LIBOR
The BBA LIBOR is the most widely used benchmark or reference
rate for short term interest rates. LIBOR stands for the London Interbank Offered
Rate and is the rate of interest at which banks borrow funds from other banks, in
marketable size, in the London interbank market.
There are actually several Libors corresponding to different deposit maturities.
Rates are quoted for 1-month, 3-month, 6-month and 12-month deposits.
A Libor mortgage is an adjustable rate mortgage (ARM)
on which the interest rate is tied to a specified Libor. After an initial period during
which the rate is fixed, it is adjusted to equal the most recent value of the Libor plus a margin,
subject to any adjustment cap.
Example:
On April 26, 2005, a lender was offering a 6-month Libor ARM at 3%, zero points, and
a margin of 1.625%. The new rate 6 months later will be 1.625% plus the 6-month Libor at that
time. If that is 2.625%, the new rate will be 1.625% + 2.625% = 4.25%. If the adjustment
cap that limits the size of rate changes is 1%, however, the new rate will be
only 3% + 1% = 4%.
