What does it mean if my variable rate loan is tied to LIBOR?
LIBOR, the London Interbank Offered Rate, is one benchmark, or index, to which the interest rate on an adjustable (variable) rate loan may be tied. (The "prime rate" is another frequently used benchmark.) Any adjustable rate loan or other financial product tied to a benchmark will follow that benchmark’s movements up and down.
For example, if the margin (the percentage added to the benchmark rate) on your adjustable rate mortgage (ARM) is 1.25% and the LIBOR is 2.5%, your interest rate would be 3.75% (1.25% + 2.50% = 3.75%). In this scenario, if the LIBOR increased a quarter percent, to 2.75%, your new rate would be 4.00% (1.25% + 2.75% = 4.00%). That could be a significant increase on a larger loan, resulting in many thousands of dollars extra interest paid over the life of the loan. Likewise, a lower LIBOR would save you money on interest payments.
If you have a fixed rate loan, the LIBOR does not affect you. If you have an adjustable rate loan, your loan documents, and possibly even your monthly loan statement, will tell you if your rate is tied to the LIBOR. If you can’t find the information there, you can call your loan servicer and ask.
In the "LIBOR scandal" of mid-2012, accusations were made that LIBOR had been manipulated by the banks that determine the benchmark's rate, allegedly since the early '90s, to either make money or to make their bank and the banking system as a whole appear stronger. Because in that particular instance the interest rates had been manipulated downward, average borrowers with LIBOR mortgages, student loans and other forms of credit most likely benefited from the manipulation. However, some consumer and institutional investors may have experienced lower returns on their money.