Why LIBOR isn’t so boring after all

As the furore surrounding Barclay’s alleged manipulation of LIBOR continues, millions of people up and down the country are left scratching their heads as to what LIBOR actually is and, more importantly, why it matters.

It’s easy to think the ins and outs of banking at a top-level will have little effect on our money but that’s usually not the case. Indeed, for many mortgage customers, what happens to LIBOR can have a direct effect on how much they have to pay each month.

Here’s why.

What is LIBOR?

LIBOR stands for the London Interbank Offered Rate. It is the average rate at which banks lend to each other. So, in simple terms if Barclays charged a 2% interest to lend another bank money, HSBC charged 5% and Natwest charged 8%, LIBOR would be 5% – the average figure.

Just as a bank will lend money at different interest rates, depending on how risky you’re deemed and how much they trust you to pay it back (if you have poor credit you’ll pay a higher interest rate), the LIBOR rate determines how much banks trust each other.

How is LIBOR calculated?

To calculate LIBOR, financial company Thomson Reuters asks a selection of British banks to submit the rate at which they could borrow funds.

Thomson Reuters then ranks all of the answers and gets rid of the highest 25% and the lowest 25% and then average the rest (by adding them altogether and dividing by the number of rates being calculated).

How does it affect me?

The LIBOR rate could affect you if your mortgage is directly linked to it. Some mortgages are linked to Bank of England base rate (BBR) while others are linked to LIBOR, usually with an additional percentage on top. For example, while some mortgages are priced a BBR +2% (which, given the base rate is currently 0.5% would give you a mortgage rate of 2.5%) other will be priced at LIBOR+1%. Just as the tracker mortgages which are tied to BBR track that, those linked to LIBOR will track this rate.

This means what you pay on your mortgage will depend on at what rate the banks are lending to each other. When LIBOR increase your mortgage repayments increase and when LIBOR falls so do your monthly payments.