Leaping LIBOR: Keep your eye on the Ball if you have an ARM

by Alex Stenback on October 9, 2008

For those of you that need a reminder of just what exactly LIBOR is, and how it can impact everything from your mortgage rate (if you have an Adjustable Rate Mortgage) to your credit card rates, Bloomberg has provided this tidy little graphic:

Libor_whatsit

Notice how LIBOR has historically tracked the Federal Funds rate, and that the correlation has broken down completely as LIBOR has spiked?  Whether or not you understand, or seek to understand the nature of the credit crisis, this fact alone will tell you that something extraordinary is afoot.

Our more narrow point is this:

If you have an adjustable rate mortgage indexed to LIBOR, you may be in for a larger upward adjustment than anticipated.  Granted, LIBOR may come back down to earth, and you likely have a cap structure that will prevent an increase of more than a point or two, but this bears watching, because:

1.  Many Prime ARM’s of a vintage (originated between 2002-2005) set to adjust in the next 12-18 months have a cap structure that allows an adjustment all the way to the lifetime cap (typically 5-6% above your initial rate) at the first adjustment.
2.  Many homeowners with Prime ARMS have exactly this cap structure, but don’t know it, or have forgotten.
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Quick PSA: If you aren’t sure whether your adjustable rate mortgage is even indexed to LIBOR, much less what your cap structure or margin is, here’s what you do:

1. Pull out the documents entitled "Mortgage", "Note", and "Adjustable Rate Rider" from the dusty folder you probably have not cracked open since your loan closed.  Read them.  Right now.

2. If after doing that you are still lost, reach out to me and I’ll walk you through it.  Assuming you can lay your hands on the documents above, it will take less than 5 minutes, or a couple of emails.

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