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Interest Only LIBOR

Interest Only Libor products are among the newest available in the market. In years past, interest only mortgages were tied into one of the Treasury Indexes, commonly the Monthly Treasury Index or 1 year T Bill. The problem was that these indexes can be influenced by the moves of the Federal Reserve. In periods where inflation was seen in the economy, the FED would move to increase short term borrowing costs which would adversely affect the T Bill. Lenders are migrating from a T Bill based product to a LIBOR based ARM because the LIBOR index has proven to be more stable and frequently offers a lower margin. Email interest only LIBOR loan questions

Interest only Libor products are tied to the LIBOR index which is the rate paid on deposits between banks in the Eurodollar market. The LIBOR rates quoted in the Wall Street Journal is the average of rate quotes from five major banks. Be aware that there are several different versions of the LIBOR indexes which can be very confusing when evaluating a LIBOR ARM. The Journal quotes a 1 month, 3 month, 6 month, and 1 year LIBOR index so be sure which index is proposed.

In general, Interest Only LIBOR ARMS offer the lowest rate and payment option in today's market. These products can be very straight forward as is seen in the information below or can be a very sophisticated financial tool as is the case with the Cash Flow Interest Only Libor. One feature is that they can easily be set up with an interest only option which can reduce your monthly carrying cost substantially. 

A very important concept to understand with these products is what a banker will describe as the yield spread curve. This is a chart graphing the differences between long term borrowing costs (traditional fixed rate mortgages) and short term borrowing costs (LIBOR indexes) Consider how steep the curve is when fixed rate mortgages are at 6% and the 1 month LIBOR index is at 2% as is the case at the time of this writing. This is how lenders have traditionally made money. Borrow at the short end and lend at the long end. By selecting a fixed rate loan, you are clearly borrowing at the long end and by selecting a LIBOR ARM, you are borrowing at the short end. Is there risk associated with borrowing at the short end? Of course there is. Interest rates will change. However, we can manage that risk by selecting the appropriate loan with a fixed period that matches your situation. If you anticipate an increase in income in a relatively short period, select a shorter fixed period. One of the things that I have never understood (and I will admit that I was guilty of this in years past) is the client being adamant about only looking at fixed rate loan pricing and later in the conversation I find that he only expects to be in the home for two to three years. Lets look at the math.

$300,000 loan

Fixed rate payment at 6.000% = $1798.65
3/1 LIBOR ARM payment at 4.750% = $1564.94
Interest only mortgage LIBOR 3/1 ARM payment at 4.750% = $1187.50

In the 3 years my client planned to keep the home, the fixed rate would have cost him $22,000 more! 

Lets try to give you a real basis of comparing specific loans. There are 3 components involved in the selection process. Index, margin, and my clients situation. I like to start with my client's situation so we can select the appropriate fixed period, determine which index is going to be used, and then look at all of my lender's margins to determine which is the lowest. All other things being equal, we will go with the lender who offers the lowest margin as that is what drives the rate during both the fixed and adjustable periods of the loan. Remember, the index will change but your margin is fixed during the life of the loan.

Interest Only LIBOR ARMS are available with fixed periods ranging from 1 month to 10 years. A conservative approach will lead us to select a longer fixed period but you may want to consider the very short end as well as these loans can offer very small margins on a low and slow moving index. I have included a chart comparing the LIBOR index to several other indexes that may be useful.

I have developed a PowerPoint presentation on interest only Libor mortgages, some real world examples, and some suggestions on how best to use them available by email

Here is a useful Interest Only LIBOR payment calculator

I have an article "Buying your home in 2008" by email explaining negotiating strategy in today's market.

As a Certified Mortgage Planning Specialist, I offer an analysis of your situation today can make suggestions on how small changes in how your debt is structured today can have a life changing effect in the years to come.  Read more about this free, no obligation service.

Interest Only LiborPrequalify for your Interest Only LIBOR

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