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

Posted on: 07th Apr, 2004 02:38 am
When you are looking for an ARM wherein the interest rate and payments won't fluctuate over a wide range, you may choose one which is tied to the LIBOR Index. In this article, you can check out the definition of LIBOR and related topics as given below:

What is LIBOR Index?

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.

What is LIBOR Index ARM?

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.

Why should you opt for LIBOR Index ARM?

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.

What are the features of LIBOR rate ARMs?

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.

What are the types of LIBOR ARMs?

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.

What type of property is eligible for the loan?

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.
Hi ispy!

Welcome to forums!

It is true that if your rate adjusts today as per the LIBOR then, your rate will be as low as 2.71% for the next 6 months.

Posted on: 07th Oct, 2010 01:06 am
Hi Jessica. My wife and I are in our 5th year of a 7/6 LIBOR. We are a bit nervous about what will happen to our payment when it starts to adjust in year 7. We are thinking of calling our Mortgage company to see about refinancing, but we are in South Florida and just like almost everyone else, we are upside down. Should we wait for year 7 or should we start the process now? we are locked in at 6 1/4 %. How volatile is the Libor these days and what can we expect every six months if we stay with the 7/6?
Posted on: 09th Oct, 2010 06:05 pm
hi flip,

as you're upside down, the lender will not refinance the mortgage for you now. you should wait till the 7th year and check out if your property value increases and whether or not you've equity in the property. if there is equity in the property, then you'll be able to get a mortgage refinance.


Posted on: 11th Oct, 2010 04:05 am
I have had a Libor indexed mortgage for the last 7 yrs. It went up to 12.5% and is now down to 9%. It started at 8%. The mortgage note has been sold 2 times since I originally got it. GMAC now has it. The previous six month adjustment put the rate at 9%. I just received a letter from GMAC stating that the rate would stay at 9% due to the Libor margin over the last six months. I am confused as to why the rate did not go down due to the current state of the world economy and the historically low interest rates. Can I expect this mortgage rate to go lower than the original rate or will it never go below 9% over th life of the loan? It is a 30 year loan and I have had it for 7 years.

Posted on: 20th Oct, 2010 07:44 pm
If there is a rate cap at 9%, then the rate will never go down below that. You need to check your mortgage docs or consult your lender in order to know about it.
Posted on: 21st Oct, 2010 03:21 am
I am applying for a conventional 5/1 LIBOR ARM and can't get a straight answer. I'm hoping you can help me!

I would like to know how my loan will be recasted; what numbers will be looked at in recalculating my loan. The index is 0.756% and the margin is 2.250%. In 60 months, will the current rate for the 5/1 ARM be added to the 2.25 margin? Or is it recasted a different way?

THANK YOU for shedding some light on this!!
Posted on: 16th Nov, 2010 04:28 pm
Welcome Valerie,

Let me explain you the situation with the help of a 5/1 ARM with a 5/2/5 Cap. During the first adjustment period after the 5 year initial fixed period, the rate can adjust a maximum of 5% up or down. At the subsequent annual adjustments, the rate can only adjust by 2% up or down. And during the lifetime, the cap limits the ARM rate increase to 5% over the initial rate during the term of the mortgage.
Posted on: 16th Nov, 2010 11:54 pm
Thank you Adonis. :) I was actually able to figure that part out, but the part that I'm still unsure of is HOW the new rate will be figured. Is it the current one year LIBOR plus my margin? Meaning, if I looked up the one year LIBOR online (assuming you can do so- and if I can, where can I find this?) the day of my recasting and added 2.25%, would that be my new interest rate?

I'm thinking yes, but I'm a bit unsure.

Thank you so much! :)
Posted on: 17th Nov, 2010 04:35 pm
Hi Valerie!

Welcome to forums!

Your rate will be the current one year LIBOR plus your margin. You can contact your lender and he will let you know the one year LIBOR. However, the rates are also available online.

Feel free to ask if you've further queries.

Posted on: 18th Nov, 2010 12:43 am
I have received a letter today from my mortgage provide to advise me of the changes to my interest charging rate as a result of the change in the LIBOR rate, the letter suggests that i will have a significant reduction in my mortgage payment, is this correct? j
Posted on: 20th Dec, 2010 05:21 am
Hi Jay!

Welcome to forums!

If your ARM is dependent on LIBOR, then any change in LIBOR index will have an effect on your mortgage payments. If the LIBOR index has reduced, then your mortgage payments will decrease.

Feel free to ask if you've further queries.

Posted on: 20th Dec, 2010 09:07 pm
I'm also upside down thus can't refinance. My 5-year interest only period has just passed and for the upcoming year, I also get the rate 3.0% - so good for me for now. I just wonder if we can request the Bank to fix the rate for the remaining 25 years assuming the LIBOR rate will increase? Or it'll be solely Bank's discretion/decision?
Posted on: 27th Dec, 2010 02:53 am
Hi gauloso!

Welcome to forums!

If you want to fix the rates, then you will have to refinance the mortgage into a fixed rate one. Unless you do so, you won't be able to get a fixed rate mortgage.

Feel free to ask if you've further queries.

Posted on: 27th Dec, 2010 10:05 pm
how high can a libor rate can go?
Posted on: 11th Jan, 2011 09:13 am
how high can a libor rate can go?
Posted on: 11th Jan, 2011 09:13 am
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