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LIBOR Will Die in 2021. What Happens Next?

liborThere has been a lot of news lately about LIBOR, or the London Interbank Offered Rate. This is the rate that major banks charge each other for short term loans. The problem was that the data for the calculation of the rate was gathered verbally from various large banks, and some of those banks were misreporting the data in order to artificially influence LIBOR (and make more money on illegal trades).

While the banks paid enormous fines and one individual was sentenced to 14 years in jail, the scandal also effectively killed off LIBOR as an “Index.” It is slated to end in 2021.

This matters little to us at JVM b/c we close so few LIBOR based ARMs. A LIBOR based ARM might be fixed for five or seven years, for example, before rolling over to a one year adjustable rate tied to the LIBOR index. A borrower’s interest rate is calculated with a set “Margin” (defined in the promissory note) + the “Index.” The One Year LIBOR index is currently 1.73% and a typical “margin” might be in the 2% to 2.5% range.

Borrowers like LIBOR b/c it has been slow and stable, and lenders liked it b/c it was a relatively accurate indicator of market rates. There is about $10 trillion dollars of consumer debt tied to LIBOR, including mortgages, student loans, and credit cards.

Prior to the 2008 meltdown, a much larger portion of mortgage debt was tied to LIBOR, particularly subprime debt. While very few new loans are tied to LIBOR, a huge dollar amount of LIBOR loans remain outstanding.

When LIBOR effectively “dies” in 2021, the note-holders and servicers will have the option to switch the index to a similar or comparable index (per the terms of the note) in most cases. This vague language seems to give the note-holders too much leeway and I would be nervous if I were a borrower with a LIBOR based loan.

Our advice: If you have a LIBOR loan, refinance into something better now while rates are so low.

Jay Voorhees at (925) 855-4491
Real Estate Broker, CA Bureau of Real Estate, BRE# 01524255, NMLS# 335646