Libor Rate Vs. Prime Rate

Libor Rate Vs. Prime Rate

It’s possible to predict exactly what your adjustable rate mortgage, or ARM, will adjust to before your creditor notifies you. Lenders join an index with a margin that is pre-determined. Your mortgage lender disclosed your margin to you from the notice of your current mortgage, and this amount never changes. The indicator is what moves down or up and causes that your interest rate to adjust downward or upward. Two of the most common indexes are the Libor and the rate. Your indicator and your margin equals your loan’s interest rate.


The London Inter-bank Offered Rate, or Libor, is that the speed international banks charge each other for short-term loans. The Libor includes four speed provisions: one-month, three-month, six-month and one year prices. The longer the duration, the greater the interest rate is for your bank-to-bank loan. Mortgage lenders typically use the Libor as the indicator for first mortgages only.

First Mortgage ARMs

Fannie Mae and Freddie Mac, the two largest government-sponsored mortgage investors, use the one-year Libor as the indicator to their ARMs. Fannie Mae and Freddie Mac ARMs adjust annually after the fixed rate period expires. Some of their ARMs have adjusted rate intervals of three, five and seven decades. When the loan reaches its adjustment period, the Libor for this day will be added to the margin required for this loan application. The Libor is calculated every day, and as of July 23, 2010, the Libor rate was 1.13 percent. If the margin on the ARM that afternoon was 2.25 percent, the interest rate would adjust to 3.38 percent for the following year. If the speed once the loan closed was 5%, the payment would reduce to reflect the new lower fixed interest rate.

Prime Rate

The Wall Street Journal publishes the prime rate every day. The Wall Street Journal surveys 10 of the largest banks from the United States to ascertain the prime rate. When seven of the 10 largest banks change their speed, the Wall Street Journal also changes the prime rate. Banks normally use the prime rate as the indicator for mortgages.

Home Equity Lines of Credit

Mortgage lenders offer second mortgage lines of credit called HELOCs which use the prime rate as the indicator. Where the indexes on first mortgages are normally the index plus the margin, this is not necessarily true with mortgages. Some loans with exceptional terms such as low loan-to-value, or LTV, or high credit ratings may obtain loans with adverse indexes. As of July 2010, the prime rate was 3.25 percent. If your indicator was -0.25 percentage, the actual rate would be 3 percent. Second mortgages utilizing the prime rate will refer to it especially as the prime rate published in the Wall Street Journal in their own mortgage notes.

Choosing Between the Two

Financial professionals consider both indexes stable. Choosing between both generally means choosing between a first mortgage or another mortgage. There are exceptions to this principle, especially first mortgage lines of credit which use the prime rate as the indicator. ARM interest prices both rise and fall with time. Both kinds of indexes have their benefits, but take into account the margin of the loan as well as the indicator. The Libor rate will be lower than the prime rate but will get a greater margin typically.

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