Interest Only Mortgages and the LIBOR, What isit?

What is LIBOR and why would we want to use a LIBOR? How does LIBOR tie intointerest only mortgages? These arereally good questions. I myself untilrecently had no idea what a LIBOR was or is, or if I wanted to use one. I am a little more educated now, and still don’t know if I want to use LIBOR.

LIBOR isthe London Inter Bank Offered Rate. In amore useful definition, it is the interest rate offered by a specific group ofLondon Banks for U.S.deposits with a stated maturity date. Itcompares to the CD rate that your local bank would offer to you.

The importantconnection to make here is the role the LIBOR plays in interest only mortgages. As more and more of our mortgage loan marketturns to this type of loan product, we will begin to hear more about LIBOR andthe many uses and influences in our day to day life.

The LIBORhas traditionally been a tool for the commercial lender and affected more ofthe commercial market than the private sector. As the private market moves into a bigger risk sector than ever before,the LIBOR will loom as a larger figure in the ratio used to determine theinterest to risk factor that your local banker, mortgage company, or financecompany will assume. The interest onlymortgage option is a bit riskier than the traditional mortgage products, inthat it requires little or no down payment, and over the course of themortgage, the interest is the only initial monies collected. That means at the end of the term, say 5years for most, the buyer still owes the same amount of principal. Risky business, this interest only loan. This is where LIBOR begins to play a biggerpicture. Commercial loans, primarily aninvestment tool, have traditionally been considered the bigger risk, sincethese loans weren’t providing housing for the borrower. But today, the private borrower is investingno more than a commercial borrower; in fact many times, even less. These new age borrowers aren’t really thatcommitted to these homes, either. Mostare using the interest only option as an investment tool, or a way to buybigger than traditionally possible, or as a way to fund a professionallifestyle with a starting salary and an expected temporary stay. Either option means a bigger risk for thelender; LIBOR helps to set risk percentages and provide stable financingoptions for the lender.

Thecommercial interest only LIBOR mortgages are for commercial borrowers. Theseborrowers are investing in residential unit complexes. In other words, they’re borrowing to buyapartment complexes, not individual homes; nonetheless, they too are being offeredthe interest only options and the interest rate for these commercial interestmortgages is set by the LIBOR rate plus a certain percentage above. 

It is forthese commercial investors that the interest only loan options should be used.The borrowers are business people, with business plans, and enough knowledgeabout the workings of commercial and mortgage loans, to understand a goodinvestment versus an impossible dream. The commercial mortgage industry is a huge market, and since most of themonies borrowed exceed the $100,000.00 limit, LIBOR rates are used fordetermining the commercial loan rates. 

I still amnot an advocate of the interest only mortgages; but for some situations theyare the best option. In a businesssetting, when many factors have been thoroughly discussed and the interest onlyoption has proven itself to be the best choice, I think it should be used. This option, however, should remain as theknowledge of LIBOR is among the masses, virtually unknown. So, as you begin your trek into the mortgage market,be prepared to hear more and more about the interest only loan options, andmore and more about the role LIBOR plays in this expanding market.