What can I do about mortgages that track the LIBOR rate?
Mortgages that track the Libor rate
If you have taking out your mortgage with a lender that is not one of the high street banks, then you may be confused and concerned about the news concerning the fixing of the LIBOR interest rates. Big banks have been trying to fix these rates for their own benefit, in order to get a financial reward, but the main result has been that these rates have been fluctuating, resulting in some borrowers becoming nervous about their mortgages. In order to fully understand what you can do about these loans, you need to understand LIBOR mortgages, and how they can affect your mortgage whether you have a loan with a sub-prime lender or not.
What are LIBOR mortgages?
The majority of mortgages taken out by UK borrowers are tracker mortgages, following the rate of interest set by the Bank of England. These variable mortgages follow the set interest rates, with the bank increasing or decreasing the rates of interest for borrowing the mortgage accordingly. With a LIBOR mortgage, often set by sub-prime lenders, the interest rate followed is the London Inter-Bank Offered Rate. This is not a public rate, but is a private interest level which is set by the banks when they lend and borrow money between each other. In most cases, LIBOR mortgages follow a three-month rate set by the LIBOR committee, a group known as the Intercontinental Exchange Benchmark Administration. This group sets the rate every day, asking the biggest banks about the rates of money exchange at certain times of day. The average of these rates forms the LIBOR. There is significantly more movement in this process than there is in the Bank of England base rate, meaning that borrowers have more flexibility in their loan.
What is the connection between LIBOR mortgages and standard bank mortgages?
The majority of mortgages track the BOE base rate
Although the two types of mortgage lending are very different, and there is a clear distinction between the way that each set of mortgages is worked out, there is still some connection between them. This is because the mortgage rates are often determined by Libor. Buy-to-let mortgages in particular are often connected directly to the rates of interest dictated by the LIBOR. Mortgages which have been lent to customers with poor credit ratings are also going to be closely connected to LIBOR. Perhaps the biggest connection, and the one which should worry all mortgage borrowers, is the association between rises in the LIBOR market, and the increased interest rates that banks charge their customers. This means that all of your bank loans, from mortgages to overdrafts and personal loans, may be affected by the LIBOR fixing scandal.
Why choose a LIBOR mortgage?
Despite the current bad news from LIBOR, in fact there are a few reasons why it might still be worth considering a LIBOR mortgage. The first is the reason why these mortgages are often chosen in the first place: they are more widely available to those with poor credit, or who need larger mortgages than the average bank can offer. As they allow greater flexibility, people who are in a vulnerable position may choose LIBOR mortgages as their only solution. Secondly, the LIBOR mortgage is more financially flexible than even a variable or tracker mortgage. This is because the rates used by the lenders are more fluid. They may increase a great deal, but they could also drop further than interest rates for the Bank of England. Borrowers who are comfortable with this risk are more likely to see it as an advantageous gamble, rather than anything else. Borrowers also like the feeling of transparency which they get with the LIBOR mortgage, since the lender doesn’t adjust their own rate to accommodate LIBOR, but instead simply sends a letter telling the borrower about any increase or decrease in the rate.
What are the downsides to a LIBOR mortgage?
What do you need to consider?
If you are contemplating a LIBOR rate tracked mortgage, then the recent fixing scandal may be large enough to have put you off the idea of a LIBOR loan. The major disadvantage at the moment is that banks are going to have to report their borrowing rates more honestly to the Administration, and this is most likely to mean that mortgage rates will increase.
Another serious problem with the LIBOR mortgage is that it is an unstable and therefore less secure mortgage. If the interest rate shoots up, then you may struggle to make the payments for that quarter of the year, particularly if this has come after a long period of low interest rates on your mortgage.
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