Well folks, based on the feedback I have received, the LIBOR ARM has certainly grabbed the attention of the American consumer. Let's discuss this a bit more.

For those of you who have not read the column published on January 16, LIBOR is an acronym for London Interbank Offering Rate. Basically, the LIBOR is the rate that European banks charge each other for overnight funds. Adjustable Rate Mortgages tied to the LIBOR is nothing new - they've been around for years. What's interesting is that the LIBOR index is currently very low - hovering at about 1.86 percent.

In order to determine the interest rate on a LIBOR ARM mortgage, you simply take the index rate and add a margin. The particular LIBOR ARM that I refer to carries a margin of 2.25 percent. This means that the interest rate on this LIBOR ARM is 4.13 percent. The rate is determined by adding the One Month LIBOR index rate and the margin of 2.25 percent.

I received a ton of e-mail on this issue. This is a monthly adjustable ARM. Yes, the rate can change on the first day of each month. This seemed to put a lot of people in a panic mode so I'd like to discuss the history of this index.

On January1st, 2002, the one month LIBOR index was 1.83 percent. On February 1st, it inched up to 1.88 percent. On March 1st and April 1st, it remained at 1.88 percent. As of last week, it dropped to 1.86 percent.

After adding the margin of 2.25 percent, the LIBOR ARM has been bouncing between 4.08 and 4.13 percent. Pretty insignificant.

So the question arises - how long is this LIBOR index going to stay so low? That's the million dollar question. The LIBOR typically follows U.S. short term rates so we can probably assume that if and when Federal reserve Chairman Alan Greenspan starts raising the Federal Funds Rate, the LIBOR rate will follow.

As I said, the LIBOR ARM has been around for years. It just wasn't a very good deal. Over the last ten years, the average rate on the LIBOR index was 4.87 percent. Adding the 2.25 margin makes the average mortgage rate 7.12 percent. This certainly isn't bad, but considering that fixed rates haven't been much higher, the LIBOR ARM hasn't been too attractive.

Now that fixed rates with no points are hovering around seven to 7.25 percent, a LIBOR ARM at 4.13 percent sounds pretty good. In fact, compared to fixed rates, the LIBOR's a bargain.

What's the risk? This is the big question. Since it's impossible to accurately predict the movement of interest rates, an educated guess is the best we can do. Assuming that the LIBOR will continue to follow U.S. short term rates, the answer to the question of when the LIBOR will start increasing falls in the hands of Mr. Greenspan.

Let's just say that the LIBOR index will follow in tandem with the U.S. federal funds rate. If the economy picks up, Greenspan will start tapping on the brakes by raising this rate. How much and how many quarter point moves?

This is why I think that the LIBOR will remain a bargain. If the Fed makes for example, eight quarter point moves in the next year or so, the LIBOR index would only increase by two percent, making the LIBOR ARM about 6.13 percent - still a bargain.

In other words, the Fed must make severe and dramatic rate increases in order for the LIBOR ARM to rise to a level that would be unattractive. Eventually it will. Everything always moves up and down. But given the Enron business, the 9/11 tragedy, and recent unemployment numbers, it's probably unlikely that the economy is going to become red hot anytime soon.

Remember, interest rates are hard to predict. But if the LIBOR continues to follow U.S. rates, and Greenspan doesn't go on a rate-hike rampage, the LIBOR ARM could remain a bargain for quite a while.

Published: April 17, 2002

Use of this article without permission is a violation of federal copyright laws.

, the president of PMC Mortgage Corporation in Alexandria, VA, is a mortgage columnist whose work has appeared in numerous consumer, real estate, and mortgage publications. Mr. Savage welcomes your questions for possible use in this column, however because of the volume of mail received, Mr. Savage cannot answer questions individually.