LIBOR and Adjustable Rate Mortgages

Yesterday I wrote about The Exploding ARM (Adjustable Rate Mortgage), where a mortgage interest rate suddenly explodes to a stratospheric level based upon a stated Base Interest Rate and the Margin.

LIBOR is the most common Base Interest Rate for ARMs.  It stands for London InterBank Offered Rate.  Reasons for its use are not clear to an outsider.  One wag has said it is used because it is outside the regulation or control of the United States, in case adjustable mortgages become bad for the US economy.  (Become?)

More practically, it is recognized as the world’s most widely used benchmark for short-term interest rates, as well as the most active interest rate market in the world.  Risks from negative amortization are not permitted with a LIBOR ARM.  LIBOR rates are posted daily at 11:00 am London time, so there is not much of a delay in reflecting worldwide economic activity.  London’s recognition as an international financial center, with proximity to both the USA capital markets and the Middle Eastern oil interests, are additional reasons for its popularity.  Our global economy and its ever-expanding search for capital investment may explain why LIBOR is now being used for adjustable mortgages in place of the previously popular USA-only prime rate.

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