What the Heck is SOFR?
Every time I finish writing another episode on mortgage financing, as if on queue, something significant changes. If you sell financial products linked to LIBOR, changes may be heading your way…okay so maybe not till 2021!
Today, Timothy Kitt, Senior Vice President, Head of Pricing and Execution for Freddie Mac released a statement on the replacement of the London Inter-Bank Offered Rate (LIBOR) with the Secured Overnight Financing Rate (SOFR), in support of the recommendation by the Alternative Reference Rate Committee (AARC). Both Fannie Mae and Freddie Mac have indicated they would work to to help lenders and borrowers transition to SOFR-based ARMs by the end of 2021.
So what is SOFR and why should mortgage originators care? The Federal Reserve Bank of New York website defines SOFR as “a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.” NMLS registered and state-licensed residential mortgage loan originators will need knowledge to clearly disclose the terms to consumers, which will be different than current ARM products consumers are used to.
AARC’s position is the SOFR model can “…meet consumer needs and be attractive to borrowers and investors at interest rates consistent with…competitive markets.” With SOFR adjustable-rate mortgages, ranges of fixed-rate periods, timing of rate and payment adjustments and interest rate caps, would be similar to current LIBOR products. Unlike current LIBOR arms, the index may be shorter term (30-90 day) based averages, margins will be adjusted upward toward ranges of 2.75% to 3.00% and adjustments will occur every 6 months instead of annually; the advantages and disadvantages are yet to be seen. SOFR has been tracked since April 3, 2018. I may just call her Sophie!
The beginning of the end of LIBOR started with an international investigation in 2012 which uncovered a widespread scheme resulting in London traders being found guilty and convicted for interest rate rigging that went back to the early 2000’s. A new index has been seen as a necessity to instill confidence back in the markets and with consumers. The investigation resulted in more than $9 billion in fines and criminal charges filed by regulators in the United States, UK and the European Union. LIBOR has been used to set interest rates on over $300 trillion in securities and loans.
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