What index does a LIBOR adjustable rate mortgage (ARM) use? Learn how the index and the margin affect the adjustable rate mortgage rate. An adjustable rate mortgage whose interest rate is tied to a specified...
An adjustable rate mortgage whose interest rate is tied to a specified LIBOR is known as a LIBOR mortgage. LIBOR is an acronym that stands for London Interbank Offered Rate. A specific group of large London banks offer an interest rate for U.S. dollar deposits, otherwise known as the London Interbank Offered Rate or LIBOR. The LIBOR index is used as a base to calculate the interest rate of LIBOR adjustable rate mortgages.
The index that is used varies. Stephen Edwards of Waterfield Financial Company, the nation's largest privately owned mortgage company, says, "It really depends on the adjustable rate that you are looking at. The adjustable rate is figured by adding the index to the margin."
The risk level of the borrower determines the margin, which is an additional percentage the lender is allowed to charge the borrower. In general, margins used for a LIBOR adjustable rate mortgage are low. However, if a sub-prime lender is offering the LIBOR adjustable rate mortgage, the margins and the rate may be higher. While the LIBOR index may vary, the margin will remain the same over the life of the loan.
Edwards offers an example to help clarify the process. "A margin may be two and three quarters," says Edwards. "So, your ARM, your adjustable rate mortgage, may always have a two and three quarter percent margin." However, Edwards adds, "The index is what can adjust with the markets."
The LIBOR fluctuates regularly with the economic condition of the world. Hundreds of different values are quoted for the LIBOR on any given day. The actual number may vary from one type of adjustable rate mortgage to another. The LIBOR is quoted in different currencies as well. The calculations used to determine the LIBOR are complex as they take into account several variables, including maturity, currency rates, and time.
Edwards continues the example, "If the index is four and your margin is two and three quarters, your rate is going to be six and three quarters. However, the index can change." If the index changes, then the rate is going to change as well. In general, ARMs are set up to experience a change in rate after a specified time. This change will reflect the most current LIBOR rate.
The LIBOR is used world-wide. International investors use the LIBOR index to determine their cost of lending compared to the cost of their funds. Basically, it is the rate that London banks offer for inter-bank deposits. Although several LIBOR rates are used for adjustable rate mortgage indexes, the six-month adjustable rate mortgage is the one most commonly used.
Any borrower who is considering acquiring a LIBOR adjustable rate mortgage should remember to research various lenders in order to locate the best financial deal available for his loan. Since different venders offer different terms and rates, borrowers should be sure to ask questions to clarify different aspects of the loan.
In general, LIBOR indexed adjustable rate mortgages do not experience wide fluctuations in rates due to interest rate caps that are put in place at the beginning of the loan. Additionally, the initial interest rates are usually lower than many other loans.
