diff --git a/docs/CONFIGURATION.md b/docs/CONFIGURATION.md
index b6b2cde9..68a3b2dd 100644
--- a/docs/CONFIGURATION.md
+++ b/docs/CONFIGURATION.md
@@ -87,7 +87,9 @@ A single file at the project root (the directory you pass as `--source-root`, or
 
 # Index directory: where Lance tables, code_graph.kuzu, and cocoindex.db live.
 # - Tilde (`~`) is expanded; `$VAR` is NOT (use absolute paths or `~`).
-# - Relative paths resolve against source_root, not cwd.
+# - Relative paths resolve against the config file's parent directory (same
+#   base as source_root), not cwd. The bare default ./.java-codebase-rag
+#   (when this key is omitted) still sits beside the resolved source_root.
 # - Env: JAVA_CODEBASE_RAG_INDEX_DIR. CLI: --index-dir. Default: ./.java-codebase-rag/
 index_dir: ./.java-codebase-rag
 
@@ -217,7 +219,7 @@ async_producer_overrides:
 
 | Field | Expanded? | Notes |
 |---|---|---|
-| `index_dir` | partial | `~` expanded; `$VAR` is NOT expanded. Relative paths resolve against `source_root`. |
+| `index_dir` | partial | `~` expanded; `$VAR` is NOT expanded. A YAML relative path resolves against the config file's directory (same base as `source_root`); the default `./.java-codebase-rag` sits beside the resolved `source_root`. |
 | `embedding.model` (when path-shaped) | yes | Path-shape = starts with `/`, `./`, `../`, `~`, or contains `$`. Plain `org/name` is treated as a hub id and passed through. Applies to the value after CLI > env > YAML > default precedence. Long-lived MCP hosts also apply the same expansion when reading `SBERT_MODEL` from the process environment (so table metadata and search agree with `index_common` defaults). |
 | `embedding.device` | n/a | Device strings (`cpu`, `cuda`, `mps`) aren't paths. |
 | `microservice_roots[*]` | no | Each entry is a directory **name** relative to `source_root`, not an arbitrary path. |
@@ -225,7 +227,7 @@ async_producer_overrides:
 
 **Tips & gotchas:**
 
-- **The file must be at `source_root`**, not in `$HOME`. The MCP server reads `JAVA_CODEBASE_RAG_SOURCE_ROOT` to find it; the CLI uses `--source-root` (else cwd).
+- **The config file may live anywhere under your project, including a subdirectory of the Java tree.** Both the CLI (`init` / `increment` / `reprocess`) and the MCP server walk up from cwd to find `.java-codebase-rag.yml`, then resolve `source_root` and `index_dir` relative to the config file's directory. So a config living in `my-context/` next to `source_root: ../` and `index_dir: ../.java-codebase-rag` resolves identically for the CLI and the MCP server. Keep the file under your project (not `$HOME`); set `JAVA_CODEBASE_RAG_SOURCE_ROOT` (MCP) or `--source-root` (CLI) only to override the discovered location.
 - **Don't commit secrets** into this YAML — it sits next to your source tree and is read by every operator who clones it.
 - **Rebuild after editing brownfield overrides.** Run a full `java-codebase-rag reprocess` (no flags) so Lance and Kuzu stay coherent, or use `--graph-only` / `--vectors-only` when you know only one store needs invalidation. Editing `embedding.model` requires a vector rebuild (`reprocess` or `--vectors-only`).
 - **Diagnose what's loaded.** `java-codebase-rag meta` prints the resolved config and each value's `*_source` (`cli` / `env` / `yaml` / `default`) — see `embedding_model_source`, `embedding_device_source`, `index_dir_source`.
diff --git a/java_codebase_rag/config.py b/java_codebase_rag/config.py
index 6603dbc3..23a9308a 100644
--- a/java_codebase_rag/config.py
+++ b/java_codebase_rag/config.py
@@ -306,9 +306,19 @@ def _pick_bool(
 def _resolve_index_dir_path(
     *,
     source_root: Path,
+    config_dir: Path,
     cli_index_dir: str | None,
     yaml_dict: dict[str, Any],
 ) -> tuple[Path, SettingSource]:
+    # Bases for relative paths:
+    #   - YAML ``index_dir``  -> the config file's directory (``config_dir``),
+    #     the SAME base used for YAML ``source_root``. Paths written in the
+    #     config file are relative to the file, so both keys stay consistent.
+    #   - CLI / env ``index_dir`` -> ``source_root`` (unchanged). These are not
+    #     "in the config file"; preserving the existing base avoids a semantics
+    #     change for operators who pass ``--index-dir`` on the command line.
+    #   - Default ``./.java-codebase-rag`` -> ``source_root`` so the index sits
+    #     beside the Java tree (the layout ``discover_project_root`` anchors on).
     raw_cli = cli_index_dir.strip() if isinstance(cli_index_dir, str) else None
     if raw_cli:
         p = Path(raw_cli).expanduser()
@@ -324,7 +334,7 @@ def _resolve_index_dir_path(
     idx = yaml_dict.get("index_dir")
     if isinstance(idx, str) and idx.strip():
         p = Path(idx.strip()).expanduser()
-        out = p.resolve() if p.is_absolute() else (source_root / p).resolve()
+        out = p.resolve() if p.is_absolute() else (config_dir / p).resolve()
         return out, "yaml"
 
     return (source_root / ".java-codebase-rag").resolve(), "default"
@@ -368,7 +378,7 @@ def resolve_operator_config(
                 root = config_dir
 
     index_dir, index_src = _resolve_index_dir_path(
-        source_root=root, cli_index_dir=cli_index_dir, yaml_dict=yaml_dict
+        source_root=root, config_dir=config_dir, cli_index_dir=cli_index_dir, yaml_dict=yaml_dict
     )
     model, model_src = _pick_str(
         cli_val=cli_embedding_model,
diff --git a/server.py b/server.py
index 69675648..c151f941 100644
--- a/server.py
+++ b/server.py
@@ -155,6 +155,27 @@ def _project_root() -> Path:
     return discovered if discovered is not None else Path.cwd().resolve()
 
 
+def _source_root_for_operator_config() -> Path | None:
+    """``source_root`` arg to hand ``resolve_operator_config`` from the MCP server.
+
+    Returns ``JAVA_CODEBASE_RAG_SOURCE_ROOT`` when set (an explicit operator
+    override that wins and suppresses the YAML ``source_root`` field, exactly
+    like CLI ``--source-root``), otherwise ``None`` — so
+    ``resolve_operator_config`` runs its OWN walk-up discovery and HONORS the
+    YAML ``source_root`` field, matching the CLI (``init`` / ``increment`` /
+    ``reprocess``) path.
+
+    Do NOT pass ``_project_root()`` (the walk-up-discovered dir) here: a
+    non-``None`` value routes into the "explicit source root" branch that
+    skips the YAML ``source_root`` field, which made the MCP server and the
+    CLI resolve different ``source_root`` / ``index_dir`` from the same config
+    file (the init-vs-MCP index_dir divergence). ``_project_root()`` is kept
+    only for the ``_resolve_lancedb_uri()`` fallback below.
+    """
+    env = os.environ.get("JAVA_CODEBASE_RAG_SOURCE_ROOT", "").strip()
+    return Path(env).expanduser().resolve() if env else None
+
+
 def _cocoindex_subprocess_env(project_root: Path) -> dict[str, str]:
     sub_env = os.environ.copy()
     sub_env["JAVA_CODEBASE_RAG_SOURCE_ROOT"] = str(project_root)
@@ -654,7 +675,7 @@ def main() -> None:
     # Load YAML config and apply embedding settings to environment
     # This ensures SBERT_MODEL and SBERT_DEVICE from .java-codebase-rag.yml are available
     # before any tool handler runs (same behavior as CLI path)
-    cfg = resolve_operator_config(source_root=_project_root())
+    cfg = resolve_operator_config(source_root=_source_root_for_operator_config())
     cfg.apply_to_os_environ()
     mcp_v2.set_hints_enabled(cfg.hints_enabled)
 
diff --git a/tests/test_config.py b/tests/test_config.py
index 4b2aefc8..a07d2f41 100644
--- a/tests/test_config.py
+++ b/tests/test_config.py
@@ -175,6 +175,57 @@ def test_source_root_from_yaml_absolute(self, tmp_path, monkeypatch):
         assert result.source_root == Path(absolute_path)
 
 
+class TestIndexDirRelativeToConfigDir:
+    """YAML ``index_dir`` must resolve against the config file's directory.
+
+    ``source_root`` already resolves against the config dir (see
+    ``TestSourceRootFromYaml``). ``index_dir`` must use the SAME base so a
+    user can express both keys relative to the config file — otherwise a
+    ``../`` in ``index_dir`` gets re-applied on top of the already-resolved
+    ``source_root`` and overshoots by one level (the "init indexes ~/"
+    symptom when the config lives in a subdirectory of the Java tree).
+    """
+
+    def test_yaml_index_dir_double_dot_resolves_against_config_dir(self, tmp_path, monkeypatch):
+        """``index_dir: ../x`` is relative to the config file's directory, not source_root."""
+        monkeypatch.delenv("JAVA_CODEBASE_RAG_INDEX_DIR", raising=False)
+        monkeypatch.delenv("JAVA_CODEBASE_RAG_SOURCE_ROOT", raising=False)
+
+        config_dir = tmp_path / "my-project-context"
+        config_dir.mkdir()
+        (config_dir / YAML_CONFIG_FILENAMES[0]).write_text(
+            "source_root: ../\nindex_dir: ../.java-codebase-rag\n"
+        )
+        monkeypatch.chdir(config_dir)
+
+        result = resolve_operator_config(source_root=None)
+        # source_root ../  -> tmp_path (one level above the config file)
+        assert result.source_root == tmp_path
+        # index_dir ../    -> tmp_path/.java-codebase-rag (one level above the config file),
+        # NOT tmp_path.parent/.java-codebase-rag (which is what resolving against
+        # the already-resolved source_root would produce).
+        assert result.index_dir == (tmp_path / ".java-codebase-rag").resolve()
+
+    def test_yaml_index_dir_bare_resolves_against_config_dir(self, tmp_path, monkeypatch):
+        """``index_dir: x`` (no ``../``) sits next to the config file."""
+        monkeypatch.delenv("JAVA_CODEBASE_RAG_INDEX_DIR", raising=False)
+        monkeypatch.delenv("JAVA_CODEBASE_RAG_SOURCE_ROOT", raising=False)
+
+        config_dir = tmp_path / "my-project-context"
+        config_dir.mkdir()
+        (config_dir / YAML_CONFIG_FILENAMES[0]).write_text(
+            "source_root: ../\nindex_dir: .java-codebase-rag\n"
+        )
+        monkeypatch.chdir(config_dir)
+
+        result = resolve_operator_config(source_root=None)
+        assert result.source_root == tmp_path
+        # Bare path resolves against the config dir, so the index sits beside
+        # the config file — NOT beside source_root.
+        assert result.index_dir == (config_dir / ".java-codebase-rag").resolve()
+        assert result.index_dir_source == "yaml"
+
+
 class TestSourceRootPrecedence:
     """Tests for source_root precedence chain."""
 
diff --git a/tests/test_mcp_server_project_root.py b/tests/test_mcp_server_project_root.py
index 48d90d8d..df3b45c1 100644
--- a/tests/test_mcp_server_project_root.py
+++ b/tests/test_mcp_server_project_root.py
@@ -1,6 +1,6 @@
 """Tests for server.py _project_root() function in the MCP server context."""
 
-from java_codebase_rag.config import YAML_CONFIG_FILENAMES
+from java_codebase_rag.config import YAML_CONFIG_FILENAMES, resolve_operator_config
 
 
 class TestProjectRoot:
@@ -23,3 +23,59 @@ def test_project_root_uses_discover_when_env_unset(self, tmp_path, monkeypatch):
 
         result = _project_root()
         assert result == tmp_path
+
+
+class TestSourceRootForOperatorConfig:
+    """The MCP server must honor the YAML ``source_root`` field like the CLI.
+
+    ``main()`` passes ``_source_root_for_operator_config()`` (not the
+    walk-up-discovered dir) as the ``source_root`` arg to
+    ``resolve_operator_config``. When the env override is unset that is
+    ``None``, which routes through the walk-up branch that APPLIES the YAML
+    ``source_root`` field. Passing the discovered dir instead would route into
+    the "explicit source root" branch and silently ignore the YAML field,
+    diverging the MCP server from ``init``/``increment``/``reprocess``.
+    """
+
+    def test_returns_none_when_env_unset(self, tmp_path, monkeypatch):
+        monkeypatch.delenv("JAVA_CODEBASE_RAG_SOURCE_ROOT", raising=False)
+        from server import _source_root_for_operator_config
+
+        assert _source_root_for_operator_config() is None
+
+    def test_returns_env_path_when_set(self, tmp_path, monkeypatch):
+        explicit = tmp_path / "explicit-root"
+        explicit.mkdir()
+        monkeypatch.setenv("JAVA_CODEBASE_RAG_SOURCE_ROOT", str(explicit))
+        from server import _source_root_for_operator_config
+
+        assert _source_root_for_operator_config() == explicit.resolve()
+
+    def test_mcp_and_init_resolve_identically_for_nested_config(self, tmp_path, monkeypatch):
+        """Regression for the init-vs-MCP index_dir divergence.
+
+        Config lives in a subdirectory of the Java tree (``my-project-context/``)
+        and points both ``source_root`` and ``index_dir`` one level up. The MCP
+        server (env unset) and the CLI must resolve the SAME source_root and
+        index_dir, landing on the real index at ``tmp_path/.java-codebase-rag``.
+        """
+        monkeypatch.delenv("JAVA_CODEBASE_RAG_SOURCE_ROOT", raising=False)
+        monkeypatch.delenv("JAVA_CODEBASE_RAG_INDEX_DIR", raising=False)
+
+        config_dir = tmp_path / "my-project-context"
+        config_dir.mkdir()
+        (config_dir / YAML_CONFIG_FILENAMES[0]).write_text(
+            "source_root: ../\nindex_dir: ../.java-codebase-rag\n"
+        )
+        monkeypatch.chdir(config_dir)
+
+        from server import _source_root_for_operator_config
+
+        mcp = resolve_operator_config(source_root=_source_root_for_operator_config())
+        cli = resolve_operator_config(source_root=None)
+
+        assert mcp.source_root == tmp_path
+        assert mcp.index_dir == (tmp_path / ".java-codebase-rag").resolve()
+        assert mcp.source_root == cli.source_root
+        assert mcp.index_dir == cli.index_dir
+