London Interbank Rate, Libor Rates (LIBOR)

By: EconomyWatch   Date: 9 September 2010

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LIBOR, or the London Interbank Offered Rate, is the interest rate charged by banks in the internationalwholesale money market based in London while issuing short-term loans to other banks. Libor rates are considered a benchmark by banks across the globe for setting their interest rates for adjustable rate mortgages (ARMs). The Libor rates are calculated daily and published by the British Banker’s Association (BBA) in conjunction with Reuters.

Although Libor rates are determined by the financial markets, they are directly impacted by the Fed funds rate. Even thepossibility of a change in the Fed funds rate leads to a change in the Libor.

Libor rates directly impact several financial instruments, such as variable rate mortgages, ARM and floating rate loans. In theUS, financial institutions use Libor as the base rate while issuing ARMs and large corporate and commercial loans.

Types of Libor Rates

There are several types of Libor rates that are used as ARM indexes:

  • 1 Month Libor rates: In this type of loan rate, the interest rate on the amount remains unchanged for the entire month of theloan period. However, the interest paid by a borrower is calculated by adding the original interest rate and a margin amount, which is based on the Libor index. The value of the Libor index is set every month, which results in monthly fluctuations in the interest payment.

 

  • 3 Month Libor rates: The interest rate on the loan amount continues to be at the same level for a three-month period. The value of the loan is reset if the borrower extends the loan.

  • 6 Month Libor rates: In this type of loan rate, the interest rate on the amount is set for a period of six months. The rate isreset in case the borrower extends the loan.

  • 1 Year Libor rates: This is the rate at which banks in the London interbank markets can borrow funds from other banks for the period of a year. The rate set on a day is applicable on the loan issued on that day. This rate on the issued loan will remain unchanged till the end of the loan term.

Of these rates, the 6 month Libor rate is most commonly used. A Libor-based loan with a short loan term is a great option forborrowers who have short-term real estate goals and who are comfortable with risk.


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