Why LIBOR Won't Hurt That Much
A: Great post by my friend Dan Green over at The Mortgage Reports about why the rising LIBOR rate won't hurt as much as the news media makes it out to be! The short answer is ADJUSTMENT CAPS that are tied to all adjustable rate mortgage holders. Lets discuss.
Mortgage Reports: Why LIBOR Will Not Impact Your Adjustable Rate Mortgage This Year
I have discussed the LIBOR rate here on UrbanDigs because so many resetting ARM's and credit debt is tied to this London rate! So, when that rate starts rising to 8 YR highs, it's hard not to notice and think ahead at the problems that may arise when debtors feel the pain of higher monthly payments! After all, this is what led to the current credit / liquidity squeeze in the mortgage markets and brought about tighter lending standards, higher rates, and fewer loan options (once subprime borrowers starting defaulting it hit the holders of the mortgage backed securities and wall street) in the first place. There is a reason I discuss this stuff!
Take a look at Dan's chart (for a buyer who took out a 3YR ARM in September of 2004 that is now resetting) that shows you what the all-important LIBOR rate has done since 2002, and note the 2.00% CAP that will kick in to protect holders of resetting ARM's and the zone above that which won't effect the debtor; assumes a 2% first year adjustment cap of course!
As Dan Green states:
The press is talking a lot about LIBOR right now and you may be getting nervous. There's no need to because most articles are leaving out the most important condition of an ARM's adjustment calculation -- the Adjustment Cap.Question I have for the consumers out there is, what does it say in the fine print of your loan agreement about how much the cap is for both the first year adjustment and subsequent adjustments? Lets not forget that 2008 should be referred to as THE YEAR THE ARM's RESET! As I discussed previously, some $355B+ worth of home loans are set to adjust next year alone putting higher payments in the lap of many homeowners! Now, that certainly can't help us can it. But at least Dan brings up a great point, which is, it won't hurt as much as the media makes it out to be!
The Adjustment Cap defines the rate by which your mortgage can move up or down when annual (or semi-annual) adjustment is calculated.
Stated differently: Your mortgage rate doesn't just change willy-nilly -- it follows very clearly defined rules. Your rate cannot adjust too high too fast, or move too low too fast.
Which brings me to credit card holders of debt that is tied to LIBOR? These guys probably already noticed an increase and as far as I know, there is NO CAP on this! Lets be frank, America does have a debt problem and both mortgage debt and credit debt has been getting more costly to the holder of late! That means more money out of the pocket of the consumer that could be going towards spending, that is now going towards living.
If there just isn't enough money to pay this off, well then, the debtor becomes insolvent! An insolvency crisis has been brewing for some time and now that risk is causing the rates on loans and other debts to cost more, I worry that the game may end in a rough way down the road. What happens when these debts can't be paid off? What happens when the corporation can't raise enough money to pay its creditors? What happens when assets no longer exceed liabilities?
Who am I kidding? This is America! I'm sure someone will come up with an innovative way to keep the game going for a few more years!! And stocks will always go up and never ever ever go down! Ahhh what a dream it is!