Another informative article courtesy of the Bentrup Group…
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LIBORmania
Written by Henry Savage

The LIBOR ARM is on a roll.  Everyone knows that fixed rate mortgages are at historical lows and millions of homeowners are saving money by refinancing. But as short-term rates continue to fall, the temptation of taking out an adjustable rate mortgage increases.

It seems that the LIBOR ARM is the most attractive of the myriad of adjustable rates available. For those who are unfamiliar with the LIBOR, let me explain.

LIBOR stands for London Interbank Offering Rate.  Basically, the LIBOR is the interest rate that European financial institutions charge each other for funds.  Many American lenders offer adjustable rate mortgages that are tied to the LIBOR index. This wouldn't normally be newsworthy - there are lots of different types of ARMs available. The thing that makes the LIBOR index interesting is that the One-Month LIBOR rate is hovering at about 1.38 percent. As far as adjustable rate indexes go, that's pretty low. And most LIBOR ARMs are offered without charging points. (One point is equal to one percent of the loan amount in cash at closing. Be careful about paying points on any mortgage.)

Here's the next thing: Various mortgage brokers and lenders are offering LIBOR-based adjustable rate mortgages with a margin as low as two percent. The margin is the amount that is added to the index in order to determine the interest rate.

You see where I'm going with this? Add 1.38 percent and two percent and you have what's called a "fully indexed" rate of 3.38 percent. Even with fixed rates hovering as low six percent, a fully indexed ARM at 3.38 percent is hard to turn down.

You'll notice that I continue to use the term "fully indexed". This is very important because many adjustable mortgage programs lure you into the loan with a low introductory, or "teaser" rate. As soon as the introductory period is over, your rate spikes up. A fully index rate isn't discounted - as the LIBOR index increases or decreases, so will your LIBOR ARM rate.

I was hot on this product back in January when the LIBOR index dropped just below two percent. With a two percent margin, the LIBOR mortgage rate was four percent - still very cheap. The index edged slightly lower all year, and made a big drop after Alan Greenspan's recent half point cut in the Federal Funds Rate. So the folks that took out a LIBOR at four percent a year ago are now enjoying a rate at less than 3.50 percent today.

What's the risk? Well, it is an adjustable rate so it can and will eventually increase. But let's look at its history.  Over the last ten years, the LIBOR index has averaged 4.87 percent. With a two percent margin, a LIBOR mortgage rate would have averaged 6.87 percent - certainly not unreasonable.

Only in 1994 did the LIBOR ever increase by more than one percent in 12 months. It's a slow moving index so a LIBOR mortgage is not likely to spike up dramatically overnight.

The LIBOR tends to follow U.S. short-term interest rates. Basically, this means that you can expect the LIBOR to start moving up when the Federal Reserve starts increasing rates. When will the Fed begin to raise rates? As soon as the economy heats up and inflation rears its ugly head. I doubt if that's going to happen anytime soon. And when it does, since the LIBOR is so low right now, it has a long way to go before a LIBOR mortgage rate becomes uncomfortable. The LIBOR's not for everyone. For those who are living in their dream home and will not be moving, lock into today's fixed rates and forget about it.

Who would be better suited to a LIBOR mortgage rather than a fixed rate?
Here are some examples:

Folks who have equity in their property as well as considerable consumer debt. Taking out a LIBOR to consolidate high interest credit card debt will save thousands in interest cost.

Folks looking for cash flow relief. Many LIBOR ARMs have "interest-only" payment options. Although you are not curtailing principal, an interest-only payment keeps your monthly obligations down. Here's an example: The principal and interest payment on a $300,000 mortgage at six percent is $1,798 per month. An interest-only payment on a 3.38 percent LIBOR ARM is only $845 per month - less than half.

Homeowners who want to take advantage of a low tax deductible interest rate. A lot of homeowners choose to take out a LIBOR ARM simply because it's the cheapest way to borrow money. What does the future bring? Who knows? But I bet the LIBOR will continue to be a bargain for a while.

HISTORICAL LIBOR INDEX
Please note this history is based on compilation off data which is accurate to the best of our knowledge. We can not be liable for any errors in the historical rates shown above. Before making any financial decision please consult with your financial advisor for the most accurate information available. This should be used only a reference and not as a basis for making any financial decision.