LIBOR mortgage - The money market mortgage

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What is the LIBOR

The London Interbank Offered Rate is the rate at which banks in the European money market lend money among themselves in the short term. The LIBOR rate is determined on a daily basis.

In the following video we explain the advantages and risks of LIBOR mortgages:

How does a LIBOR mortgage work?

The rate of a LIBOR mortgage consists of two different parts: the margin of the bank and the actual LIBOR rate. Most providers of LIBOR mortgages allow the customer to choose a term of usually 3 to 5 years, however, some providers offer shorter or longer terms. During the term of the mortgage, the margin, which is currently around 1% and depends on the creditworthiness of the customer, does not change.

In addition to the term, the customer can select a LIBOR-basis (1-, 3-, 6-, or 12-month basis, 3 and 6 months are the most popular versions). During the selected basis, the LIBOR rate remains unchanged and is only adjusted according to the selected basis, e.g. every 3 months. Therefore, the actual interest rate changes every 3 months.

Switch option

The Switch-Option allows the customer to switch (for a small fee) to a fixed-rate mortgage on the next interest date during the chosen term. Usually, the term of the fixed-rate mortgage then has to be at least as long as the remaining term of the LIBOR mortgage. Thus, if your LIBOR mortgage has a term of 5 years and after 2 years you decide to switch to a fixed-rate mortgage, the term of your fixed-rate mortgage has to be at least 3 years.

CAP option

The CAP-Option, also known as interest ceiling, provides the customer with protection against rising LIBOR rates. Thus, the customer can decide at which rate the interest ceiling comes into effect, the interest ceiling will then be equal to the maximum rate. However, the interest ceiling is tied to a premium. The amount of the premium is based on the actual rate at which the interest ceiling comes into effect as well as the term of the mortgage: the lower the interest ceiling and the shorter the term, the higher the premium will be.

PROs of a LIBOR mortgage

• Has been the least expensive mortgage type in recent years
• Transparent composition of the LIBOR rate
• Useful when the level of interest rates is falling or if it’s already low, because the customer benefits from rate adjustments quite quickly
• Protective options against rising rates

CONs of a LIBOR mortgage

• If action is not taken quickly enough, the rate may rise very high within a short period of time
• Due to regular rate adjustments, budgeting is not possible
• Monitoring of the market is required in order to not miss a change in trend regarding the interest rates

A LIBOR mortgage suits customers who want to benefit from a low level of interest rates or who expect the interest rates to fall. A certain degree of risk-bearing capacity is important. In addition, market know-how and a financial cushion can be helpful.