Final answer:
Lenders use a financial index, such as the prime rate or LIBOR, as the adjustable number to compute the interest rate on an adjustable-rate mortgage (ARM), which can vary with changes in inflation.
Step-by-step explanation:
The adjustable number that lenders use to compute the interest rate on an adjustable-rate mortgage (ARM) is typically tied to a financial index, such as the prime rate, LIBOR, or the Treasury bill rate, which reflects the general trend of interest rates in the broader economy.
These rates can be influenced by movements in the rate of inflation, and as such, ARMs often include built-in inflation adjustments. For instance, if inflation goes up by two percentage points, the interest rate on an ARM might also increase by two percentage points to compensate for the change in purchasing power. With an ARM, the initial interest rate is usually lower than that of a fixed-rate mortgage, which can make ARMs attractive to borrowers.
However, since the rate can adjust over time, there is a risk of increased payments if the index rate rises. Lenders use these adjustments to safeguard against the risk of higher inflation, which could otherwise lead to lower real loan payments.