Libor, Li-what!?

What the hell is LIBOR and why should I care?

If you have a mortgage, you should at least know what LIBOR means, even if you don’t end up caring about it.

Disclaimer: This is a brief explanation of what it is, it’s way more complex than how I’m portraying it, and I don’t claim to be a professional financial advisor by the way…I’m just a 24-year old woman trying to learn more about her money 🙂

So.

LIBOR stands for London Interbank Offered Rate, and it sounds like “Lie-Bore” (think of a really boring, skeezy, sleazy blind date as a metaphor to remember how to pronounce it).

And LIBOR means just that: it’s a short term interest rate of how much international banks charge one another for lending and borrowing money. When I say “short term interest rate“, I mean that the rate can change anywhere from overnight to 12 months. So in other words, the LIBOR tracks how much it costs for about 20% of the most established, trustworthy banks in the world to borrow money from other banks. Big banks. Not little ones around the corner in the ‘hood. Big names.

In light of what’s happening to the financial markets in North America, people should care about LIBOR because it is used as the benchmark rate by which you set the ARM (Adjustable Rate Mortgage) loans.

Makes sense, non? Banks lend you money for a mortgage. Who lends money to the banks? Other banks, mais oui! And that’s where the LIBOR comes in.

If you’re more mathematically inclined:

If Index + Margin = ARM (Adjustable Mortgage Rate)… or your interest rate on your mortgage

And if Index = LIBOR

Then we substitute in LIBOR, and we get: LIBOR + Margin = Mortgage Rate

It matters more than ever now, because the LIBOR (remember, the index benchmark rate for interbank loans), is starting to divert from the Federal fund rate that it used to follow so closely. It’s a gap of about 5.7% which is the highest it’s been in years.

Basically, what’s happening is other banks are worried that if they lend out money (short term), they won’t ever see it again. So the cost of borrowing goes up, and the LIBOR rises with it.

Basic economics – anything in scarce supply (like iPhones, no scratch that, a Hermes Birkin Bag), increases in demand (and usually, price, if so inclined – think back to the unlocked iPhones sellin’ on Ebay for a grand each when the actual phone was only $599 and now $399)…

And since the index (LIBOR) is going up, going back to our equation above – your mortgage rate will rise as well, because banks who lend money to you, still want to pull a profit over how much it costs them to borrow money, to lend to you.

Tu comprends?