LIBOR Rate; What is It? And Why Should You Care?

Here is a buzz word for you that you might have heard during the Sub Prime crisis. The word is "LIBOR". LIBOR stands for London Inter-bank Offered Rate. LIBOR is the short term interest rate at which banks borrow funds from each other. Although we have seen Fed Chairman, Ben Bernanke, lowering rates quite significantly, we are seeing some concerns with LIBOR which is indicative of a potential credit tightening between banks. If banks won't loosen the purse strings to other banks, then the loans to consumers can become more of an adversity. Typically the LIBOR rate isn't that far off from the Fed Funds Rate. The Fed Fund rate is the interest rate on "overnight" loans between banks. However, due to this liquidity problem we have had, the banks have become concerned about lending to each other. Hence the LIBOR has been rising independently from the Fed Funds Rate.

Why Should You Be Concerned?

If you don't have an Adjustable Rate Mortgage (ARM) or if you pay off your credit cards on time, then you don't have to be concerned unless you just want to know about the "whys?" on our dilemma with this credit crunch. However, if you do have an Adjustable Rate Mortgage and you have a high balance on your credit card where you don't think you are going to pay it off any time soon, then I'd say, pay attention to this. The reason is that it is tied into the LIBOR rate, not the Fed Funds rate. It might create a hardship for you, if you are in these type of situations. So before you go for a new mortgage, ask if it is tied to the FED Funds Rate or the LIBOR Rate. And be aware that if the LIBOR rate goes up, so will your credit card interest rate.

There is a good chance the LIBOR rate will not return to normalcy for a long time, because of its close tie to the FED Fund Rate and our financial markets being unstable. So despite the efforts of Bernanke trying to lower interest rates, we could actually see rates going up due to a tightening in the LIBOR rate. Shaky confidence has led the credit market to demand higher yields with their inter-bank lending versus the Fed Funds Rate and the Treasuries, which are considered risk free.

LIBOR rates are offered in Euros, not dollars. In the stock market we have what we call Futures for equities, currencies, interest rates, commodities, and even the weather. Basically, it is betting on one of these areas a set price for where it will be in the "future". Click "here" for a more in depth definition of "Futures". There are current conditions right now that show that the increase in the "Euro March Future's Contract" and the change in the "LIBOR Future's Contract" could be indicative of LIBOR rates are going up. And that means the credit crunch is not over despite the Fed lowering rates drastically the last week of January.

I know this all sounds confusing to the average person who isn't even an investor. However, it is important for consumers and homeowners to understand some of these "internal" conditions in the market so they can plan ahead to prevent any hardships for the future. The bottom line to all this as a consumer and any homeowner that has an ARM mortgage is, you need to refinance soon and/or do not carry credit card balances.