Which type of loan adjusts interest rates periodically based on an index?

The correct choice is the Adjustable Rate Mortgage (ARM) because it is designed to have its interest rates adjusted at specified intervals based on a designated index. This means that the interest rate may fluctuate over the life of the loan, leading to monthly payments that can vary significantly depending on market conditions.

The way an ARM functions allows borrowers to often start with a lower initial interest rate compared to a Fixed Rate Mortgage, which remains constant throughout the loan term. This feature can be advantageous for certain borrowers who expect their financial situation to improve or who plan to move before any significant rate adjustments take place.

In contrast, a Fixed Rate Mortgage locks in a set interest rate for the entire term, providing stability in monthly payments. A Home Equity Loan typically involves a fixed interest rate and is secured by the borrower’s home equity, while a Balloon Mortgage features a short term with a large final payment due, but it does not involve periodic interest rate adjustments based on an index. Understanding these distinctions helps in making informed decisions about various mortgage options.