The labor of predicting LIBOR....
April 8, 2008 7:43 PM   Subscribe

Should I choose a private student loan based on the 1-month LIBOR or the Prime Rate?

I have private education loan approvals that are based on both the 1-month LIBOR rate (more specifically, the quarterly average of the 1-month LIBOR) and the Prime Rate. Chase Education is calculating the 1-month LIBOR currently at 3.62 (an average of Jan-Mar rates of 4.223, 2.849, 2.708) and the April rate has posted at 2.486, so a clear downward trend. Historically the lowest LIBOR has hit was 1.340 in 2003.

My margin with Chase would be +2.5% so right now calculated at 6.12%. The best offer I was received based on the Prime Rate is Prime +1%, so right now a rate of 6.25% with the margin. Within the last ten years, the lowest prime rate was 4.0%.

Both rates have obviously experienced cuts in the past quarter, but other than a crystal ball, is there is any way to get an idea of which rate will experience further decreases and thus save me from accruing more interest?
posted by Asherah to Work & Money (4 answers total) 3 users marked this as a favorite
Have you seen this page? It says "Historically, the spread between the Prime Lending Rate and LIBOR has been increasing, meaning that over the long term a loan with interest rates based on LIBOR will be less expensive than a loan based on the Prime Lending Rate. A variable rate loan pegged to the LIBOR index will grow more slowly than a loan pegged to the Prime Lending Rate." and "If the difference in interest rates is less than 25 bp [(.25%)], prefer the loan that is pegged to the LIBOR index."
posted by true at 7:49 PM on April 8, 2008

Response by poster: I have explored the detail thoroughly regarding LIBOR v. Prime as well as additional google searches, just was trying to gain some insight into the LIBOR v. Prime potential future trends.
posted by Asherah at 7:54 PM on April 8, 2008

Prime is pegged to 3% over the Fed Funds rate (right now anyway). LIBOR is a market rate that changes day-to-day. But both rates tend to move in virtual lock-step. Here's a 10 year chart of both rates.

In fact, over the last 10 years I don't really see the relationship that the FinAid website mentions--the average spread has been 2.86% with some periods of volatility, including recently. But, in general, the spread has remained in the 2.5% - 3.0% band (the spread spiked up in 2001 and has spiked both up and down in the last six months).

As for predicting interest rates...well, lots of money in that. I wouldn't put much stock in predictions you get here. Especially in the long term. For what it's worth (not much), the futures markets are implying a high likelihood of a 25bps or 50bps cut at the next FOMC meeting on April 30th (here's a chart!). But that's a short-term prediction and shouldn't be any sort of guide to long term trends.
posted by mullacc at 8:55 PM on April 8, 2008

I just mailed in my forms to switch to LIBOR, but for me, it wasn't going to be LIBOR vs. Prime, but rather LIBOR vs whatever interest rate Iowa Student Loan could get for its bonds, which would have meant a huge increase next month :P. Historically LIBOR has gone up to 5%
posted by delmoi at 9:01 PM on April 8, 2008

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