Nationwide Mortgage Licensing System (NMLS) Practice Exam

Which of the following is incorrect regarding an adjustable-rate mortgage?

1. The index is fixed

2. The margin is fixed

3. There are rate caps on both the adjustment period and the life of the loan

4. LIBOR is a typical index used

The correct answer is: The index is fixed

An adjustable-rate mortgage (ARM) is characterized by its flexibility in interest rates, which are typically tied to an index. The index itself is variable and reflects the changes in market interest rates. This means that the index can fluctuate over time, impacting the interest rate of the mortgage. In contrast, the margin – which is the fixed percentage added to the index to determine the overall interest rate charged to the borrower – remains constant throughout the life of the loan. Additionally, adjustable-rate mortgages often include rate caps that limit how much the interest rate can increase during each adjustment period and over the lifetime of the loan, providing some protection to borrowers from significant interest rate hikes. LIBOR (London Interbank Offered Rate) is indeed a common index utilized for ARMs, and among the features described in the question, the notion that the index is fixed is incorrect because it is inherently variable, designed to react to the changes in broader economic conditions. Thus, the correct understanding emphasizes that while margins and certain caps can be fixed, the index used in an adjustable-rate mortgage is not.