjustable rate mortgage, what does the interest rate adjust according to?

1. Market trends

2. Homeowner's income

3. A pre-selected index

4. The lender's discretion

The correct answer is: A pre-selected index

In the context of an adjustable-rate mortgage (ARM), the interest rate adjusts according to a pre-selected index. This index is a benchmark that reflects the cost of borrowing or the prevailing interest rates in the market. It is typically tied to economic indicators such as treasury bills, LIBOR, or other financial indices. When the index changes, the interest rate on the mortgage adjusts accordingly, which can result in either an increase or decrease in the monthly payment. This method provides a transparent way to determine how interest rates will adjust over time, as they are linked to an objective financial market point rather than subjective measures like a lender's discretion or individual financial factors such as a homeowner's income. Understanding the significance of the chosen index is crucial for borrowers, as it directly impacts their financial situation over the life of the loan.