Do you have an adjustable rate mortgage or loan? If you do, then a recent article on the Consumer Finance website may be relevant to you.
The news relates to the London Interbank Offered Rate, LIBOR for short. In this post, we’ll explain what LIBOR is, what effect it has on your loan rates and what you can do if LIBOR goes away.
What is LIBOR?
LIBOR is an index that is used to calculate adjustable interest rates for loans and mortgages. It is not the only index. Others include the United States Prime Rate and the Constant Maturity Treasury Index, or CMT.
LIBOR is calculated using bank transactions that have become less common over time. For that reason, the LIBOR panel has announced that it cannot guarantee that LIBOR will be available as an index past the end of 2021.
How Does LIBOR Affect Loan Rates?
Adjustable Rate Mortgages (ARMs) are the loans that are most likely to rely on LIBOR. Adjustable mortgage rates are calculated by adding:
- An index rate such as LIBOR or CMT; and
- A margin expressed as a percentage.
For example, the interest rate for an ARM might be calculated like this:
- LIBOR (.37%) plus margin (2%) = ARM of 2.37%
When the index increases, your interest rate will go up. If it decreases it will go down. The margin always stays the same.
How to Tell If Your ARM Uses LIBOR
The best way to tell if your Adjustable Rate Mortgage uses the LIBOR rate is to read the fine print. Your mortgage should specify the index used to calculate your rate and the margin that is added to it.
If you are unable to find information about the index in your loan contract, you can call your lender to find out whether your interest rate uses LIBOR.
What Will Replace LIBOR?
The question of what will replace LIBOR is already being investigated. In the United States, the job falls to the Alternative Reference Rates Committee or ARRC, which was created by the Federal Reserve to investigate alternatives to LIBOR.
The ARRC has recommended a new index called the Secured Overnight Financing Rate, or SOFR, to replace LIBOR. It has also created a transition guide to help lenders change from LIBOR to SOFR ahead of LIBOR’s elimination at the end of 2021.
Will Changing from LIBOR Affect Your Mortgage Rate?
The burning question for any homeowner with an ARM is whether switching from LIBOR to SOFR or another index will impact their interest rates and mortgage payments. The short answer is maybe but there’s no way to predict when the change will happen or what it will be.
That said, one option to consider is refinancing your mortgage from an ARM to a fixed rate mortgage. With a fixed rate mortgage, the issue of LIBOR’s existence or disappearance will not matter because your rate will stay the same for the term of your mortgage.
Addition Financial offers both Balance-Only Refinancing and Cash-Out Refinancing Options. Apply online here.
