The published cost of money that serves as the minimum basis for determining the interest rate for an adjustable rate mortgage. Among the commonly used indices are the Prime Rate (Prime), the London Interbank Offering Rate (LIBOR), the Cost of Funds (COF) and the 1 year Treasury Bill (1 year T). The particular index is generally, though not always, selected based on how often an interest rate is supposed to adjust. Loans which allow monthly interest rate adjustments commonly use the Prime Rate. Loans that adjust semi-annually may use LIBOR. The 1 year Treasury and the Cost of Funds are often used for loans which adjust on an annual basis. There are other Treasury instruments which are used for 3 and 5 year adjustment periods. The interest rate of the loan is determined by adding a margin to the index. The size of the margin is typically a function of the index used and the credit worthiness of the borrower. Typical margins on a Prime Rate based loan would be 0.0 to 5.0 so that if the Prime Rate were 8.25% and the margin were 2.0 (typical for an “average” borrower), the interest rate would be 10.25% (8.25 + 2.0).
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