In search of a new, more reliable benchmark rate index, the Alternative Reference Rate Committee (ARRC) has decided to transition to the Secured Overnight Financing Rate (SOFR) for indexing rates, replacing the London Interbank Overnight Rate (LIBOR).
Why was the change necessary and how is it better for consumers?
“The methodology for calculating LIBOR is outdated,” said Chris Cordry, EVP, Sr. Director of Capital Markets at PrimeLending. “More importantly, LIBOR has become increasingly subject to potential manipulation due to the now small number of reporting Banks who submit the funding rates that are averaged to create this index.”
In other words, many financial markets pushed to migrate away from document and transaction derivatives that LIBOR was using because they could be manipulated by incorrect information from participating institutions.
How Does SOFR Work?
SOFR is based on actual transactions, instead of document-driven derivatives. That means it’s less likely to be influenced by the wrong data. This will be the benchmark index for most Adjustable-Rate Mortgages (ARMs) and home equity loans moving forward.
How Are Home Buyers and Homeowners Impacted?
If you currently have an adjustable-rate mortgage (ARM) or a home equity loan, you may be affected, as many of these loan types are tied to LIBOR. According to Cordry, “regulators want financial institutions migrated off LIBOR products by the end of 2021, but most mortgage companies have either converted or are in the process of converting to SOFR-based products.” To find out if your existing loan is a LIBOR loan, contact the mortgage company that services your loan.
Most new ARMs for home buyers will be a SOFR product, so you would be unaffected by this change. PrimeLending now has a full line of SOFR loan products. Contact a PrimeLending loan officer for more information about our loan types to fit every need.
While ARMs are less popular at the moment due to fixed-rate mortgages offering historically low rates, that may not always be the case. That’s why it’s important to know when change takes place and what it could possibly mean for you, now or in the future.
If you need more information, contact your PrimeLending loan officer. If you want to learn more about the benchmark rate transition from LIBOR to SOFR, call 800-317-7463 or connect with a loan officer.