Many adjustable rate mortgage (ARM) loan interest rates are tied to the London Interbank Offered Rate (LIBOR) and that rate has recently gone up.
Q: My mortgage is adjustable, tied to the one year LIBOR. Up until the last few months, that was a good thing and my interest rate stayed very low. But lately, that’s not so much the case. My interest rate has been rising a bit, even though the U.S. Treasury rate has stayed extra-low.
My interest rate does not reset again until next September, but I cannot help but notice that this LIBOR has gone thru the roof since last August. Is the European crisis causing this? Although our Federal Reserve Chairman “promised” us low rates for a few more years, the rates tied to these LIBOR are looking scary right now.
What are your thoughts about the near future for LIBOR-based rates? And, should I think about refinancing?
A: While the Federal Reserve has tried to keep interest rates low in the United States, it does not control international interest rates. LIBOR is the London Interbank Offered Rate. As the name implies, it is an interest rate that is used in Britain and in European financial instruments.
However, during the last ten years, more U.S.-based mortgage products switched from being tied to the United States Treasury rate to LIBOR rates. And as you’ve discovered, being tied to one index or another can make a huge different when your mortgage interest rate adjusts.
If your mortgage is tied to the Treasury rate and you receive a notice this month of a change in your adjustable rate mortgage (ARM), you might find out that your mortgage interest rate has gone down. Recently, we saw a loan tied to the Treasury rate that is about 2.875 percent. That loan had a margin of 2.75 plus the one year Treasury rate. With the one year Treasury rate about .11 percent (just over one-tenth of one percent, or virtually zero), the new rate on the loan was 2.875.
However, a LIBOR based mortgage with the same margin would have an interest rate of about 4 percent. LIBOR these days is about 1.13 percent or about a full percentage point above the U.S. Treasury one year rate. While the 4 percent rate is still historically low, it is significantly higher.
So you are correct that rates are higher, but it’s hyperbole to say that LIBOR-based rates have “gone through the roof.” Even the one year LIBOR interest rates are rather low at a bit over one percent. But that does not mean that people whose interest rates are tied to LIBOR won’t feel a greater deal of pain as events in Europe develop and as interest rates fluctuate. LIBOR tends to be more fluid than U.S. Treasuries, especially with the whipsaw economic changes flying through Europe at the moment.
We wish we could predict interest rates, especially for LIBOR rates, but with the uncertainty in the world and, in particular, with the Euro, it’s hard to know what will occur in the coming months or even a year or two from now.
Some economists we have read don’t expect interest rates to rise much over the next year or two, but if there are particular international events that can affect the European market, interest rates can, and will, fluctuate, especially with LIBOR-related loan products.