Adjustment Index
You bought an ARM (with an arm and a leg). ARM: Adjustable Rate Mortgage. The key word in there is "Adjustable." So you may fairly ask the smiling banker as she's shaking your arm off, so happy to have sold you this loan, "What adjusts?" And she replies, "Your interest rate." "Based on?" "An index. We use LIBOR, the London Interbank Offered Rate. Your loan is priced at 200 basis points, or 2% above LIBOR, and we adjust the rate every quarter."
So as you start out on your 30-year sojourn to pay off your mortgage and own the house that currently owns you...you gulp with LIBOR at 3% and you now paying 5% interest on your remaining $387,500 of mortgage. LIBOR stays the same for 6 months, then goes up a quarter point to 3.25%, and your rates go up to 5.25%. That LIBOR figure, broadly published around the world, is your adjustment index, reflecting the changing rent you continue to pay on the money you've borrowed. There's a reason that banker is smiling.
And no, that vibrating sound is your knees knocking as you think about LIBOR going to 7% and you living in your parents' station wagon down by the river.
Related or Semi-related Video
Finance: What Is a Basis Point?124 Views
finance a la shmoop what is a basis point?
well one percentage point is a hundred basis points, half a percentage is 50
basis points, five percentage points is? yeah we're gonna make you do that one on [frowning man talks to camera]
your own. well the basic idea is that in very large financial transactions those
involved need highly granular computation grids, and basis points
divid interest rates much more tightly. if a company borrows three billion
dollars just noting that the rate is four percent is really vague. it would
need to be noted as four point zero zero percent. why? because just one basis point [equation on screen]
i.e. one hundredth of a percent per year on three billion dollars borrowed
is still a lot of money. that is one basis point on three billion bucks is
300 grand .so basis points are a real thing in high finance transactions and [smiling man talk to camera]
okay okay the answer is 500 basis points. yeah all right now you can go back to
spinning this thingy. [man spins fidget spinner]
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