Libbor Rates, Swap Rates, Mortgage Rates

[Guest wrongmove]

I have to say, these record libor rates we have been seeing these last few days have been quite exciting.

But do they have any implication for mortgage rates?

It seems that banks are reluctant to lend to each other (they don't know where the "toxic" debt is), but will it stop them lending to individuals, backed by property?

I don't know the answer, but I was wondering if anyone had any ideas.

Certainly, mortgages are not linked to libor - they are linked to base and to swap.

[Jason]

Well, Libor and Swap rates are kind of similar, I think.

Libor is just the rate at which banks lend unsecured funds to each other, swap rates are the rate which they will lend expecting repayments along the way. I.e. Libor rates refer to banks who will pay back the money very short term (usually next day) and swap rates are where they will lend and expect an income stream from the loan (I.e. medium/long term) and expect security on it (i.e. a house) (I think).

As for Mortgages etc...

As we all know, the majority of loans are sold off to the markets as mortgage backed securities (swap rates), they do this because it reduces risk to the bank. Now if the money (swap rates) is higher, they will make less money so they up the fixed rate mortgages to keep their margins higher.

So yes, it will effect fixed rate mortgages, but will take time. With variable rate mortgages, the bank *may* have to borrow to up their reserves, which generally only has an impact as a cost to the bank, so again they may start to demand higher margins due to higher costs.

All this has only kicked off in the last month, so it will take time to see what happens. Generally I would expect mortgages to become more expensive, as the banks aren't making as much money. The first thing you will see, and are seeing, is stupid risky lenders cutting back quickly as they run out of funds, and they won't make any money if they borrow at these high rates.

[Guest wrongmove]

Well, Libor and Swap rates are kind of similar, I think.

Libor is just the rate at which banks lend unsecured funds to each other, swap rates are the rate which they will lend expecting repayments along the way. I.e. Libor rates refer to banks who will pay back the money very short term (usually next day) and swap rates are where they will lend and expect an income stream from the loan (I.e. medium/long term) and expect security on it (i.e. a house) (I think).

As for Mortgages etc...

As we all know, the majority of loans are sold off to the markets as mortgage backed securities (swap rates), they do this because it reduces risk to the bank. Now if the money (swap rates) is higher, they will make less money so they up the fixed rate mortgages to keep their margins higher.

So yes, it will effect fixed rate mortgages, but will take time. With variable rate mortgages, the bank *may* have to borrow to up their reserves, which generally only has an impact as a cost to the bank, so again they may start to demand higher margins due to higher costs.

All this has only kicked off in the last month, so it will take time to see what happens. Generally I would expect mortgages to become more expensive, as the banks aren't making as much money. The first thing you will see, and are seeing, is stupid risky lenders cutting back quickly as they run out of funds, and they won't make any money if they borrow at these high rates.

Cheers Jason, that all sounds sensible to me. Just one further question - libor has shot up, but swaps don't seem to be doing much - in fact there have been some reports of fixed rate mortgages getting cheaper. Does that sound right to you?

From reading around it seems the effect of the libor rates will depend on how long the situation lasts - if things sort thenseleves out and banks start lending to each other again, then the effect will be just about zero. However, if the situation persists, then things could get really, really interesting.

Thanks again for taking the time to reply.

[Jason]

Well, I would guess that the lower swap rates further in the future mean they expect rates to fall in the future, i.e. a negative yield curve, i.e. recession.

Things may settle down, but maybe the banks will learn a lesson?!?!

[Guest wrongmove]

Well, I would guess that the lower swap rates further in the future mean they expect rates to fall in the future, i.e. a negative yield curve, i.e. recession.

Things may settle down, but maybe the banks will learn a lesson?!?!

The yield curve is certainly well inverted from a few months to a few years - 3 month rates are way ahead of 2 year, though this has happened a few times recently.

I take it your last line is ironic

[DoctorJ]

Well, Libor and Swap rates are kind of similar, I think.

Libor is just the rate at which banks lend unsecured funds to each other, swap rates are the rate which they will lend expecting repayments along the way. I.e. Libor rates refer to banks who will pay back the money very short term (usually next day) and swap rates are where they will lend and expect an income stream from the loan (I.e. medium/long term) and expect security on it (i.e. a house) (I think).

As for Mortgages etc...

As we all know, the majority of loans are sold off to the markets as mortgage backed securities (swap rates), they do this because it reduces risk to the bank. Now if the money (swap rates) is higher, they will make less money so they up the fixed rate mortgages to keep their margins higher.

So yes, it will effect fixed rate mortgages, but will take time. With variable rate mortgages, the bank *may* have to borrow to up their reserves, which generally only has an impact as a cost to the bank, so again they may start to demand higher margins due to higher costs.

All this has only kicked off in the last month, so it will take time to see what happens. Generally I would expect mortgages to become more expensive, as the banks aren't making as much money. The first thing you will see, and are seeing, is stupid risky lenders cutting back quickly as they run out of funds, and they won't make any money if they borrow at these high rates.

nice explanation. makes a bit more sense now.

After the last couple of weeks I was expecting things to move along swiftly but it all seems to have blown over

Edit: maybe its contained

Edited September 5, 2007 by DoctorJ