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Released: August 08, 2012
Help Desk FAQ
What does it mean if my variable rate loan is tied to LIBOR?
LIBOR, the London Interbank Offered Rate, is one benchmark, or index, to which the interest rates on adjustable (variable) rate loans and some investments may be tied. (There are other benchmarks, such as the Prime Rate, too.) Any adjustable rate loan or other financial product tied to a benchmark will follow that benchmark’s movements up and down.
For example, if the margin (the percentage added to the benchmark rate) on your adjustable rate mortgage (ARM) is 1.25% and the LIBOR is 2.5%, your interest rate would be 3.75% (1.25% + 2.50% = 3.75%). In this scenario, if the LIBOR increased a quarter percent, to 2.75%, your new rate would be 4.00% (1.25% + 2.75% = 4.00%). That could be a significant increase on a larger loan, resulting in many thousands of dollars extra interest paid over the life of the loan. Likewise, a lower LIBOR would save you money on interest payments.
In the "LIBOR scandal" of mid-2012, accusations were made that LIBOR had been manipulated by the banks that determine the benchmark's rate—allegedly since the early '90s—to either make money or to make their bank and the banking system as a whole appear stronger. Because in that particular instance the interest rates had been manipulated downward, average borrowers with LIBOR mortgages, student loans and other forms of credit most likely benefited from the manipulation. However, some consumer and institutional investors may have experienced lower returns on their money.