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Like a variable-rate mortgage, a LIBOR mortgage is a mortgage whose interest rate can change during the repayment term. The interest rate of a LIBOR mortgage, also known as a money market mortgage, is adjusted to reflect the market rate every 3 to 6 months, depending on the terms of the mortgage. The repayment term of a LIBOR mortgage is also fixed – usually at three to five years.
LIBOR stands for London Interbank Offered Rate. This is the interest rate banks charge when they lend each other money for the short term. The LIBOR mortgage comprises just two components: the LIBOR interest rate and the margin set by the bank. It is therefore very transparent.
The interest rate for a LIBOR mortgage is calculated using the LIBOR and the margin applied by the lender. Although the LIBOR is recalculated every day, a LIBOR mortgage offers a bit more stability. Borrowers can choose at what intervals the interest rate should be adjusted. Lenders usually offer a choice of a 3, 6 or 12-month LIBOR. The repayment term is usually three to five years.
When interest rates are low, a LIBOR mortgage is the cheapest option. It has generally been the lowest-cost home financing choice for the past ten years.
When interest rates fall, borrowers feel the benefits straight away. Since the LIBOR can fluctuate strongly and therefore rise dramatically, this mortgage type is only suitable for borrowers who have the funds to cope with a sharp rise in rates.
Who knows what the interest rate will be in, say, four years’ time? No one. Even the savviest experts can only speculate. To take out a LIBOR mortgage, you need to have a financial cushion against risk, as the LIBOR mortgage clearly involves a certain level of risk in a climate of rising interest rates.
Some lenders offer protection against interest rate fluctuations, in the form of a CAP. This sets an upper limit above which the interest rate may not rise during the entire term of the mortgage. But this interest rate ceiling comes at a price. Usually, the costs for this type of agreement must be paid at the beginning of the mortgage term.