What Is a 5-2-5 LIBOR Home Loan?
A mortgage is a loan used for the purchase or construction of your home. Most mortgages are either fixed rate loans, which have the same interest rate for the entire term, or adjustable rate mortgages, or ARMs, which have an interest rate that fluctuates with market conditions. A 5-2-5 LIBOR home loan is a type of adjustable rate mortgage with an interest rate that is tied to the LIBOR average and has certain caps on how much the interest rate can change during the loan.
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What is LIBOR?
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LIBOR stands for the London Interbank Offered Rate, which is one of several major interest rate indexes that ARMs can be tied to. When the time comes for your interest rate to be adjusted, LIBOR ARMs will adjust based on what the current LIBOR rate equals. Most ARM interest rates are set to the index rate plus a margin. For example, your 5-2-5 LIBOR home loan interest rate may be equal to the LIBOR rate plus 2 percentage points, so if the LIBOR rate was 5 percent, your loan's interest rate would be 7 percent.
Periodic Caps
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The first two numbers in the 5-2-5 LIBOR home loan indicate periodic caps on the interest rate change. The first "5" represents the maximum amount the interest could change on the first interest rate adjustment. For example, if your loan started at 4 percent, when the first rate adjustment is made, the interest rate could not jump to more than 9 percent. The second number represents the maximum annual change for future adjustments after the first. For example, if your loan was at 6 percent, it could go no higher than 8 percent in the following year.
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Lifetime Caps
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The last number in the 5-2-5 LIBOR home loan represents the maximum change over the life of the loan. In a 5-2-5 LIBOR home loan, the interest rate cannot increase by more than 5 percentage points over the life of the loan. For example, if your loan starts at 5.5 percent, the interest rate cannot rise to more than 10.5 percent at any time during the life of the loan.
Benefits
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The interest rate caps help to protect you in the event of steep rises in interest rates. For example, if the economy entered a period of hyperinflation and rates rose to 20 percent, increases in your interest rate would be limited. In addition, an ARM loan is beneficial because if interest rates fall, you can take advantage of lower rates automatically at adjustment time without having to refinance your mortgage.
Warning
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Make sure you fully understand how high your home loan payment could go. The interest rates on ARMs typically start low. However, if the rate rises faster than you expected and you cannot make the monthly payments, you could lose your home to foreclosure.
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References
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