FED RATES FALL - BUT YOURS MAY NOT!
MANY ADJUSTABLE, SUB-PRIME HOME LOANS TIED TO LIBOR BENCHMARK
On Thursday, the Federal Reserve Board dropped the rate it charges overnight to banks - the Fed-Funds Rate, 1/4 point, to 4.25%. A drop in the Fed's benchmark Discount Rate is also predicted, as soon as within a few days. Despite all the press about recent Fed rate cuts, and the hope this will trickle down to lower mortgage rates for consumers, many borrowers will experience no rate relief. For some, certain rates could actually increase.
The reason?
Many ARM loans, as well as those offered sub-prime, to borrowers with dings on their credit histories, are tied the London Interbank Offered Rate, or LIBOR. LIBOR is an interest rate applied internationally, and has become the rate at which many banks around the world lend money to each other. Under normal circumstances, the LIBOR closely tracks the Fed Funds rate. In recent months, however, due to the credit crunch in the U.S., the LIBOR has remained stubbornly high. On a global scale, banks have become afraid to lend money as easily to one another.
Yesterday's U.S. Dollar Three-Month LIBOR stood at 5.11%, down from 5.36% of June, 2007. During the same period, the three-month T-Bill rate fell more steeply, from 4.8% in June, to 2.95% on Tuesday, December 11th.
This is precisely where the confusion comes in for many who took out adjustable-rate and sub-prime loans, and many types of "jumbo loans" of over $417,000, a couple of years ago. First of all, many borrowers had no idea what LIBOR was, and most further assumed it was a U.S. Interest Rate benchmark. When that rate closely paralleled the Fed Funds Rate, there seemed no reason to differentiate. Today, however, rates tied to LIBOR, when adjusted, will be reset much higher than those tied to U.S. benchmarks - T-Bills rates, or the U.S. Prime Rate.
Here's an example. If your adjustable-loan interest rate were to reset today, and that loan were indexed to the one-year Treasury rate, your new rate might be 5.75%, depending, of course, on the specific terms of your loan. If your loan were tied to LIBOR, your reset rate might be 6.75% - over 17% higher!
In a recent study by the Federal Reserve Bank of New York indicates that the six-month LIBOR will determine the new rates for 99% of all sub-prime loans that will reset within the next twelve months, and 38% of all "stated income", or "Alt-A" loans.
Fed rate cuts have benefited many consumers, however. Those with Home Equity Lines of Credit, usually tied to the Prime Rate, or the rate banks charge to their best customers, have seen their rates fall, on average, to 7.60%, from 8.25% early in September. Certain credit card rates have fallen to 13.46% during the same period, from 13.97%.
Read more detail in Jane J. Kim's story in today's Wall Street Journal.
DEAN MOSS & DEAN'S TEAM CHICAGO
