Libor: What it means for US consumer loans


Acronyms and interest rates rule the lives of borrowers. That’s especially true of one scandal-plagued index whose reign will soon end.

Regulators plan to phase out the London interbank offered rate (Libor) by 2021, after traders were found to be manipulating the rate for their own profit. In the aftermath of the scandal, the perpetrators faced jail sentences and billions in fines.

Regulators need a substitute for Libor, the rate undergirds about $350 trillion in loans, and the New York Fed has recently come up with a substitute.

But until then, this acronym still very much occupies an important part of the financial life for millions of Americans. Libor directly impacts the amount you pay on loans such as adjustable-rate mortgages and private student loans.

When Libor rates rise, as they have done in recent months, consumers with these types of loans take notice.

“Your payment may go up or down if it’s tied to the Libor,” says Tisa Silver-Canady, assistant director at the office of Financial Education and Wellness at the University of Maryland.

What is Libor?

Libor is the rate a select group of creditworthy international banks charge each other for large loans. It is administered by the Intercontinental Benchmark Administration (IBA), which asks a panel of up to 16 banks the following question:

“At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 am London time?”

Thomson Reuters collects the data, averages it and publishes several different rates in different currencies every morning. These are the rates that affect your ARMs and student loans.

IBA took over for the British Bankers’ Association in the aftermath of the scandals. This was a big deal because Libor is used as a reference rate for borrowing and lending around the world. It is the most widely used benchmark for short-term rates and is used in the U.S., Canada, Switzerland and London.

The Libor interest rate maturities can range from overnight to 12 months. Mortgage lenders normally look at the six-month and the one-year Libor for ARM loans.

Libor on the rise

Interest rates are rising, and that’s especially true for Libor. The 6-month Libor has risen more than a percentage point over the past year to 2.46 percent today. Companies with debt backed by Libor will their borrowing costs rise, potentially harming their ability to compete.

What’s going on?

The Federal Reserve is letting billions of dollars of debt roll off its balance sheet, pushing prices down and yields up. That’s in addition to other interest rate increases, such as the 10-year Treasury, which jumped after the GOP tax bill was passed and inflation fears resurfaced.

ARMs impacted by Libor

Gains in Libor are a big deal if you have a mortgage that’s linked to the rate, as about half of mortgages in the U.S. are.

With an ARM you lock in an interest rate, typically a low one, for a fixed period. Once that period ends, the mortgage resets to the current interest rate of that index. ARMs come in many flavors, including the commonplace one-year and 5/1 ARMs.

The first number you see represents the number of years you pay a fixed rate (one or five in this case), and then the second year tells you how often the rate is reset (once a year.)

If Libor is down when the mortgage rate resets, your monthly payment will be lower. If Libor is higher, your premium each month will rise. The difference in Libor may not mean much to someone who has enough money to handle an increased mortgage payment, but for people just getting by, a rising Libor can be devastating. Only 39 percent of Americans can pay for $1,000 emergency expense from savings.

The rate on a 5/1 adjustable-rate mortgage increased from 3.5 percent last December to 4.02 percent today. That’s a big deal to a lot of people – 6.5 percent of all mortgage applications have an adjustable-rate, according to the Mortgage Bankers Association.

You have the option to refinance your mortgage into a fixed-rate loan before the ARM adjusts, but the ability to do that will depend on many factors such as the equity in your home, your credit standing and your job situation.

Student loan rates move with Libor

Private student loans that aren’t backed by the federal government and are tied to Libor also are beholden to it. Many banks will lend money to students with rates that are tied to Libor, says Silver-Canady.

For instance, you may take out a student loan with a rate that’s Libor plus 2 percent or Libor plus 7 percent. The difference in percentages is based on the creditworthiness of the borrower and/or the co-signer. And just as with ARMs, when the Libor is up, your student loan payment will be higher. When it’s down, it will be lower. Libor won’t have any bearing on a fixed-rate federal student loan.

Understanding the impact of the Libor on interest rates will make you a savvier borrower when you’re looking for a mortgage or student loan. Whether you are going with a loan tied to Libor or not, you have to pay attention to your credit and to finance charges.

“People don’t look at the interest rate. They only look at the sticker price,” Silver-Canady says. “How much you borrow today in order to finance a purchase and what you end up paying fluctuates, depending on the interest rate.

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