If your adjustable-rate mortgage is linked to LIBOR, brace yourself

— -- The London Interbank Offered Rate, or LIBOR, sounds like one of those funny British idiosyncrasies, like warm beer or the royal family. But if you have an adjustable-rate mortgage or a student loan tied to the LIBOR, you will not be amused by what's been happening to this index in recent weeks.

LIBOR is the interest rate large banks charge each other for short-term unsecured loans. About half of adjustable-rate mortgages, and nearly all subprime mortgages, are pegged to the LIBOR, usually plus a margin of several percentage points. Last week, the six-month LIBOR was 4.13%, vs. 2.99% at the end of April, according to Bankrate.com. In the past few days, the index has been edging lower, falling to 3.83% on Monday, according to Bloomberg.com. Nevertheless, the LIBOR is still a full percentage point higher than it was in May.

If you have a one-year ARM that's scheduled to reset within the next few weeks, it may well be tied to LIBOR. And if that's the case, brace yourself. Borrowers who have been paying 5% on their ARMs for the last six months could see their rate rise to about 6.5%, says Greg McBride, senior analyst for Bankrate.com.

For prime borrowers whose mortgages reset six months ago, that could mean a big jump. The payment on a $250,000, 30-year loan with a 5% rate is $1,342 a month. At 6.5%, the payment jumps to $1,580 a month. Subprime borrowers, who pay a higher margin over the index, could see their rate jump as high as 9%.

An Oct. 6 report by Citigroup Global Markets predicts that the LIBOR increase could boost subprime defaults by 10%. The report estimates that 121,590 securitized ARMs will reset next month.

"We could see another wave of homeowner distress if LIBOR-index borrowers begin to see sharp payment increases," McBride says.

Monday's decline in the LIBOR reflected expectations that government intervention will stabilize the banking system. Many one-year ARMs are reset every six months, so if the downward trend continues, the rate increase will be temporary, says Keith Gumbinger, vice president for HSH Associates, which publishes information about mortgages and consumer loans.