LIBOR and Loans

Many are unaware of the LIBOR (London Interbank Offered Rate) and how it affects them in their daily lives. The LIBOR is the average interest rate that banks charge when they make short-term unsecured loans to other banks. This, in turn, affects interest rates for such things as student loans, mortgages, and the value of major currencies and is a major influence on the Interbank Forex market. It is essentially the interest rates of 16 major banks averaged out. Approximately 80% of all sub prime mortgages are tied to the LIBOR.

Mortgages Tied to LIBOR Rate

If a mortgage is obtained chances are that the interest rate is closely tied to the LIBOR or other indexes such as the Cost of Funds Index (COFI). Loans are typically pegged to indexes called the one-month, three-month or six-month LIBOR. The rates reflect the averages of what banks are charging for longer term loans and those with adjustable rate mortgages can be in for a very unpleasant shock if rates rise. It is estimated that 60% of all adjustable loans in the US are tied to the LIBOR. Unfortunately most buyers have no idea what the LIBOR is and how it can affect their lives.

LIBOR and Short Term Corporate Loans

The LIBOR is also the benchmark for short term corporate loans. If the LIBOR goes up it impacts a wide range of borrowers including corporations and small businesses that depend on the availability of credit to finance day to day operations. If credit markets freeze or interest rates rise it can directly affect businesses resulting in layoffs and rising prices for consumer goods. The LIBOR also affects the value of various currencies on Interbank Forex markets.

LIBOR Rate and Student Loans

Almost 50% of all lenders peg the interest rate charged to the LIBOR and student loans are no exception. Rates tied to the LIBOR are typically LIBOR+2.80%. If rates go up the loan becomes more expensive and can significantly increase the cost of a college education. The recent credit crunch has adversely affected the availability of student loans. Many economists are telling those with loans tied to the LIBOR to brace themselves for a rise in interest rates.

LIBOR and Interbank Forex

LIBOR has a profound influence in currency markets including the Interbank Forex. The spread between 90 day T-bill and 90-day LIBOR rates can give investors a sense of confidence in the US dollar. When confidence in the US dollar is high the spread will be very close while conversely, if confidence is low the spread will be higher. While LIBOR is primarily about interbank lending rates it can reflect investor confidence in various currencies on the Interbank Forex market.

LIBOR Affects Confidence in the Dollar

If you have a mortgage, have taken out a student loan, or work for a company that depends on the availability of credit, the LIBOR can have an impact on your financial life. The LIBOR helps to determine the confidence that Interbank Forex investors have in the Dollar and helps to determine the exchange rate. Although located in far away London the LIBOR has a direct impact on the daily lives of Americans.