What Is a LIBOR Mortgage?

LIBOR

The LIBOR changes frequently. When banks in London borrow from one another, they are charged interest based on the current LIBOR. The LIBOR rate changes when there are changes in Wall Street, the British economy, national unemployment and the housing market. Generally, in times of economic robustness the LIBOR is high, and vice versa.

When an ARM is tied to the LIBOR rate, a mortgage customer must use the current LIBOR value to calculate his new mortgage rate. In LIBOR mortgages, the current LIBOR rate is added to a margin (a fixed value predetermined in a mortgage note) to get the current mortgage rate. For example, if a borrower has a mortgage with a margin of three percent and needs to calculate his rate as of April 2010, his new mortgage rate would be 4.94 percent (0.94 plus 4).

Savvy mortgage customers can take advantage of LIBOR loans. The LIBOR value drops significantly in times of economic distress. This happens because the market is sluggish and lower rates encourage more borrowing. Therefore, a smart mortgage customer can take a LIBOR loan and take advantage of the lower LIBOR during the period of economic uncertainty (e.g. after the 2008 credit crisis).

The LIBOR value can fluctuate dramatically. Mortgage customers should be aware of the adjustments on their loans. Many LIBOR loans adjust frequently, sometimes as often as every month. If the housing market starts to strengthen, the LIBOR will begin to tick up. This should signal to LIBOR customers that it may be time to refinance.

Some LIBOR mortgages are very risky. The riskiest LIBOR loans come on Option-ARM loans. These are mortgage loans that offer payment options to customers. These payments are: a 30-year payment, a 15-year payment, an interest-only payment and a minimum payment. Customers who make only the minimum payment will see their mortgage balance increase, not decrease. In addition, LIBOR adjustments could adjust so dramatically that the minimum payment is too costly for a borrower. As a result, some customers may not be able to escape these loans as their principal balance increased above the value of their homes.