A Libor mortgage is an adjustable rate mortgage that is tied to one of the rates from the London Interbank Offered Rate. Libor mortgages offer borrowers lower interest rates, but are generally only available to borrowers with top credit scores.
As explained on our adjustable rate mortgage page, the interest rate for an adjustable rate mortgage (ARM) is based on two factors: the index and the margin.
The index is usually pegged to the prime interest rate (the rate banks charge each other for lending money), U.S. Treasury bills, constant-maturity Treasury (CMT) securities, the Cost of Funds Index (COFI), the London Interbank Offered Rate (LIBOR), or other financial instruments.
The margin is the additional interest charge by the lender. In other words, the margin is the lender's profit.
Because the Libor is usually less prone to large fluctuations than other indexes, investors view the Libor as more of a safe haven.
Libor mortgages offer lower interest rates than other adjustable rate mortgages because the Libor index has been much lower than other indexes used for adjustable rate mortgages. Also, there is less risk to the lenders, and thus the lenders are willing to accept a lower margin. Libor mortgages also offer less risk to the lenders because borrowers generally must have A-quality credit.
Libor mortgages offer other attractive features in addition to lower interest rates.
Libor mortgages are otherwise similar to most other adjustable rate mortgages. They have an initial rate period, which is the period during which the borrower gets the lowest rate on the mortgage. Initial rate periods vary from six months to as long as ten years.
Like other ARMs, Libor mortgages have adjustment periods after the initial rate period ends. Adjustment periods for Libor mortgages are typically six to twelve months. At the time of these adjustment periods, the interest rate on the mortgage may change if the Libor index has gone up or down.
Also, Libor mortgages have rate adjustment caps that limit how much your interest rate can go up at each adjustment period. Typically, the caps on six month adjustment periods are 1%, and 2% on one and three year adjustment periods.
Libor mortgages have been extremely popular in 2007 because the Libor index has been below 2%. In fact, it has been as low as 1.38%. If you tack on a margin of 2% for the lender's profit, the borrower still has an initial rate as low as 2% + 1.38%. And, no matter how you look at it, an initial rate of 3.38% is pretty hard to beat.
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