LIBOR Loans

Discussion in 'After Hours Lounge (Off Topic)' started by Mike Slade, Dec 18, 2003.

  1. Mike Slade

    Mike Slade Second Unit

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    Anybody know anything about LIBOR loans? I'm looking to buy a house and these seem like they could be a pretty good deal. It almost cuts the payment in half from a normal fixed 30 year loan. However the changing interest rate and the interest-only for the first 10 years is a little scary. Anyone have one of these loans or have any advice?
     
  2. Denward

    Denward Supporting Actor

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    LIBOR stands for London Interbank Offered Rate. It's just another interest rate that Adjustable Rate Mortgages (ARMs) use as a reference for calculating your mortgage rate at each reset date. The aspects of the loan that concern you have nothing to do with the fact that it's LIBOR-based.

    I think the last few years have been particularly bad times to take ARMs. Interest rates are still near historic lows, so why not lock that in and not worry about rates going up? While it may be nice to be required to pay interest-only for 10 years, you would be well-advised to pay off principle during that time. Make sure that you have the option to pay principle, and that it would actually reduce your outstanding principle and the associated interest calculated and charged to you.

    If you're looking at the interest-only payment and comparing that to a conventional loan where your payments are principle and interest, you're comparing apples and oranges a bit. If you borrow 100,000 and pay interest only for 10 years, at the end of 10 years you still owe 100,000. If you pay principle and interest for 10 years, you will still owe about 85,000.

    ARMs often come with a first year "teaser" rate that is much lower than the "correct" rate. If LIBOR stays the same over the next year, does your rate and payment go up in the second year?
     
  3. Mike Slade

    Mike Slade Second Unit

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    As you can probably tell, I don't know too much about all this. I do understand that paying interest only never dents the priciple which is not good. But at the same time from what little I know and what others have said, on a conventional loan, for the first part of the loan you are paying a very little towards the principle. I think the people who have recommended the LIBOR loans use that as an argument if you only plan to stay in the house for a short time (5-7 years).
     
  4. Denward

    Denward Supporting Actor

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    It's true that in the first several years, the principle goes down very little. However, any amount that you pay towards principle will reduce your loan amount, reduce the amount of interest the bank charges every month, and it will be more money in your pocket when you sell the house.

    Again, the initial payments may be very low because of the teaser rate. A very important question is, "If LIBOR doesn't change for the next year, what happens to your rate in the second year?"

    How much of a down payment are you planning to make? 10%, 20%? If you buy a 100,000 house with a 10% down payment, and pay interest only for 5 years, you will still owe 90,000 to the bank when you sell the house. If you sell the house for 110,000, will the $20,000 be enough to pay real estate agent commission, and other expenses? If your home doesn't appreciate much in that time, it could cost you money to sell your home.

    If you only plan on staying in the house 5-7 years, you might want to consider a 5/25 (or a 7/23) mortgage. Your rate is fixed for the first 5 years and then resets to current rates at that time. The rate for the first 5 years will be a bit lower than a conventional 30 year mortgage.

    Let me repeat something I said before. The LIBOR aspect of the loan is not relevant to your question. Your question is really about interest only ARMs. There are probably interest only ARMs that are based on U.S. Treasury Rates, or any number of other interest rates.
     
  5. Mike Slade

    Mike Slade Second Unit

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    Thanks for your advice. I will look into some of the things you have mentioned
     

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