Is LIBOR or Prime Better for Loans?

Tamsen Butler
Interest rates are important when applying for a mortgage.
Interest rates are important when applying for a mortgage.

It is a common question among potential mortgage borrowers when searching for the best interest rate and terms: What's better LIBOR or Prime for loans? While it is true that both of these interest rate indexes have similarities, there are also some definite differences that may sway your decision of which loan to apply for when trying to buy a house.

LIBOR and Prime Explained

The LIBOR rate is the London InterBank Offered Rate, which is the interest rate at which some London banks are willing to lend money. Although this rate is set by London banks, it is an index that is commonly used within the United States as well as in other areas of the world.

The Prime rate is the interest rate charged by lenders to their best (or prime) customers and usually correlates fluctuations with the Federal Funds Rate, although the Prime rate is not the same as the Federal Funds Rate. The Prime rate is often offered with a variety of loan products including mortgages, credit cards and other credit products.

Lender Offerings

When you ask your lender, "What's better LIBOR or Prime for loans?" don't be surprised if you discover that only one or the other is available for mortgage loans through your lender. While one lender may offer mortgages based on the Prime rate, another lender may solely offer LIBOR-based mortgage loans.

When inquiring about a mortgage loan through a lender, don't assume that the mortgage interest rate is based on your preferred index. Ask a representative about the index that the loan is based on to find out if it is a LIBOR-based rate, a Prime rate-based rate, or something else entirely.

The rate index you are offered by your lender will be more important if you plan to obtain an adjustable rate mortgage loan. A fixed rate loan has one interest rate that does not change throughout the life of the loan, but an adjustable rate mortgage loan's interest rate will fluctuate throughout the life of the loan, making the index it is based on very important.

What's Better LIBOR or Prime for Loans for Homes?

There is no clear cute, definitive answer to which interest rate index is better for loans. Before deciding on one over the other, take a look at the different factors which need to be taken into consideration.

Starting Rate

What interest rate does the loan begin with? If you make the decision that a Prime rate mortgage is superior to a LIBOR rate mortgage, but then realize that the LIBOR loan has a much lower initial interest rate than the Prime loan does, this may give you reason to pause and reconsider your decision.

Do be sure to take into consideration the fact that the initial interest rate of any mortgage loan is only one factor that you should use to sway your decision. In particular, adjustable rate mortgages may initially have very low interest rates but you need to examine how high the interest rate has the potential to go.

Terms

When obtaining a loan with an adjustable mortgage rate, keep in mind that the interest rate adjustments follow a certain schedule. For this reason, look at the potential for interest rate increases when deciding whether LIBOR or Prime is better for you.

Both Prime and LIBOR-based loans can begin interest rate fluctuations as early as one month into the loan. Examine all options when deciding on what term to obtain and which index to base your loan on.

Margin

Mortgage loans based on an index usually feature a margin, which is the additional percentage rates added to the base index. You will probably not find a mortgage loan that is based solely on either index, but instead will find loans that have margins added, such as one or two percentage points. Always know the margin of a loan before deciding which index is best.

Your Decision

Take all factors into consideration before deciding on one loan over another. While the LIBOR index is historically lower than the Prime Rate, other factors should always be taken into consideration.

Is LIBOR or Prime Better for Loans?