LIBOR on the Rise

The recent acceleration of the European Debt Crisis has made a significant impact on the factors which drive mortgage rates. The effect has been to improve fixed term mortgages, while adjustable rate mortgages have begun what’s projected to be a steady and prolonged increase. For anyone who still has an adjustable rate mortgage, the stars have all aligned to make right now the perfect time to get into a fixed rate product.

Fixed rate mortgages are tied to the bond market. More specifically, each fixed rate product is tied to an individual mortgage backed security, and these securities are traded daily on the open market. As an investment vehicle, mortgage backed securities carry relatively less risk than many other financial vehicles. As a result they are often considered as a “safe haven” trade, very similar to US Treasury bonds. “Safe havens” do especially well when the market is in a state of volatility. Because these assets are traded in US dollars, they do especially well when the dollar strengthens against a foreign currency. As the Euro crisis has deepened, mortgage bonds have benefitted and American homeowners have seen the rate on a 30 year fixed mortgage drop back below 4.0%.

In a sharp contrast, adjustable rate mortgages (ARMs) have risen over the same time frame. This is because ARMs are tied to a different index. The overwhelming majority of ARMs are tied to the 12 month LIBOR. Although the LIBOR has historically been the most stable index as compared to all others, it is a European-based index and has therefore risen in response to the European debt crisis.

The London Interbank Offered Rate, better known by the acronym “LIBOR,” is the rate which London based banks charge each other to borrow funds within their system. The 12 month LIBOR rate has held steady roughly 0.75% for nearly a year, from October of 2010 through August of 2011. But as the European debt problems have emerged, LIBOR has begun to rise. First to 0.8332% in September, then 0.9086% in October, and finally reaching over 1.0% in November, this represents a 0.25% increase in a three month time span. For a rate which has been typically referred to as “stable,” a 0.25% increase in three months represents cause for concern.

Should the European debt crisis spread in 2012 (as many predict it will into Russia and surrounding countries), LIBOR will have nowhere else to go but up. Since the majority of ARMs are tied to this index, those rates will also continue to increase with each adjustment period. For those who still have adjustable rate mortgages, they might be able to ride out the storm if they plan to sell the house before their next adjustment period. But for those who plan to hold their properties long term, now would be the perfect time to get into a fixed rate product.

Arnaud Dufour
Sr. Mortgage Banker
adufour@dljfinancial.com
714-677-4107

CA DRE # 01360217
NMLS # 335758