{“related terms”:“London Interbank Offered Rate, Adjustable-Rate Mortgage, Eurodollars, Interest Rates”,“keywords”:“LIBOR, London Interbank Offered Rate, adjustable-rate mortgages, international banking, Eurodollars”,“description”:“Learn all about LIBOR, the pivotal rate used in international banking and for adjustable-rate mortgages.”,“categories”:“Financial Terms, Banking”,“title”:“Understanding LIBOR: The Fundamental Interbank Offered Rate”,“content”:"# Understanding LIBOR: The Fundamental Interbank Offered Rate
LIBOR (London Interbank Offered Rate) is the rate that international banks dealing in Eurodollars charge each other for large loans. Some domestic banks use this rate as an index for adjustable-rate mortgages (ARMs).
How LIBOR Impacts Loans
For example, European lenders may offer to finance a hotel in California at the LIBOR rate plus three percentage points, adjusted monthly. This means if the LIBOR rate is 1%, the interest on the loan would be 4% (1% + 3%). The rate would be reassessed every month, which can result in fluctuating loan payments.
Why LIBOR Matters
- International Banking: LIBOR acts as a benchmark rate for international transactions, ensuring uniform rates for loan agreements between banks across different countries.
- Adjustable-Rate Mortgages: Many ARMs use LIBOR as a benchmark rate to calculate the interest charged, directly influencing homebuyers’ monthly payments.
- Financial Products: Besides loans, other financial instruments such as derivatives and futures are often tied to the LIBOR rate.
Transition Away from LIBOR
Given its pivotal role in financial markets, the planned phase-out of LIBOR by the end of 2021 has driven significant industry adjustments. The move aims to enhance transparency and reduce reliance on LIBOR, addressing long-standing criticisms of rate manipulation and lack of robustness.
New Benchmark Rates
- Secured Overnight Financing Rate (SOFR) in the U.S.: Viewed as a more reliable benchmark, SOFR is based on actual overnight borrowing costs in the Treasury repurchase market.
- Sterling Overnight Interbank Average rate (SONIA) in the UK: Similar to SOFR, SONIA also rests on transaction-based data, deemed more transparent than LIBOR.
Common LIBOR Terms
- Eurodollars: U.S. denominations held in foreign banks or in international branches of American banks. LIBOR’s prominence shines in this market.
- Interest Rate Swap: A financial derivative where two parties exchange the interest payments on loans of the same currency with different terms.
Frequently Asked Questions
What is the LIBOR rate used for?
LIBOR is used as a benchmark for setting interest rates on various financial products, including adjustable-rate mortgages, student loans, and derivatives.
Why is LIBOR being phased out?
LIBOR is being phased out due to concerns over its reliability and susceptibility to manipulation. Alternatives like SOFR and SONIA are considered more transparent and robust.
What will replace LIBOR?
Different regions are adopting various benchmarks. In the U.S., it’s the Secured Overnight Financing Rate (SOFR); in the UK, it’s the Sterling Overnight Interbank Average rate (SONIA).
How does LIBOR affect my mortgage?
If you have an adjustable-rate mortgage (ARM) tied to LIBOR, your interest rate\u2014and consequently your monthly payments\u2014will vary based on changes in the LIBOR rate.",“tags”:“LIBOR, Adjustable-Rate Mortgages, Eurodollars, International Finance”}
Related Terms: London Interbank Offered Rate, Adjustable-Rate Mortgage, Eurodollars, Interest Rates
