An ARM is often tied to a market interest rate or interest rate index.

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Statement context: The claim is that an ARM is often tied to a market interest rate or interest rate index.

Exploration of the concept: An ARM, or adjustable-rate mortgage, is specifically designed so that the interest rate can change over time. This variability is achieved by linking the rate to a recognized market index or reference rate.

Why this linkage is typical: In most ARM arrangements, the lender selects an index (for example, a widely used market rate such as SOFR, LIBOR in the past, the Prime Rate, or another published index) and adds a fixed margin or spread. The combination determines the actual rate charged to the borrower at different adjustment periods. This setup ties the borrower’s cost of borrowing to broader market conditions, rather than keeping a constant rate for the life of the loan.

What this implies about the statement: Because ARMs rely on a market-based index to establish the rate adjustments over time, the assertion that an ARM is tied to a market rate or index accurately describes a fundamental feature of these loans.

Contrast and clarifications: For comparison, a fixed-rate mortgage maintains the same rate for the entire term, illustrating how deviation from this linkage would define a different product. Some ARMs may have caps, floors, or margins that limit how much the rate can move, but the core mechanism remains the index-based adjustment tied to market conditions.

In summary, the wording accurately captures the essential characteristic of ARMs being linked to an external market rate or index, which explains why borrowers’ interest costs can fluctuate over the life of the loan.

29:390:370:W1 Final Exam Winter 2025

An ARM is often tied to a market interest rate or interest rate index.

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