For those with Adjustable Rate Mortgages and other adjustable rate loans, particularly car loans but also some credit card accounts, be aware that the benchmark rate at which trillions of dollars in such loans are tied will be discontinued in 2021 (unless something changes, which seems unlikely).
This rate, the London Inter-Bank Offered Rate, or LIBOR, is being eliminated after a series of scandals in which officers at banks manipulated the rates by submitting fraudulent data. The data, which is collected daily, uses information about what the banks claim they are offering these loans at. But because the volume of such interbank transactions has gone down so much, often times these numbers (from a given bank) are not backed by any actual loans -- the number is simply what the bank says they would offer a loan at if they were to make one. This opens the door to collusion between a fairly small number of players to make minor manipulations in the rates and, because of the volume of loans tied to these rates (which include huge corporate and government contracts as well as personal), these can result in millions of dollars into the pockets of those involved. Many people have been banned from the financial industry and some have received lengthy prison terms.
The commission that overseas the index determined that the volume of these transactions is now simply too low to make it a viable index free from manipulation by small numbers of people, so they are simply getting rid of it.
So how does this affect you?
If you have a LIBOR-indexed loan, then it's pretty much guaranteed that it has a clause in it that says that if the LIBOR goes away that the lender can replace it with another suitable index. But which one? For new loans it won't make much of a difference because the margins in the contract will reflect any offset introduced by the new index rate. But for existing contracts, that margin is already hardwired into the contract and if they choose a new index that has an upward offset relative to the LIBOR, then the interest rate on your loan just went up, permanently, by whatever that offset is.
So the lenders are going to want to choose an index that has as large a positive offset as they can get away with -- and since new loans will adjust the margin to compensate, there is no penalty to doing so because it won't cost them any business down the road. The only thing they have to really worry about would be their reputation getting tarnished -- and haven't they already done that about as much as possible. That's unlikely because few people will notice since those affected know they have an adjustable rate and they expect the rate to generally go up and they have never read the contract they signed and so they don't know what their margin is or what index rate it is tied. The other thing would be a class action lawsuit at some point, and while I will not be at all surprised to see that happen, that will be many years after the fact and so it won't be much of a deterrent to the people making the decisions since all they care about is the short-term numbers.
A lot of work is already going into identifying or creating a new index that will (supposedly) be a drop-in replacement. It's possible that the regulators may pass rules mandating how existing loans are to be transitioned to a new index, but probably not.
So what should you do?
First, find out what the index and margin are on any significant adjustable rate loans you have. This is something you should do anyway. If you don't have your loan documents, call your mortgage servicer and they can usually look it up over the phone.
Second, seriously consider getting out of any adjustable rate loans before the transition. Again, that's something you should be doing anyway because it's unlikely that the rates are going to do much of anything except go up for the next few years (always subject to change, of course).
This rate, the London Inter-Bank Offered Rate, or LIBOR, is being eliminated after a series of scandals in which officers at banks manipulated the rates by submitting fraudulent data. The data, which is collected daily, uses information about what the banks claim they are offering these loans at. But because the volume of such interbank transactions has gone down so much, often times these numbers (from a given bank) are not backed by any actual loans -- the number is simply what the bank says they would offer a loan at if they were to make one. This opens the door to collusion between a fairly small number of players to make minor manipulations in the rates and, because of the volume of loans tied to these rates (which include huge corporate and government contracts as well as personal), these can result in millions of dollars into the pockets of those involved. Many people have been banned from the financial industry and some have received lengthy prison terms.
The commission that overseas the index determined that the volume of these transactions is now simply too low to make it a viable index free from manipulation by small numbers of people, so they are simply getting rid of it.
So how does this affect you?
If you have a LIBOR-indexed loan, then it's pretty much guaranteed that it has a clause in it that says that if the LIBOR goes away that the lender can replace it with another suitable index. But which one? For new loans it won't make much of a difference because the margins in the contract will reflect any offset introduced by the new index rate. But for existing contracts, that margin is already hardwired into the contract and if they choose a new index that has an upward offset relative to the LIBOR, then the interest rate on your loan just went up, permanently, by whatever that offset is.
So the lenders are going to want to choose an index that has as large a positive offset as they can get away with -- and since new loans will adjust the margin to compensate, there is no penalty to doing so because it won't cost them any business down the road. The only thing they have to really worry about would be their reputation getting tarnished -- and haven't they already done that about as much as possible. That's unlikely because few people will notice since those affected know they have an adjustable rate and they expect the rate to generally go up and they have never read the contract they signed and so they don't know what their margin is or what index rate it is tied. The other thing would be a class action lawsuit at some point, and while I will not be at all surprised to see that happen, that will be many years after the fact and so it won't be much of a deterrent to the people making the decisions since all they care about is the short-term numbers.
A lot of work is already going into identifying or creating a new index that will (supposedly) be a drop-in replacement. It's possible that the regulators may pass rules mandating how existing loans are to be transitioned to a new index, but probably not.
So what should you do?
First, find out what the index and margin are on any significant adjustable rate loans you have. This is something you should do anyway. If you don't have your loan documents, call your mortgage servicer and they can usually look it up over the phone.
Second, seriously consider getting out of any adjustable rate loans before the transition. Again, that's something you should be doing anyway because it's unlikely that the rates are going to do much of anything except go up for the next few years (always subject to change, of course).
