What is LIBOR Index and why to go for LIBOR Rate ARM?

LIBOR stands for "London Interbank Offered Rate". It is the average of the interest rates on US dollar deposits that a group of banks in the London money market borrow from one another. This Index is calculated on the basis of currency rates, time and maturity. It is calculated by the British Banker's Association.

The LIBOR Index is often used as the reference rate for adjustable rate mortgage and short term unsecured loans in the US financial markets. So far, the variations in the LIBOR interest rates are small as compared to that of the Prime Rate.

There are different types of LIBOR indexes such as 1 month, 3 month, 6 month, and 12 months LIBOR index. LIBOR interest rates are just as volatile as interest rates on short term US government security. However, compared to other ARM indexes such as COFI, MTA and CODI, the LIBOR interest rate is more volatile.

A LIBOR ARM is an adjustable rate mortgage which has an indexed rate based on the LIBOR index. When added to the margin, the LIBOR Index gives the Indexed rate of such ARMs.

Here are the top 5 reasons why you should go for LIBOR ARM.

1. Avoid negative amortization: LIBOR rates protect you from negative amortization due to availability of periodic and lifetime rate caps.


2. Attractive rate buydown: 30 year LIBOR ARMs can allow you to buydown the interest rate and margin by 1/4% for only 3/8 th of a point unlike in a 30 year fixed rate loan wherein one can buydown the rate by 1/4% for 1.5 points.


3. Low margin: A potential borrower can expect to get a low margin on the LIBOR ARM as compared to other adjustable rate loans. However, for subprime loans, the margins and LIBOR rates may be higher. This depends more on the creditworthiness or risk level of the borrower.


4. Aggressive low rates: LIBOR index ARMs are available at comparatively lower rates than adjustable rate mortgages tied to other indexes such as the COFI, 6-Month Treasury Bill and the 6-Month Certificate of Deposit.


5. Avoid wide rate fluctuations: LIBOR ARMs protect you from wide fluctuations in the interest rate through periodic and lifetime rate caps.

Some of the common features of ARMs with LIBOR rate index are:

• Initial rate period: The initial rate remains fixed for a period of 6 months to 10 years.
• Adjustment Interval: This is the period between rate adjustments after the first rate adjustment takes place. LIBOR rates often adjust after every 6 months to 1 year.
• Maximum Rate: The highest interest rate that LIBOR ARMs can have over its entire life is usually 5-6% higher than the initial low rate.
• Rate Caps: Usually 6 month LIBOR Index loan has a rate cap of 1% whereas 1 year and 3 year LIBOR Index loans have 2% cap. There are some 5 year LIBOR rate ARMs in which the rate cap is similar to that of 1 year and 3 year LIBOR rate loans while there are others on which the cap is same as that of 7 year and 10 year LIBOR loans.

The different types of LIBOR rate loans available are:

• 1 month LIBOR ARM: The index linked to this loan fluctuates each month as a result of which your payment changes on a monthly basis.


• 3/1 ARM: The initial rate is fixed for a period of 3 years after which the rate is adjusted every year on the basis of the LIBOR Index.


• 5/1 ARM: The interest rate remains fixed for 5 years after which the rates adjust annually with changes in the LIBOR Index.


• 7/6 ARM: This is a loan option wherein the initial rate is fixed for 7 years after which the LIBOR rate adjusts every 6 months.


• 10/6 ARM: Here the interest rate remains fixed for the first 10 years at the end of which the LIBOR rates adjust every 6 months.

The property types on which lenders offer ARMs with LIBOR rates include:

• 1-4 unit primary residence such as condo, PUDs and mobile homes
• 1-4 unit investment property
• Second homes

If you're planning to move out of property within the fixed rate period of an ARM, you can opt for LIBOR ARM which is a flexible loan option. The LIBOR Index ARM is especially suitable for first time buyers who'll be able to save in interest due to low initial rates and monthly payments.