What the LIBOR Phase-Out Means for Your Mortgage
Homebuyers are likely to know acronyms such as ARM (adjustable-rate mortgage) or PMI (private mortgage insurance) thanks to their experiences shopping for a mortgage. However, LIBOR (London Interbank Offered Rate) is a term most will not recognize.
Despite its obscurity, the LIBOR and its impending disappearance as a standard mortgage benchmark rate may impact many borrowers in the coming months. In particular, homeowners with a previously-mentioned ARM or reverse mortgage, or those considering one soon, should determine how these upcoming changes might influence their mortgage plans.
A New Benchmark
A benchmark rate reflects the costs banks charge to each other. A consumer loan’s interest rate is often calculated based on a benchmark plus an additional rate – referred to as the margin – which depends on the lender used and the borrower’s credit history. Introduced in 1986, LIBOR is currently among the most common benchmarks used for variable-rate mortgages.
Previous efforts to manipulate the LIBOR, which relies on estimates and self-reporting from financial institutions, resulted in new safeguards and a call for a more secure benchmark. Currently, it’s scheduled to be discontinued by the end of 2021. However, Fannie Mae and Freddie Mac, America’s federally-backed mortgage companies, will no longer purchase loans using LIBOR after the end of 2020.
Borrowers with fixed-rate mortgages will be unaffected by this change, but those with adjustable-rate mortgages will have to deal with the consequences. These loans re-adjust based on their benchmark rates after an initial period, usually just a few years. In most cases, seniors who opted for a Home Equity Conversion Mortgage (HECM) that is paid out over time or established a line of credit should know that their reverse mortgage features an adjustable interest rate as well.
If you have an ARM, now is an excellent time to review your loan documents to determine if it uses the LIBOR as its benchmark rate, and confirm when your next adjustment will occur. Consider contacting your lender to inquire about their plans for replacing the LIBOR. You’ll want to be well-informed so you can make the best decision about your options.
As with most transitions, there is a lot of uncertainty, and everyone’s options will depend on their specific circumstances. Taking no action beyond staying informed about your mortgage is a reasonable approach. With interest rates historically low and expected to remain that way, mortgage rate adjustments or a new benchmark in the next few months could result in lower monthly payments or access to additional equity from reverse mortgages.
Low interest rates also make refinancing from an ARM to a fixed-rate mortgage a smart option for homeowners who expect to remain in their home for many more years. The stability of an interest rate that won’t fluctuate and the opportunity to shorten a loan’s term can result in substantial savings.
With the LIBOR transition on the horizon, mortgage shoppers should be sure to ask prospective lenders which benchmark the mortgage products they are considering will use. Before closing on a loan still tied to LIBOR, ask for a clear explanation of how you should prepare for the transition.
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