An index rate is used by lenders to determine the interest rate on variable rate loans, such as credit cards, home equity loans, personal loans, and auto loans. Different index rates are used for each type of loan, with the prime rate being the most common in the US. The final interest rate is determined by adding the bank’s margin to the index rate.
An index rate is the standard lenders use to determine the amount of interest a borrower will pay on a variable rate loan. In general, credit cards, home equity loans, personal loans, and auto loans are variable rate loans. Unlike a fixed-rate loan, which uses a fixed interest rate for the life of the loan, the interest rate on a variable-rate loan fluctuates periodically. In other words, the interest rate on the loan changes, usually every three, six, or twelve months, based on a specific index rate.
Typically, based on a particular money market rate or the average interest rate in a particular business market, different index rates are used for each type of loan. In the United States, for example, the prime rate is the most common factor used to determine interest rates for variable rate loans. Reported daily by the Wall Street Journal, the prime rate is based on banks’ borrowing costs in the global market, as well as the rate of return offered on certificates of deposit, savings accounts and money market accounts. The interest rate for an adjustable rate mortgage, on the other hand, is generally determined by the cost of funds index (COFI) rate. This is the average amount of interest paid by banks and other financial institutions in a particular region.
Other commonly used index rates include the London Interbank Offered Rate (LIBOR), the Constant Maturity Treasury (CMT), and the Cost of Savings Index (COSI). Updated daily, LIBOR is based on the interest rate banks are charged for borrowing unsecured funds on the London wholesale money market, while CMT is based on the weekly or monthly average of a bank’s treasury values. country. COSI uses the average interest rate that depositors of a particular bank pay on their certificates of deposit. All index rates are regularly published and consumers can easily find them once they know which index rate their loan uses.
Although the index rate greatly influences the interest rate on a loan, the final rate is determined by adding the amount charged by the bank, or margin, to the index rate. For example, if the index rate is 5% and the bank’s margin is 2%, the final interest rate would be 7%. Typically, borrowers can expect to receive a margin rate of 2% to 4%, however the exact amount varies depending on the bank and the applicant’s credit history.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
