(click on chart to see full sized image)
A reader asked about how the Prime rate compares to the 1 mo LIBOR rate. Some loans are based on Prime as an index instead of the 1 mo LIBOR. Here’s a comparison of the PRIME rate with the 1 mo LIBOR and the FED Funds Rate. You can see that on average the PRIME is 2.8 points above the 1 mo LIBOR. I get this data from searching online databases from the St. Louis FED and other reliable sources. The conclusion from looking at these data is that the various indexes on which variable loans are based do move in roughly the same upwards and downwards directions in roughly similar time frames.
Just make sure that you ask the right questions of your banker or broker that enable you to know what you may be signing up for. The interest rate of your loan will be based on an index plus an additional percentage called the margin. The margin may be 2.5 or more points. So the interest rate of your loan if based on 1 mo LIBOR would be 3.90% plus 2.5% or 6.4%. Ask if you can buy down the margin of the loan. An upfront fee of a certain number of points can reduce the margin to something like 0.75%, so the interest rate would be 3.9+.75= 4.65%. The return on investment of buying down the margin is usually very good and is something you should consider if you plan to keep the property for an extended period.
Some creative loans tempt you by giving you a lower starter rate for the first year or more. Make sure that you know how the loan will adjust over time. You may find that you pay for those starter or teaser rates by having the loan adjust way above the prevailing rates in year three or four or five. If you are in a position to refinance out of a particular loan you can do so, but that is paying good money for refinancing that could go towards paying off the loan. Are you thinking about paying off the loan or about using the home as an ATM machine to take advantage of appreciation? What if there is no appreciation or negative appreciation? You could find yourself in a situation where you cannot refinance and are unable to make the higher adjusting payments. These are questions you should ask yourself before signing on the dotted line. Don’t just take the word of your broker or banker as gospel. That is what has contributed to many people being in financial distress in this correcting market where appreciation is not happening as much as people had been counting on. Ask around and get answers to important questions. You’ll make a better mortgage decision, one that you can be confident in.
