How to Calculate Adjustable Rate Mortgage LIBOR
If you have an adjustable-rate mortgage (ARM), understanding how to calculate the London Interbank Offered Rate (LIBOR) is crucial. LIBOR is a benchmark interest rate used by lenders to determine the interest rate for various financial products, including ARMs. By knowing how to calculate LIBOR, you can better manage your mortgage payments and be prepared for potential rate adjustments.
What is LIBOR?
LIBOR is a daily reference rate based on the interest rates at which banks borrow from one another in the international interbank market. It is published daily for different currencies and maturities, ranging from overnight to one year. The most commonly used LIBOR rates are the 1-month and 3-month rates for the U.S. dollar.
Step 1: Understand Your ARM Terms
Before you can calculate LIBOR for your ARM, you need to understand the terms of your mortgage. Review your mortgage documents or contact your lender to find the following information:
- Index: The specific LIBOR index your ARM is tied to (e.g., 1-month or 3-month LIBOR)
- Margin: The additional percentage added to the index to determine your interest rate
- Adjustment Period: How often your interest rate is adjusted (e.g., annually, semi-annually)
- Interest Rate Caps: Any limits on how much your interest rate can increase at each adjustment or over the life of the loan
Step 2: Find the Current LIBOR Rate
LIBOR rates are published daily by the Intercontinental Exchange (ICE) Benchmark Administration. You can find the current LIBOR rates on various financial websites or directly from the ICE Benchmark Administration website (https://www.theice.com/iba/libor).
Let's say your ARM is tied to the 1-month LIBOR, and the current rate is 1.25%.
Step 3: Add the Margin
Once you have the current LIBOR rate, you need to add the margin specified in your mortgage terms. The margin is a fixed percentage added to the index to determine your fully-indexed interest rate.
For example, if your mortgage has a margin of 2.25%, you would add it to the LIBOR rate:
1.25% (1-month LIBOR) + 2.25% (margin) = 3.5% (fully-indexed interest rate)
Step 4: Consider Interest Rate Caps
If your ARM has interest rate caps, you need to factor them into your calculation. There are typically two types of caps:
- Periodic Cap: This limits how much your interest rate can increase at each adjustment period.
- Lifetime Cap: This limits the maximum interest rate you can be charged over the life of the loan.
Let's say your ARM has a periodic cap of 2% and a lifetime cap of 5% above the initial interest rate. If your initial interest rate was 4%, and your fully-indexed interest rate calculated in Step 3 is 3.5%, you would not exceed either cap.
However, if the fully-indexed interest rate was 6.5%, it would be adjusted to 6% due to the periodic cap, and 9% due to the lifetime cap.
Step 5: Calculate Your New Mortgage Payment
Once you have determined your new interest rate, you can use a mortgage calculator to estimate your new monthly payment. Keep in mind that your payment may also be affected by changes in the remaining loan term or outstanding balance.
Conclusion
Calculating LIBOR for your adjustable-rate mortgage may seem daunting, but it's essential to understand how it affects your monthly payments. By following the steps outlined in this article, you can stay informed and prepared for potential interest rate adjustments.
Remember to review your mortgage terms, find the current LIBOR rate, add the margin, consider any interest rate caps, and then calculate your new payment. If you're ever unsure or have questions, don't hesitate to reach out to your lender for clarification and guidance.
Staying on top of your ARM's interest rate adjustments can help you budget effectively and make informed financial decisions throughout the life of your mortgage.