Actions To Take In A Rising LIBOR Environment

Updated for 2019 and beyond.

LIBOR has risen dramatically since the end of 2015. The catalyst was the Fed raising the Fed Funds rate for the first time in years from a target rate of 0% – 0.25% to a target rate of 0.25% – 0.5%.

Latest 12-month LIBOR rate

If you are in an adjustable rate mortgage where your initial fixed rate period will go variable within a couple years, you are going to be paying higher rates if you don't refinance because ARMs are usually tied to LIBOR + a fixed margin.

Below is a snapshot of my mortgage refinance terms from early 2016. Notice how my 2.375% ARM rate is based off 1 Year LIBOR + a margin of 2.25%. Also observe how the math doesn't add up: LIBOR at the time was 0.42% + 2.25% margin = 2.67% instead of 2.375%. In other words, lenders subsidize you for the initial 3, 5, 7, 10 year fixed term to win your business.

Adjustable Interest Rate Table Financial Samurai

If my ARM were to float today, my 2.375% mortgage interest would actually jump to around 3.82% (2.25% margin + 1 Year LIBOR 1.57%). Although 3.82% isn't particularly high in the history of mortgage rates, it's still 60% higher than what I was paying. Everything is relative in finance.

If you refinance now, you will also re-lock a subsidized rate for your ARM, or simply get a higher, non-subsidized rate with a 30-year fixed mortgage. Check the latest mortgage rates online. Your goal should be to get multiple quotes for free, and then pit them against each other to get the best rate possible. This is exactly what I've done to get a 2.375% 5/1 ARM for my latest refinance.

Regulatory Changes

So why has the spread between risk free rates and LIBOR widened so dramatically? According to Jeff Rosenberg, Chief Investment Strategist for Fixed Income at BlackRock, rising LIBOR isn't a signal of credit stresses in the financial sector; instead, rising LIBOR is due to impending regulatory changes to U.S. money market funds (MMFs).

Jeff writes, “The reforms, adopted by the Securities and Exchange Commission in 2014, go into effect Oct. 14 of this year m. The new rules will change the structure of money market funds by moving from a fixed $1 net asset value (NAV) to a floating NAV for institutional “prime” money funds, and imposing potential redemption fees and suspensions in the case of some other MMFs.”

As result of the new rule, there's been a large shift of money market funds out of prime funds and into government funds (prime funds invest primarily in corporate debt securities). “This uncertainty has fund managers increasing liquidity and shortening maturities as Oct. 14 approaches. The result is a decline in the supply of short-term (i.e., three-month) funding in the corporate financing market, and a rise in borrowing costs,” Jeff continues.

Confusing! The bottom line is that once again, thanks to government regulation of the free market, there is another kink in the system.

What Else To Do Besides Refinance?

1) Increase your savings rate. Higher interest rates dampen demand because it makes borrowing money more costly. The more cash you have, the less you need to borrow. The more cash you have, the more you have to lend. Short-term pullbacks are common with risk assets because there needs to be a recalibration of the yield spreads back to its historical range. There is NO RUSH to buy risk assets as a result. The S&P 500 and Dow Jones Index are near record highs in 2017.

2) Research higher income generating assets. As a retiree who paradoxically works his butt off and is therefore in a higher marginal tax bracket, I'm salivating at finally being able to build a sizable municipal bond portfolio that's state and federal tax free. After buying stocks with a growth bias since the recession, my goal is to now shift the principal gains towards income generating assets as global growth slows.

It's always important to focus on converting “funny money” into either a real asset that doesn't go *POOF* in the next recession or a steady income generating asset. I know so many people who were paper millionaires during the 2000 dotcom bust who ended up with NOTHING but a tax bill for assets also worth NOTHING.

A) Conservative Muni Bond ETFs

MUB: iShares National AMT-Free Muni Bond ETF. It holds more than 2,750 various muni bonds with the top 10 of its holdings accounting for only 2.47% of total. 99% of MUB bonds have been awarded a credit grade of between A and AAA. 56.3% are rated AA.

I'm also focused on CMF, a California Muni Bond fund so I don't have to pay state taxes on the income either. Check out your local state muni bond ETFs so you don't have to pay state income taxes as well on the dividend proceeds.

B) Higher Yielding Real Estate Crowdfunding Investments

Real estate crowdfunding has opened up once unobtainable real estate investment opportunities to the masses. Multi-family property and commercial real estate have traditionally been available only to institutions and extremely high net worth individuals. Now that there's Fundrise and Fundrise, the two leading real estate crowdfunding platforms that have raised the most amount of capital and have allocated the most amount of capital, investors can now invest in various real estate deals with just $1,000 – $5,000.

I think real estate crowdfunding is one of the most attractive opportunities over the next 10 years. Being able to invest in the heartland of America where cap rates are 10%+ versus under 4% on the coastal cities is attractive.

Real estate crowdsourcing with RealtyShares
Examples of RealtyShares deals that have closed. Click to discover more.

You can also read my comprehensive RealtyShares review post and Fundrise review post.

3) Boost your Certainty Income. Because we are in a political and interest rate transition period, we have uncertainty. When there is this much uncertainty, investments tend to go nowhere. Therefore, it's only logical to boost your “Certainty Income” through additional effort.

Now is the time to take that second job or add on another consulting client. Now is the time to launch your website to grow your personal brand. Build your book of business today for the potential fade. And if things turn out just fine in 2017, then you'll simply have an extra income rocket booster by your side.

I'm finishing up a 3-month consulting contract with an SF-based insurance company this month, in the interview process with a health tech startup, sat down with the CFO and CMO of a potential partnership/acquisition last week, and just got back from a 1.5 day paid gig in Seattle with a large financial institution. Oh yeah, and then there's publishing on Financial Samurai 3X a week, baby! Always be hustling and looking ahead for new opportunities.

Here's my proposed Active Income vs. Passive Income for a better life
If 20% – 39% of your total income can come from active income, I think this is ideal.

Bullish Or Bearish Doesn't Matter

Rising LIBOR is a short-term negative, but likely a long-term positive. There cannot be sustained higher rates if there isn't a sustained higher demand for money. If the demand for money fades, so will LIBOR. Not only is everything relative in finance, everything is also rational in the long run as well.

It's always nice when your investments act as a tailwind for net worth growth. Just know that it's even nicer if you can build enough income streams so you aren't reliant on your investments at all. Besides, active income is more enjoyable than passive income. Sitting back and collecting the digital Benjamins is not really fun or rewarding. Going out there and doing work that's meaningful while earning is.

Wealth Building Recommendations

Explore real estate crowdsourcing opportunities: If you don't have the downpayment to buy a property, don't want to deal with the hassle of managing real estate, or don't want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.

Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you're looking for strictly investing income returns.

Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It's free to look.

Fundrise Due Diligence Funnel
Less than 5% of the real estate deals shown gets through the Fundrise funnel

Stay On Top Of Your Money: Sign up for Personal Capital, the web’s #1 free wealth management tool to get a better handle on your finances. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool to see exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying. After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms.

Updated for 2019 and beyond.

About The Author

36 thoughts on “Actions To Take In A Rising LIBOR Environment”

  1. Do you still plan to aggressively purchase MAV, MUB, and CMF now that the 10-year treasury is getting close to 2%? Looks like it is at 1.912% at 6am ET….just curious if your plan remains the same with the Trump win.

  2. Am I the only one that thinks that dividend growth stocks are the best asset class out there? I mean, if you had to choose one sort of investment (meaning not a blog, business that you own, or any sort of non-investment passive income). Because, ultimately, the stock market, interest rates, commodity prices, inflation, etc., will do whatever they want. But the businesses that make America will continue to grow as they always have.

    I can’t imagine that a portfolio of banks, insurance companies, healthcare companies, energy companies, railroads, consumer staples, and others that have paid and raised their dividends over decades will lead you anywhere bad over the long term. It just seems like the best way to go when it comes to your investment dollars.

    Now as far as the original point you were making, Sam, do you still feel like a 5/1 ARM is the way to go? What about commercial property? Should that be approached differently?

    ARB–Angry Retail Banker

    1. ARB,

      I totally agree with you to a point. For the average investor this is the best and easiest way to go. However, if you value capital preservation and tax consequences as much as you value income, unfortunately an investor in this low rate environment has to be more creative.

      If only a person could get a 5% CD, life would be so much easier!!!!

      Thanks, Bill

  3. Sam, I’ve been having similar thoughts. I’ve got a watch list of REITs that I’ve been wanting to buy. They’re just now starting to correct as speculation grows that the FED will raise rates in December. Like you, I believe it will be a “dovish” hike but REITs will likely get battered leading up to it, presenting a favorable buying opportunity.

    Here’s hoping!

  4. Are most ARM’s tied to 1 year libor instead of 3month? I’m surprised for a number of reasons, especially as 1 year is really not at all a traded/market rate compared to 3m or even 6m.

    The 1yr Libor rate you’re referencing is at a level much more like the market 10yr rate.

      1. There’s no escape for the rise, but the absolute level is very different. 10 yr swaps are at 1.60% right now, which basically means the market expects 3m libor to average 1.60% over the next 10 years. 3m libor right 0.88% today, and 1 year is 1.58%. That means you’re paying almost 80% over the spot 3m rate ! By contrast 1 year swaps on 3m are around 0.96%. So you’d be much better off if your ARM reset off 3m Libor instead. Is that possible?

  5. Thanks for your post. I was thinking of this exact same topic the other day.

    I’m trying to better understand BXMT. It seems like they raise capital at fixed interest rates to buy real estate debt that adjusts to LIBOR. They win if LIBOR goes up and they lose if LIBOR goes down. Am I thinking this wrong?

    If that’s the case, why not just hedge using eurodollar futures?

  6. Your First Million

    I think you are right, whether someone is bullish or bearish on this… increasing savings and ramping up your acquisitions of income producing assets is always the best answer. Everything goes in cycles and we have to keep investing through the good times and the bad. It’s impossible to time the market (or any cycle), so what I do is that when I know we are towards a bottom, I increase my holdings more than I normally would during other times.

  7. Matt @ Distilled Dollar

    Great analysis here and I’ll just echo was AE said above. I recently refinanced my student loans at a 5 year ARM so I’m keeping a closer look at LIBOR. The big goal is to have the debt eliminated within 2 years, so I’m trying to eliminate the time LIBOR can impact the loan.

  8. My mortgage was so low that I couldn’t find savings by having an arm. I was going to save about $23 a month, or about $1380 in 5 years — not even enough to refinance the mortgage. Consequently, I’m not worried about a LIBOR increase.

    One thing that does concern me is the effect it may have on mortgages. Certainly, even a 4% interest rate is fantastic relatively in the long run, but people are used to the 3.3-3.6% conventional and likely won’t be as up to date with interest rate fluctuations. Wondering if it hurts home sales. Concerning because I just got my real estate license.

    1. Higher rates WILL hurt home sales. It’s all about incremental changes. My ARM going up to 3.8% from 2.375% is a 60% increase. That does hurt affordability, which is why everybody needs to be cautious.

      If the economy is indeed growing faster, pay is getting better, more jobs are available, then higher rates are justified. Higher rates can become a bullish indicator. But right now, there is some artificial reasons why LIBOR is higher, which makes the outlook more uncertain than it normally is.

  9. As someone that is new to Financial Samurai, I’d just like to say I love all the investment options you bring up for us to consider. As far as investing in a rising interest rate environment, my actions might be slightly different (mortgage considerations aside).
    I usually hold a portfolio of investments that include fixed income (corporate and government), REITS, and equities, no matter what interest rates are doing. Although it earns me a small return, most of my fixed income investing is more for safety of principal. I usually wouldn’t allocate a higher percentage of my portfolio to fixed income investments if interest rates rise (although I’m sure many do) but what I would do is sell some of my fixed income investments and purchase more equities if I saw a large drop in the market (say 15-20%) and felt equities were oversold. Once I were to believe equities were no longer oversold, I would use future contributions to my portfolio to bring fixed income back up to its previous level. My equities are mostly composed of solid dividend paying stocks with a history of rising dividends and I intend to hold onto them and live off the dividend income forever, so hopefully I wouldn’t end up as the paper millionaires you talk about in the 2000 dot com bust that ended up with nothing.
    One thing that rising interest rates do have an effect on for me is my borrowing to invest. I had been borrowing a significant money to invest ever since the financial crisis of 2008. In the last few years, however, I have scaled back my borrowing significantly.

    1. Who do you borrow money from to invest and at what rate? Your brokerage via margin?

      I guess it’s not that strange since millions of homebuyers borrow 80% of the value or more to buy a home.

      I’d just be a cautious at this stage in the market. Don’t want to give up your gains and then some.

      1. I use a HELOC to borrow money. I first started using it after the 2008 financial crisis. Here in Canada, at that time, I was actually able to borrow money at 2.25% and then claim the interest expense as a tax deduction. I was probably in a 40% tax bracket at that time and so I was borrowing money at closer to 1.5% (to the best of my knowledge, here in Canada, variable rate mortgages are based on Bank of Canada Prime Rate and not LIBOR) I then piled hundreds of thousands of dollars into Canadian Bank stocks, Canadian telecom companies, and other large blue chip Canadian companies that had been hammered and, as such, were paying dividends of like 6%. I then claimed the dividend tax credit eligible to all Canadians and paid next to no tax on these dividends. I believe I made about $500,000 because of this.

        That was back in 2009 – fast forward to today and it now costs 3.25% to borrow money and dividends more like 3-4%. As such, I have slowly taken profits over the last few years and paid most of the HELOC back. However, I still own many of those same stocks I originally bought (TD Bank, RBC, BCE, Telus….to name a few).

        You are right though, at this stage in the market I am being much more cautious and have reduced the leverage almost back to zero.

        1. Impressive! Were you not worried as much about the financial markets in 2008 and 2009? If not, what gave you the conviction to go borrow money to invest? Also, how much do you think you made an extra profits based on your borrowing?

          1. Well, I was worried a little bit but I was looking at the companies I mentioned and noticing that they were making more and more money every quarter, despite the financial crisis, and they basically had a decades long history of paying out and increasing their dividends. I reasoned that even if the dividends got cut in half, they would still more than pay for my borrowing costs. Plus I also reasoned I didn’t mind holding these companies for the long term anyway.
            I also figured I had borrowed a few hundred thousand in the form of a mortgage for an investment property and wasn’t getting nearly the same income stream or a tax break on the rental income…looking at it from this perspective, borrowing to invest in some of Canada’s strongest companies with stable and increasing dividends versus borrowing to invest in anther rental property seemed to make sense…especially at that time.

            I went all in and basically retired off the windfall. The funds got invested in a joint account with me and my wife and we’ve generated capital gains of $400,000 over the last 6 years as we’ve slowly taken some profits and paid back the HELOC…we basically doubled our money. Add to that the dividend income each year.

            1. Very nice. Another positive datapoint that things are much better than they really are.

              Capital gains of $400K + the capital gains of your primary residence right?

              It’s crazy how good everything has been for 7 years. I’m so happy to lock in a win and just collect 2-5% now low risk / risk free.

        2. Financial Canadian

          TD, RBC, Telus… all great companies and you definitely made a smart move to borrow and buy these during the financial crisis. I can’t believe you had the mental fortitude to get INTO the market when everyone was screaming to get out. I bet you’re very pleased with your decision now!

          1. Yeah, very pleased! There was a few sleepless nights as I started getting in slowly after the first 20% drop (so I did lose some money at first) but I kept adding a little bit each month and after a little while it started going up and in the end it really paid off. I thought it was probably a once in a lifetime opportunity and believed I could ride it out until the recovery, knowing the dividends were likely to stick around and were more than double my borrowing costs.

  10. Bonds should go lower in value as interest rates rise. As should REIT funds. Assuming they do actually rise. If you own the individual bond, then that’s not terrible, since you can hold to maturity. I’m looking at some state munis as they’ll also be tax free at the state level. I’m not sure if this is the same for all states.

  11. I thought that rising interest rates are generally bad for REITs. Or are you saying that you will start aggressively buying them once the 10yrs bond yield hits 2% because you believe that should be the top for a while (i.e. possibly good entry point for REITs)?

  12. Can you clarify why owning muni’s would benefit if rates increases….do muni bonds like other bonds drop in value whem rates increase? Also dont people pay up for muni because its worth it to them for the state state exemption so is there a downside to owning munis not in your state

    1. Muni bonds decline, all else being equal, when rates rise. There usually is a slight premium to Net Asset Value due to the tax benefits. Sometimes the premium is higher or lower than historical. Therefore, there is a multi-part component to the analysis.

      Incline Village, Nevada along Lake Tahoe trades at a 5% – 10% premium to the California side properties b/c Nevada is state tax free, for example.

  13. PatientWealthBuilder

    good post and you are right: LIBOR matters. I had an ARM pegged to it and got really jittery when rates kept getting lower and stayed there. I was like, “these rates have to go up and my ARM is about to be subject to adjustments!!!” I know my personality. And I really really like fixed obligations. My local gas and electric company offers fixed monthly bills. They true-up over time if you owe more or less for the year. But I always know my payment every month. So I finally caved in last year and refinanced my personal residence at a decent fixed rate. I hope I will look smart in 10 years – but that assumes I don’t move for a long time. I am addicted to refinancing! I also refinanced my investment property to a 15 year fixed. So now I have this awkward incentive for rates to go up so I don’t feel like I did the wrong thing. It looks like you’ll be fine because you’re saving so much now you’ll be able to react later if rates start to rise and you feel like you’d rather have a fixed rate.

    1. I’m with you on this. With rates this low I love locking them up for 30 years. I just bought a new house with a 3.25% assumable fixed for 30 years. I could have a little lower rate with an ARM, but I’d be worried about what happens in 5 years. It all comes down to preference and life circumstances I guess. I prefer to buy and hold in really good areas, whether or not I live there long term. A lot of people plan to move in 5-10 years, so an ARM makes sense.

  14. Call me short sighted or ignorant, but I keep hoping for the Fed to raise the funds rate to something sustainable instead of its current spineless low.

    How many people, and pensions, have to be driven to insolvency before the madness ends,

  15. Since I don’t have any debt I haven’t been watching the LIBOR as closely as I should. I still have money in savings accounts so I need to be watching the LIBOR more closely. I have been waiting to be deploy cash into the market since August 2014 if the market starts to take a downturn. I was able to jump in February of 2016 with a big tranche but looking back wish I had deployed more. In the meantime my cash pile continues to increases since I am not a huge fan of the investment choices out there.

  16. I have been watching the LIBOR rise steadily since I refinanced my student loans at a variable rate. The interest is still well below what I was paying, but the gap has been closing monthly.

    I have started throwing extra payments at the balance from ESPP sales.

    Also in the middle of wrapping a 7/1 Arm refi on our house – thanks for the tips awhile back

  17. Financial Canadian

    In 2013, when bond yields dramatically increased in the period of a few short months, markets went nuts. It will be very interesting to see if this occurs again, as well as what role the new money market fund policies have in these rate changes.

  18. I wasn’t aware in the change in LIBOR so thanks. For better or worse I don’t have an ARM so not a lot of risk there. I’m more interested in what Mr market might due. I found it interesting you noted if 10 yr yield hits 2 your going into bond funds among other things. I assume this means you expect a gradual melt up in rates with some stops along the way and not a sudden move? That’s my take but I’m curious on your full thoughts knowing the market is never predictable.

    1. As an investor, you need to set buy and sell anchors based on your research, beliefs, and goals. Because I believe interest rates will stay lower for longer, and believe the realistic 10-year bond yield range is between 1% – 2.5% for years to come, buying bonds/REITS when the 10Y hits 2% would therefore be in the upper range of my forecasts.

      And if we get to 2.5%, I will be buying even more. Everybody has to make their own decisions.

  19. I agree with you Sam, there does appear to be some changing in the winds. As long as people are aware of it and will be focusing their future investments accordingly like you have, then it should be alright.

    I look forward to the rising interest rates! :)


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