The End of LIBOR Could Raise Your Loan Payments. We’ll Explain.

It’s time to pull out those loan documents from your bank. And we totally understand if reading them makes your eyes glaze over. But because an upcoming technical change to  the way interest rates are set–which could have an impact on how much you repay– it’s worth another look. There is good news, though: Just search for the word LIBOR, and you’ll know pretty quickly if you need to take action.

LIBOR stands for the London Interbank Offered Rate, and it’s going to be retired at the end of 2021. LIBOR is the interest rate that up to 16 banks charge each other for short-term, unsecured loans. Since there were relatively few transactions of this type, the banks– meaning, individual bankers– often make estimates instead. That makes the index vulnerable to manipulation. And it was. In 2008, manipulation of LIBOR was one of the factors that exacerbated the global financial crisis. Bankers were arrested and later sentenced to jail.

Still, LIBOR remained the most common base rate used in business lending, according to Fran Garritt, director of global markets risk and credit risk for the the Risk Management Association. “For most small businesses, the last thing they’re going to worry about is what’s going on with LIBOR,” says Marilyn Landis, president and CEO of Basic Business Concepts, which provides CFO services to small businesses. “But it could be a hit to them, depending on how banks handle it.”

LIBOR pops up in a number of places in your company’s finances. LIBOR is most likely to be used in variable-rate loans, including lines of credit or adjustable-rate term loans. SBA Express Loans may be LIBOR-pegged, as are loans from the Main Street Lending Program. Trade finance contracts often use LIBOR, as do hedging productss such as interest rate swaps. LIBOR is also common in accounting, valuation, and financial modeling, according to Garritt.

Community banks, says Landis, are less likely to use LIBOR, and may instead use a rate based off of the Prime Rate. That, in turn, is based on rates set by the Federal Reserve.

In New York, Governor Andrew Cuomo’s budget proposal, released January 20, would allow LIBOR-based contracts to use a replacement rate recommended by the Federal Reserve Board, the Federal Reserve Bank of New York, or the Alternative Reference Rates Committee. The leading contender for many loans is the Secured Overnight Financing Rate, or SOFR, which represents the cost of borrowing cash overnight, backed by U.S. Treasury Securities.

If you have an adjustable loan based on LIBOR, don’t be surprised if you hear from your bank near the date of your next rate adjustment. Otherwise,  be proactive and call them. As LIBOR is phased out, “you also take the risk of LIBOR behaving badly when there are not many loans against it,” says Garritt.

A few banks might take this opportunity to raise your rate, but Landis doesn’t expect that to be common. “Banks’ cost of money is low, so this probably isn’t a bad time for this to happen,” she says.