A working group of finance professionals has determined that a new interest rate index could replace Libor, the current benchmark rate index that is expected to retire after 2021.
That means the mortgage industry should start preparing for the transition to the new index soon, the group told reporters on Thursday.
The London Interbank Offered Rate tracks the interest rates banks lend to each other in the short term. Libor has long been used as a "benchmark" in many adjustable rate products, including mortgages. This index was tarnished by a pricing scandal that erupted in 2012 and the financial sector had to find a replacement.
The proposed replacement, known as a secure overnight rate, has been reviewed by the Federal Reserve Task Force since it was convened in 2014. The Alternative Reference Rate Committee includes professionals from Mortgage Guarantors Fannie Mae and Freddie Mac, as well as regulators.
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The committee determined that this rate would work well for the mortgage industry, meeting the needs of consumers and attracting "investors at rates that are consistent with, and determined by, competitive markets," committee members said.
have already started building their systems to link to SOFR. Nadine Bates, Fannie's treasurer, however, noted that the industry, including lenders and other creators, could take up to 12 to 18 months to prepare for the transition.
Still to be determined is how "traditional" products, or mortgages previously contracted with Libor-linked rates, will be treated after the withdrawal of the index.
The ARRC also released Thursday a white paper that shows how to base an adjustable rate mortgage on the average SOFR rate can give borrowers stable rates. Since it would be based on averages set before the ARM reset dates, it would provide "certainty," the group said.
"The reset frequency would be set at six months to mitigate any potential disparity between the loan rate that consumers pay and changes in market interest rates related to forecasts of changes in economic conditions, and the tariff ceilings would be adjusted accordingly. "
Adjustable rate mortgages have often been used as "teasers" to get consumers into homes they could not afford during the housing bubble. When these mortgage rates are reinstated at higher rates, many homeowners can no longer afford them. Regulations adopted after the crisis required lenders to ensure that consumers could afford the ARM arm for their entire life, regardless of their responsiveness.
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