In what type of loan is the interest rate tied to some economic index?

An adjustable rate mortgage (ARM) is characterized by an interest rate that is tied to an economic index. This means that the interest rate can change over time based on fluctuations in that index, which is often linked to broader financial indicators like Treasury yields or the Cost of Funds Index. Homeowners with an ARM typically start with a lower initial interest rate, which can adjust after a predetermined period, leading to potential increases (or decreases) in monthly payments depending on market conditions.

This linkage to an economic index allows the lender to adjust the interest rates periodically, reflecting current economic circumstances. Since ARMs can provide more favorable initial rates, they can be attractive to borrowers who may plan to sell or refinance before rates adjust significantly.