Is The LIBOR On Target?
June 2nd, 2008
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It was last August when HUD first allowed the use of the LIBOR index with FHA ARMs.
In other words, borrowers –who had been able to get an FHA adjustable-rate mortgage with rates that move up or down with the one-year Constant Maturity Treasury (CMT) index — would also have the option of FHA ARMs based on the LIBOR index.
One reason to use the LIBOR index would be to make the sale and re-sale of such loans more attractive on the international market. That, in turn, could help hold down rates in the U.S.
The LIBOR typically has a lower margin then a Treasury index — the fixed amount added to the index to create the rate. For instance, if the index is 3.00 percent and the margin is 2.5 percent, then the rate charged to the borrower would be 5.5 percent. If the index moved up to 3.5 percent, then the new rate would be 6.0 percent — 3.5 percent plus 2.5 percent.
Thus, as I explained last August, if you have an interest in an FHA ARM be sure to look at both the index and the margin. The LIBOR index typically has a 2.25 to 2.50 margin while an ARM with a Treasury index might have a 2.75 percent margin.
While indexes move up and down, you at least want to compare the LIBOR and Treasury measures. If the LIBOR margin is within .25 to .50 of the Treasury index, then either index might be attractive. But if the margin gap is more than .25 to .50, then you might favor the Treasury index, if the margin is less than .25 to .50 then the LIBOR might be a better choice.
I have never been a great fan of the LIBOR index for the simple reason that it does not reflect U.S. economic trends — it is, after all, the London Inter Bank Offered Rate. If I am going to get an ARM, I would prefer a loan that uses the 11th District Cost of Funds Index because it’s based on the interest costs paid by lenders. Since lenders want to hold down interest expenses, the 11th District COFI is closely aligned with borrower interests.
Now we have something new with the LIBOR, concerns that the rate is too low.
The LIBOR is determined by the British Bankers’ Association and, reports Bloomberg, the BAA “has been under pressure to overhaul the 24-year-old system after the Bank for International Settlements said in a March report some members understated their rates to avoid being perceived as having difficulty raising financing.”
If the LIBOR has been artificially held down that would be good news for borrowers. If somehow the LIBOR should be higher that would not help large numbers of FHA mortgage borrowers. Indeed, if the LIBOR was higher you would expect foreclosure levels to rise still further.
If you have an FHA mortgage based on the LIBOR index, keep your eye on news from London. There have been no changes made to the way the index is calculated, but the debate may not be over.
For the full Bloomberg article, see: BBA Avoids Changes to Libor, Seeks to Bolster Review (Update3
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March 15th, 2009 at 12:04 pm
My mother is considering a reverse mortgage and the ARM is based on the Libor Index. I expected the Libor Index to be similar to the Prime Rate, however, during my investigation, I see things like 3M, 4M, 5M, etc … index. If her loan adjustment is annual, does she use the 12M Libor index interest rate?