What is LIBOR and How Does It Affect Me?

An acronym for London InterBank Offered Rate, LIBOR is the benchmark interest rate international banks use for loans between each other. There are separate rates for one-day, one-month, three-month, six-month as well as one-year loans. The news agency Reuters publishes rates daily at 11 a.m. The LIBOR rates cover five currencies: the U.S. dollar, the Euro, the Swiss franc, the pound sterling and Japanese yen.

How does LIBOR affect bank rates?

Adjustable rate loans frequently use the day’s LIBOR rates. This may affect interest-only mortgages as well as credit card interest. Lending institutions typically add a point or two to the LIBOR base rate, which creates their profit margin.

LIBOR also affects prices for interest rate and credit default swaps, forms of insurance against defaulting loans. This contributed to the 2008 financial crisis, creating a false sense of comfort with mortgage-backed securities. Subprime mortgage defaults added to the crisis when issued interest rates were below LIBOR. Insurers didn’t have cash on hand to cover the swaps.

How does LIBOR affect the average person?

Those carrying adjustable rate loans may see their interest rates reset based on LIBOR rates. If LIBOR goes up, so does the interest on an adjustable rate loan. Interest on monthly credit card balances may do the same, depending on the terms of a given card.

People carrying only fixed-rate loans and who pay off credit card purchases monthly may still be affected by LIBOR on an arm’s-length basis. All consumer and business loans cost more when the LIBOR rate increases. A bigger effect on the economy as a whole has more money directed to interest payments, lowering overall consumer demand. Businesses start to feel the pinch of reduced spending and, if LIBOR stays high for a lengthy period, recessionary conditions develop. This could result in both higher prices and increased unemployment.

Knowing how LIBOR affects interest rates on loans may help a consumer plan and time borrowing, but there’s not much negotiating value in this information.

About Paul Gaulkin CPA

Paul Gaulkin is a Certified Public Accountant and enrolled with the U.S. Treasury to practice before the IRS. Mr. Gaulkin possesses unique technical knowledge in the process of securing relief for taxpayers nationwide with IRS and State tax problems. With an accounting degree from Florida International University, he is able to transform complex tax and accounting problems into easy to understand solutions.

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