Consumers May Face Higher Mortgage Costs, Says Cleveland Fed
How much is your adjustable-rate mortgage costing you? Consumers expecting relief may be unpleasantly surprised
In 2009, homeowners holding Libor-based ARMs will pay $34 million more in Ohio alone, says Federal Reserve Bank of Cleveland study
A new study released today by the Federal Reserve Bank of Cleveland suggests that adjustable-rate consumer mortgages (ARMs) based on the "Libor" interest rate may be costing a lot more than comparable mortgages based on U.S. Treasury rates. Using data on Ohio mortgages, the study’s authors estimate that 90 percent of existing subprime mortgages are linked to Libor. If current interest rate trends continue, Libor-based ARMs would cost consumers $34 million more in 2009 in Ohio alone, than comparable mortgages based on other indexes. About 45% of that cost would be paid by holders of subprime mortgages.
Which interest rate lenders use as the index for their adjustable-rate mortgages makes a significant difference in the actual interest rate the homeowner will be charged, according to the report published in the Bank’s Economic Commentary, written by Mark Schweitzer, research director, and Guhan Venkatu, senior policy analyst. Efforts to close this gap by bringing Libor back in line with Treasury rates will help homeowners as well as the broader economy, say the authors. They note that governments have intervened aggressively, with central banks lending outside of the usual channels and other government entities guaranteeing interbank lending, which will help restore normal financial market functioning.
ARM rates are generally tied to one of two indexes – the London InterBank Offered Rate (Libor), or U.S. Treasury rates. The Libor – an average of the interest rates on uncollateralized loans made between banks in London for a specified term – has served as a basis for many bank-to-bank transactions in U.S. dollars, and other financial transactions, including residential mortgages. It is also a more typical index for subprime mortgages.
Historically, markets have kept the interest rates for instruments of similar maturities and risks comparable. But as banks have become increasingly unwilling to lend to one another, Libor rates have risen while rates on Treasury securities, considered the safer and more liquid asset, have declined. Mortgages based on Libor are at risk of resetting to higher rates than mortgages for comparable borrowers with ARMs based on Treasury rates.
To read the Commentary, Adjustable-Rate Mortgages and the Libor Surprise, follow this link: /research/commentary/2009/012109.cfm