The interest rate on adjustable-rate mortgages is tied to a financial index that reflects current lending rates.
You usually can't pick the index for your mortgage. The lender does that.
But you can pick your lender, and the index you're offered tells you a lot about the quality of the loan you'll get.
The best index is the one-year Treasury Constant Maturity , or TCM.
It's usually the lowest of the three indexes and the least prone to radical swings up or down. It comes with the most consumer-friendly loans given to borrowers with good credit.
Typical terms include a cap that says your interest rate can never go up by more than 6 percentage points, with just one reset of no more than 2 percentage points a year.
The 6-month London InterBank Offered Rate is a less attractive alternative.
LIBOR reflects the rate that international banks based in Europe charge each other for overnight loans. It is about a point higher, and more volatile, than the TCM.
Loans based on LIBOR often have more costly terms, too. These loans usually reset every six months -- or twice a year. Interest rates can increase by as much as 3 percentage points at the first adjustment, and by another percentage point at each following reset -- or by as much as 2 percentage points a year.
Additional information on the 6-month LIBOR is available from the British Bankers Association.
The 11th District Cost of Funds Index is the worst index.
COFI averages payments that banks in California, Arizona and Nevada make on deposit accounts. It's about a point higher than LIBOR and often used in loans that carry the most onerous terms.
If a lender offers you a mortgage tied to COFI, keep looking.