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

When we talk about the index for the ARM, we are talking about the instrument that the adjustments to the mortgage rate will be tied to. Various indices are used, including government treasury instruments, the Fed Fund rate or LIBOR.

You must first understand that an ARM is a loan with an interest rate that goes up or down within a certain set period, and the movements are predicated upon the movements of the underlying index. If your ARM is tied to the CD rate, and the bank’s CD rate increases, your interest rate will likewise go up. Another feature of an ARM is that there is an adjustment cap, which prevents the interest from moving up or down too often, even if the index does; sometimes this is an advantage if you just adjusted and then rates move upwards. Of course, the opposite can happen, and if your rate has just 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.

Your ARM may be tied to the Treasury Bill rate, which is the rate the US Government pays on its 90 day investments. The Fed Funds rate is another very popular basis for ARMs. LIBOR is the London Interbank Offered rate, which is the rate that commercial borrowers pay each other for the use of funds.

How you decide upon the right index is dependent upon your particular situation and how you believe interest rates will move. Adjustable rate home loans that use CDs as the reference rate tend to change more quickly. On the other hand, if your ARM is based on T Bills, it will react more slowly. 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.

But in addition to these standards, new products are always been introduced on the market; an example would be the option ARM, that will let a borrower decide how much mortgage he is going to pay each month! There is a minimum payment that allows for the interest (so the bank gets its money) and then the other options will pay down some portion of equity. One of the big problems with an option mortgage is that you can end up with an increasing instead of decreasing mortgage; this is also known as negative amortization.

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

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• Home Mortgages 101: A Must-Read for First-Time Home Buyers!