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You have a lot of choices to make in buying a house and deciding upon a home loan, and in today’s confusing loan world, you now also have to choose the index that you want for your Adjustable Rate Mortgage (ARM).

The index is the underlying instrument that is used as a basis for the change of the mortgage rate. Various indices are employed, including government treasury instruments, the Fed Fund rate or LIBOR.

The basic idea of an ARM is that the interest on the loan is adjusted up or down, periodically, based on a chosen underlying interest rate that is indicative of interest rates in general. One such instrument would be Certificates of Deposit-your loan rate would go up and down with the CD rate. Adjustable rate mortgages have adjustment caps, which means that the interest rate can only be adjusted at certain periods, even if the underlying interest rate goes up more often; this can be an advantage if you just readjusted and then rates move up. Of course, the opposite can happen, and if your rate has recently been readjusted at a high rate, and then the index moves down, you will not be able to take advantage of that until your next readjustment period.

ARMs can be tied to a lot of underlying instruments, such as the 90 day U.S. Treasury Bill. The Fed Funds rate is another very popular basis for ARMs. Another popular index used by a lot of lenders is the LIBOR, or the London Interbank Offered Rate, which well rated international companies pay to borrow.

Which is the right choice depends on your own circumstances and your view of where interest rates are heading. CD ARMs change every six months, for example, and therefore react more readily to interest rate changes. ARMs that have the Tbill rate as the index do not move as frequently as the CD index. LIBOR is one of the quickest moving indices, so if you want to take advantage of rapidly falling interest rates, this is the one to use.

An option ARM is one in which the interest rate adjusts monthly and the payment adjusts every year, and the borrower is offered an “”option”" on how large a payment he would like to make. Of course, there is a minimum, normally the amount of interest, so the bank can guarantee its return, and then the balance goes toward the mortgage principle. One of the big problems with an option mortgage is that you can get an increasing instead of decreasing mortgage; this is also known as negative amortization.

This is a lot of information for the borrower to digest, and the best solution is to consult with a professional mortgage broker who can explain it all and recommend the best solution for you.

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