Mortgage rates and refinancing help please!

Factual Questions
1

I am thinking about refinancing my mortgage. Need to drop that pesky PMI that I am paying now, as well as take advantage of the lower rates that are available now.

I have two questions for the finance savvy dopers out there…

  1. LIBOR rates. Libor means London Inter Bank Offer Rate. This is similar to the discount rate set by the FED in the US. One can get a mortgage based on the LIBOR rates and these rates seem to be significantly lower than standard mortgage rates, even over long periods like the last 10 years. Is there a catch to doing this? If everyone could use LIBOR rates and save hundreds of dollars every month, I would think this would be more common than it is. The explanation I heard was the mortgage reps don’t make as much money off of it so they don’t recommend it to consumers. Kind of makes sense, but still sounds too good to be true.

  2. Modern style banks with many mortgage options. I have heard of newer styles of mortgages where your statement comes every month (often online) with options of how much you would like to pay. Just interest - for a low payment, or any amount of principle you like. Also, as rates lower you have an option to change your rate every month if you like. I have searched online and cannot find banks or mortgage companies that offer anything similar to this.

Are these things myths, modern day financial urban legends? Or are they worth seriously considering? Anybody that has a unique mortgage or refi tip to help me out please do tell the straight dope on this.

2

I’m a US banker and have no clue about mortgage options and rates accross the pond, but I’ll bump this to give you another shot at an answer. Coldfire, you got anything on this?

3

Well, the following note is purely economics:

Well, you’re basing your mortgage rate (or rather the bank is) on a foreign rate, which enters you into the wild and wooly world of forex and uncovered interest rate parities in some way.

It’s a bit complicated to explain and I’m not sure I’d do a good job. Now I don’t know how these things are structured as financial instruments but I have to suspect that you’re essentially borrowing funds on the London market.

My instinct is that there is risk bundled into this that US and LIBOR rates go in the opposite directions, which has exchange rate implications insofar as someone is likely to be having to be exchanging pounds sterling for dollars somewhere. Someone would get stuck with the bill for the same.

I’m gonna stick my neck out and say that you’d better read any contract for such a mortgage real careful like because I have the suspicion that some risk is going to be passed forward to you.

But all this depends on how the mortgage is structured and the like. It could be there is a way to take advantage of LIBOR rates without exchange rate risk and minimizing the risk that the Brit economy is going to go in a significantly different direction than the US economy.

If you’re a risk taker, dive in and investigate further.

4

I am not a lawyer, banker, mortgage broker, real estate agent, or game show host. Neither am I English or living in England. I am in the process of a refinance here in the States, however, and have studied the various options available here. My guess (and it’s only that) is that the rates you’re being offered based on the LIBOR are adjustable rate mortgages, or ARMs (at least, that’s what they’re called over here). The rate on such mortgages is adjusted up or down based on the current prevailing index rate (in your case, the LIBOR) at specified intervals, most commonly annually. Most often, there’s a limit on the amount by which the rate can increase in any one period, and often there’s also a cap on the total increase over the life of the mortgage. The interest rate on such mortgages at any given time is typically lower than the rate for a fixed-rate mortgage of the same amount and term. The reason a lower rate is offered is that the lender is incurring less risk – they don’t want to have a loan outstanding to you at 6.5% if the LIBOR (what they pay for money) shoots up to 15%.

I have no idea what rates have been like historically in Great Britain, nor what other factors may come into play for you. I can say that over here, I can see very little benefit to an ARM right now, when fixed rates are at or near historical lows. Any significant change in rates is likely to be upward, rather than downward – there’s just not much room left for them to go down. Given that, most people are probably far better off with a fixed-rate loan right now. In an environment where rates are extremely high, as they were in the late 70s and early 80s, an ARM can be a good bet, since you have the chance of having your rate go down significantly.

It’s also possible that we’ve all misunderstood your question, and that you’re located in the States and you’ve simply come across adjustable-rate loans tied to the LIBOR instead of to the Federal Reserve Discount Rate. My comments about adjustable vs. fixed rates would still apply, however.

As for the other options for different types of payments, etc., in general you can count on any unusual arrangement offered by a lender to be in their best interest, but not yours; there are exceptions, but generally you should be sure you understand all of the implications of any special arrangements before signing on the dotted line.

5

It appears to simply be the index your ARM will be based on. I’m assuming that using a LIBOR index mortgage(s) can be more easily and profitably combined and sold as securities and related financial instruments in that the return to the investor is more assured as the mortgage will index to the market rate.

http://www.iii.co.za/zaadvice/?type=glossary&letter=l

LIBOR stands for London Inter Bank Offer Rate. It’s the rate of interest at which banks offer to lend money to one another in the so-called wholesale money markets in the City of London. Money can be borrowed overnight or for a period of in excess of five years. The most often quoted rate is for three month money. ‘3 month LIBOR’ tends to be used as a yardstick for lenders involved in high value transactions. They tend to quote rates as ‘points above LIBOR’. So if 3 month LIBOR were (say) six per cent, a bank may choose to lend to another bank at (say) 6 and a quarter per cent. e.g. a quarter per cent above above 3 month LIBOR.
Lending to individuals tends to be based on base rates which are set by the Chancellor after consulting with the Bank of England. Base rates tend to be less volatile. Some home lenders offer mortgage rates linked to LIBOR. The lender offers funds in Sterling or in a foreign currency. Bear in mind that LIBOR-linked borrowing by individuals is higher risk, especially if you are borrowing in a foreign currency.

The LIBOR rates are set each day at 11am by leading banks but rates fluctuate throughtout the trading session according to sentiment about the outlook for base interest rates. LIBOR rates are listed each morning in the Financial Times and other newspapers.

Banks also offer to borrow money in the wholesale money markets. The rate is called the London Inter Bank Bid Rate (LIBID).

http://www.owners.com/Tools/Library/ShowArticle.asp?ID=2
Adjustable Rate Mortgages

Adjustable Rate Mortgages (commonly called ARMs) are flexible loans with interest rates and monthly payments that rise and fall with the economy. With an adjustable loan, the borrower shares in the benefits and risks of having the loan tied to market changes. Because the borrower shares in the risk of rising rates, lenders are able to offer lower initial interest rates than on fixed rate mortgages. The interest rate on your loan is then adjusted periodically according to whatever market index you chose when selecting your ARM.

Interest rate and monthly payment can change every six months, once a year, every three years, or every five years. For example, a one-year ARM has an adjustment period of one year, which means that the interest rate and monthly payment can change once a year. The frequency and dates of adjustments are established when you apply for your loan.

The interest rate on an adjustable mortgage changes according to a financial index. You may choose an ARM tied to any one of a variety of market indexes, such as CDs, T-Bills, or LIBOR rates. When your interest rate is up for adjustment, your lender will take the current rate of the index to which your loan is tied and add a margin, a certain set number of interest points laid out in your loan agreement, to determine your new rate. So, your interest rate and monthly payments could increase or decrease over the life of your loan, depending on the activities of the market.

Caps set forth in your loan agreement limit the amount by which the interest rate can increase at each adjustment. And ceilings, or lifetime caps, limit the total rate increase over the life of the loan. So, if you have a typical one-year ARM, your annual rate increases may be capped at 2%, which means that your interest rate can never increase by more than 2% over the previous year. Separately, your loan may have a lifetime rate cap of 6%. So, if you had an initial interest rate of 5%, the highest interest rate you could ever pay would be 11%. Caps protect you from drastic changes in interest rate, but do not guarantee you the stability of a fixed rate loan. With an ARM, you exchange the possibility of lower interest rates for the possible risk of rising rates.

An ARM might benefit you in several ways. ARMs usually come with initial interest rates that are 2-3 points lower than those on comparable fixed-rate mortgages. The lower initial interest rate can help you qualify more easily and afford the house you want to buy. You will most likely qualify for a larger loan with an ARM than with a fixed rate mortgage. You might also want to consider an ARM if you plan to move in a few years, so you are not concerned about the possibility of rate and payment increases. If you plan to move within 5 years, a 5-year ARM would even give you the advantages of a lower interest rate with none of the risks. And, even if you plan to live in your new home for longer, it might be safe to take the risks involved in an ARM if you expect your income to increase enough to cover potential increases in payments, or if you expect rates to fall.

6

Nah, every U.S. bank that I know of pricing mortgages off of LIBOR does so off the Dollar LIBOR. That one is almost entirely insulated from forex pressures. A severe Pound or Euro squeeze might move it for a few basis points for a few days, but it tracks pretty faithfully to the fed funds rate (but on a preceding basis; that is, it anticipates changes to fed funds.)

The main risk is that they are generally connected to ARMS with quick resets (sometimes monthly) and generally come without caps.

7

Yes, I actually live in the US and currently have a mortgage based on the rate set by the Fed. I should have mentioned that in my original post. Didn’t mean to mislead you all!

But, all the advice given here by you and everyone else is still applicable to me or anyone outside the US, so no harm done.

It sounds like that rates were high here in the US, throughout the 90’s. This was because Greenspan was trying to curb possible inflation. Meanwhile in Britain rates were comparibly lower, so some people caught on that a LIBOR based rate could be much lower than a US - based more traditional rate. Now that rates in the US are heading way down, I would imagine that this is no longer the case.

There are different ways of doing morgages than the most common route. LIBOR rates are something most people probably haven’t heard of. I barely remembered what LIBOR stood for and I have a finance degree. So, while it is certainly not safe to jump right in and get one without researching it further, it is good to know that other options are out there even if the US rates are soaring too high.

8

Dollar LIBOR? What you are saying is more in line with what I was hearing about these rates. That they fluctuate monthly. I assumed this was a seperate issue, and so I broke my post up into to questions.

If the Dollar LIBOR is based of the Dollar, how is it different from the Fed’s Discount rate? Also what are caps, by the way?