To understand what a LIBOR adjustable rate mortgage is, you must understand what LIBOR means and what an adjustable rate mortgage is. An adjustable rate mortgage is a mortgage with an interest rate that varies. Initially, the interest rate that is offered on this type of loan will be lower than the going rate. This lower rate will be set for a specified time, and then, it will be adjusted to reflect a more current interest rate.
Adjustable rate mortgages are highly popular loans in certain financial climates. Specifically, when interest rates are very high, borrowers will look to adjustable rate mortgages for savings. Additionally, borrowers whose earning capacity may fluctuate for the better in the near future may opt to acquire an adjustable rate mortgage with its lower initial payments.
LIBOR is the short and easy way of referring to the London Interbank Offered Rate. The London Interbank Offered Rate is the interest rate that is offered by a specified group of London banks for inter-bank deposits made by international investors. Basically, the LIBOR index used for LIBOR adjustable rate mortgages is the rate offered by the large London banks for United States dollar deposits.
This rate index, the LIBOR, is then used to calculate an interest rate for the LIBOR adjustable rate mortgage. The LIBOR index varies and is quoted on a daily basis. A LIBOR adjustable rate mortgage’s interest rate is calculated by taking the LIBOR index and adding it to a predetermined margin. The margin is a numerical amount, expressed as a percentage, that lenders are legally entitled to charge borrowers.
In general, margins vary among lenders, but usually, LIBOR indexes reflect low margins. For example, mainstream lenders may offer competitive margins, whereas, sub-prime lenders may offer larger margins. Specifically, the credit worthiness or risk level of the borrower plays a role in determining the size of the margin.
The numerical amount of the margin remains stable over the life of the loan. However, the LIBOR index varies and this results in the changes made to monthly payments. As the economic conditions worldwide fluctuate, so does the LIBOR. Additionally, the LIBOR is also quoted in different currencies.
The most commonly used LIBOR adjustable rate mortgage is the 6-month term. Other terms are available, and popular ones include one, three, five, and ten year terms. Generally, LIBOR indexed adjustable rate mortgages have relatively stable interest rates due to caps that are put in place at the beginning of the loan acquisition.