LIBOR – Interest Rates That Concern Not Just Your Mortgage

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LIBOR is an index rate which specifies the interest charged when banks lend to one another. With the name London Interbank Offered Rate (LIBOR), it’s not hard to guess where the committee setting them is housed.

And because LIBOR was conceptualized long ago, at a time when London was the financial centre of the world (which it still is), many other currencies have adopted it as an index as well. This means that the numbers are not solely based on GBP.

There are now so many variances that I’m too lazy to pinpoint how many there are exactly. You can find that there are LIBOR index rates for GBP, USD, JPY, EUR, CHF, etc.

On top of that, there are also numerous layers for each index categorized by time. A simple reference can be as immediate as “overnight” to as long as 12 months. All these variety just makes the life of consumers all that more difficult.

For example, you could be puzzled with terms like

  • Overnight LIBOR
  • 3 month LIBOR
  • 12 month LIBOR
  • and so on…

You would be excused if you gave up questioning how LIBOR works after a few tries. Most frontline bankers probably don’t have a clue as well.

Which begs the question of why bank home loans are pegged to something too complex for the average homeowner to understand.

The main consumer use of LIBOR is that many mortgages are pegged to it plus a spread. For example, the mortgage of a regular home owner might be 3-month LIBOR plus 2%. An adjustable mortgage that resets after the expiry of teaser rates will likely revert to such an interest structure. You will need to get a 20-year fixed rate mortgage to get a pegless loan.

Historical rates

LIBOR has a long long history. It’s so long that I decided not to look further when I saw a basic chart of it’s historical performance. What I can tell you is that in the last 30 years, it peaked into double digits at around 11% in 1989. So if you think you are having a hard time now with blood-sucking mortgage payments, be thankful that we are no longer in the late 1980s.

It was hovering around 5% in the early months of 2007.

It is important to note that we are currently still in a period of record low LIBOR figures. The drastic drop began in late 2007. Contrary to the many corporate bankruptcies in 2008 which many believed was the start of the subprime chaos, it was actually in late 2007 when subprime began it’s tumble. This nicely coincided with the LIBOR slide. In fact, LIBOR has been so weak for so long that some short term indexes have actually been going at negative numbers for quite a while.

I don’t really understand how that makes sense. Does it mean that the lender will pay us for taking a loan with them? Because I don’t see my mortgage instalments getting smaller or my savings account getting fatter.

Should you take a LIBOR pegged mortgage?

That is really a tough question to crack. On the one hand, personal finance experts have been advocating long term fixed rate mortgages for stability and predictability to the average homeowner who don’t mess with the financial markets.

But on the other hand, LIBOR is still fluctuating around it’s all time lows. This means that if there ever is a good time to exploit the fluctuating LIBOR index, this is definitely the best time. Home owners who have been able to take advantage of low LIBOR for their home loans have been laughing at their neighbors on fixed rates for many years.

If there ever is a time to take advantages of low interest rates, the time is when LIBOR is at it's lowest (which is now).
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If there ever is a time to take advantages of low interest rates, the time is when LIBOR is at it’s lowest (which is now).

The potential problem we could face is that consumers start taking low LIBOR as a given. This might induce the tendency to freak out when the Federal Reserve eventually raises interest rates.

Since we have been operating in a “zero” interest environment for almost a decade, there are now many bankers who have not even experienced how rising interest rates will affect the market. Let alone a home owner.

Should you stay away from LIBOR related mortgages?

There are many critical points you should assess when making such a decision. But let’s narrow down to the 2 main criteria.

It all boils down to whether your house is a home or investment. Sort of like whether you treat it as a new car to keep or a used car to sell.

If you see your house as a long term home where you can really foresee yourself living in for the next 10 to 20 years, you are obviously a conventional homeowner. In this case, a long term fixed rate mortgage could be more suitable choice when we take the long term into account.

Rates will eventually rise. With a long term view, you will inevitably have exposure to LIBOR hikes in future should you take such a loan.

Is there a better way to describe this?
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Is there a better way to describe this?

 

Whereas, you could guard yourself against interest rate volatility by signing on a 20-year fixed rate mortgage. It is sort of like a hedge against volatile rates.

If you are leaning more towards being an investor and build a portfolio of beefy real estate assets, you have to work out your time frame within the exit strategy. If for example, you have decided to hold onto a house for 3 years, low teaser rates could be ideal. It allows you to enjoy low mortgage payments. And you might be able to sell the house before the rates reset.

Of course, that comes with a different set of risks. If you don’t know what those risks are… are you really ready to be a real estate investor?

If you have to refinance

If you are already on a LIBOR pegged loan and feeling stressed out with mortgage rates, there are basically 2 things you can do when you have no intention to sell the house.

The first and easier option is to call up the bank and request for a remortgage (re-price). It’s not easy getting banks to lower their rates for you just because you insist on it. So very often, you will not get anywhere with such requests. Sometimes when you do get lucky, you might be offered a different loan structure to sign on to.

But do take note of the terms and conditions you could be signing to. Very often, the new offer might be attractive when compared to your current loan, but not when you compare with what is available in the market.

This leads us to the second method. To refinance to another lender.

Because banks operate in a very competitive market, and customers tend to have a huge lifetime value, lenders are often very willing to spend big just to acquire new borrowers. This can lead to them slashing their mortgage rates in their customer acquisition strategies.

This means good news for you.

Fixed or adjustable?

If you are refinancing your loan from a LIBOR pegged mortgage, the obvious choice now is to get a long term fixed rate mortgage. But those are not always available due to many factors including credit, eligibility, criteria, etc.

If your only refinancing options are still LIBOR pegged mortgages, the best long term option is the loan with the lowest long term spreads.

Home loans are typically set up in 2 ways. Either you get one with low teaser rates which rises over time, or one that does not have teaser rates but constant over the long term. The latter is the better choice with the longer term in mind.

Sometimes, a lender might offer you something good with conditions attached. For example, they may require you to sign up with their mortgage insurance in order to grant you a good deal. If you are not familiar with these things, do pick up some tips on buying insurance before agreeing to these terms.

Lastly, you might even consider fully paying up your loan if you have excess cash on hand. You can then get rid of this headache once and for all.

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