In an adjustable rate mortgage, what dictates the changes in interest rates?

In an adjustable rate mortgage (ARM), the changes in interest rates are dictated by a market index. A market index is a benchmark interest rate that reflects the general level of interest rates in the economy. These indexes can vary widely, including options such as the London Interbank Offered Rate (LIBOR), the Constant Maturity Treasury (CMT), or the Cost of Funds Index (COFI).

The specified market index serves as a reference point for adjusting the interest rate on the mortgage at predetermined intervals, such as annually or semi-annually. As the index fluctuates due to economic conditions, the interest rate on the mortgage will adjust accordingly. This relationship ensures that the mortgage rate is aligned with current market conditions, protecting lenders and affecting the borrower's monthly payment amounts.

In contrast, the other options do not accurately capture the mechanism of rate adjustment in an ARM. The mortgage term merely indicates the overall duration of the loan, while the lender's discretion pertains to credit evaluation and loan approval rather than interest rate adjustments. Finally, while the borrower's credit score does play a significant role in determining the initial interest rate offered, it does not influence the adjustments made to the rate after the loan has been originated.