Understanding Mortgage Products: What is a Libor ARM?
I was asked a few questions about this particular mortgage product the other day and thought it would make a good informative piece.
Definition of Libor: London InterBank Offered Rate, or the interest rate that is given by large London lenders for deposits of American cash.
In fact, there are several of these interest rates, each corresponding with a different timeline of ARM (adjustable rate mortgage). This timeline can range from a 1-month to a year term. These mortgage products are known as Libor ARMs.
How Does a Libor ARM Work?
Just like a local adjustable rate mortgage depends on an index, Libor ARMs depend on these InterBank offers to adjust your mortgage rate. As with other ARM products however, there are still some risks:
- High Rate Caps: Libor ARMs can have high caps on interest rates. Even if they start out low, this could become a serious problem.
- Index Changes: The indexes that Libor ARMs are based upon can change quite quickly. This can be both a positive and a negative depending on which way rates are swinging.
- No Flex in the Payment: Libor ARMs don’t offer negative amortization like other ARMs do. Negative amortization is when you have a payment option that does not fully pay the interest due. This unpaid interest is added to your principal balance, thus the "negative" amortization.