Interest rates on auto loans, adjustable rate mortgages (ARMs) and student loans may begin to creep up in the next few weeks if Europe's economic turmoil is sustained. More important, it could become harder to get a loan at all if bank worries persist.
The upward pressure on interest rates is coming from London, where 16 banks in the British Bankers Association set daily an interest rate known as the London interbank offering rate, or Libor. While it's used primarily by European banks to determine the rate at which they lend to each other, the Libor rate is used in many U.S. credit agreements as an index to determine interest rates on such things as credit cards and ARMs.
If Banks Stay Worried, Concern Will Spread
Recently, as a sovereign debt crisis spread from Greece across the continent, the Libor rate has shot up to a 10-month high. The Libor dollar rate rose again Wednesday, hitting 0.5378%, up from 0.5363% on Tuesday. While this is nearly double last year's rate, it's still down substantially from the 4.8% it reached at the height of the global financial crisis in 2008.
"An increase in Libor is significant because it indicates some sort of change in the market, and banks are being more cautious," says Polina Vlasenko, research analyst at the American Institute for Economic Research in Great Barrington, Mass. "If this proves to be a sustained trend, something that will go on for a couple of months, then slowly all other interest rates will start creeping up. If banks in London are worried, then at some point banks in the U.S. will start worrying."
Many U.S. banks use the prime rate, the U.S. version of Libor. It's a long-term rate, which has hovered at 3.25% for an extended period. But that could change if Libor keeps rising because European banks will simply start borrowing in the U.S. market, which will make credit tighter here.
Will U.S. Lending Conditions Be Hit?
A rise in the prime rate won't be felt immediately by many consumers. That's because many recent home-equity line of credit agreements specify that the interest rate is prime plus 1% but a minimum of 5%. So if prime rises from 3.25% to 3.5%, many consumers will continue to pay the minimum 5% rate.
Ryan Sweet, an economist at Moody's Economist.com, says he doesn't believe Libor's rise will affect American consumers seriously unless it climbs substantially from its current levels.
But he notes: An added concern is that it could be harder to get a loan at all.
"One of the things we're watching as troubles in Europe intensify is whether it will begin to affect lending conditions in the U.S.," Sweet says, noting it could unwind some of the improvement in lending conditions we've seen since the beginning of this year. Banks are being very cautious in whom they lend to, but it's easier to get a loan now than it was this time last year."
Europe's Troubles Aren't Disappearing Quickly
Vlasenko at the American Institute for Economic Research says one reason that Libor may be rising is that European governments are borrowing more money in the bond markets to pay their bills. That could cause the Libor rate to climb because liquidity is being removed from the market, so there's less left for private borrowers. If the increase is limited to that, she says, the rise in Libor could be a temporary problem without a lasting impact.
But the financial woes of European governments look like they won't dissipate quickly or easily. So U.S. borrowers may be feeling the far-reaching and unwelcome impact of Libor's rise.
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