What does the formula for an adjustable-rate mortgage (ARM) include?

The formula for an adjustable-rate mortgage (ARM) primarily involves two main components: the index rate and the margin. The index rate is a benchmark interest rate that fluctuates based on market conditions, while the margin is a fixed percentage that is added to the index rate to determine the overall interest rate on the mortgage.

In a typical ARM, the interest rate is calculated by taking the current value of the index rate and adding the margin agreed upon at the inception of the loan. This combination results in the total interest rate that the borrower will pay during the adjustment periods of the loan.

It's important to note that while the loan amount is crucial in determining the borrower's payment obligations, it is not part of the formula to calculate the interest rate itself. Similarly, an interest cap pertains to limits on the changes in the interest rate but does not directly factor into the computation of the rate. The focus of the ARM formula revolves specifically around the dynamic nature of the index and the fixed margin.