Don't let the name fool you -- the London Interbank Offered Rate has an impact on more than just the London market. If you have a student loan or mortgage, the amount of interest you pay may be influenced by the LIBOR. In fact, the LIBOR directly impacts over $300 trillion of financial contracts worldwide and more than half of U.S. adjustable rate mortgages, according to the "Seattle Times" and Marketplace.org. If the LIBOR rate increases, it could affect your financial products, as well as the entire banking industry.
The LIBOR is calculated each day when banks report the rates at which they can borrow money from other banks. The four highest and four lowest rates are withdrawn, the rest are averaged and the LIBOR is established. If a particular bank reports a higher LIBOR rate, it suggests that other banks have less confidence in that bank's ability to repay the loan. Higher LIBOR rates can sometimes indicate fraud. In 2012, Barclay's was fined for trying to manipulate its LIBOR reporting rate so other banks would not think it unstable.
Banking Industry Health
According to Marketplace.org, because the LIBOR rate is an average of banks' lending costs, it is a good measure of the banking industry's overall health. When the LIBOR rates are low, this indicates that banks are faring well in current market conditions. A higher LIBOR rate suggests a struggling banking industry that may be balking under current market conditions and a reduction in public confidence in the banks. For example, during the credit crisis of the late 2000s, when loans became difficult to obtain, the LIBOR rate increased.
Loans and Mortgages
If your loan is calculated using the LIBOR as a base rate, a higher LIBOR means a higher interest rate. Most adjustable rate mortgages add two to three percentage points to the six-month LIBOR average. Student loans use the three-month or one-month LIBOR and add either four or nine percentage points respectively.
According to the "Seattle Times," U.S. consumers have access to less credit when the LIBOR rate rises. Less credit means less spending and less money in the U.S. economy. Because consumers make up more than two-thirds of the U.S. economy, a higher LIBOR rate can shrink the U.S. economy.
- Keith Brofsky/Photodisc/Getty Images