Transition away from LIBOR (to SOFR) addressed in ‘what you need to know’ from CFPB

The impact of the transition from one commonly used index for setting interest rates on adjustable-rate consumer loan and other products – primarily residential mortgages – to another, new index is addressed in a “what you need to know” blog posting by the federal consumer financial protection agency.

In the posting, the Consumer Financial Protection Bureau (CFPB) said the “London Interbank Offered Rate” (LIBOR) – an index used for setting the rates on variable rate loans and lines of credit, among other things (including adjustable-rate mortgages, or ARMs) – is expected to be phased out after 2021. In its place, the bureau said, the Federal Reserve’s Alternative Reference Rates Committee (ARRC) has recommended an index dubbed the “Secured Overnight Financing Rate (SOFR).” The Fed is already encouraging financial institutions to begin adopting the new rate index, which is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities.

According to figures provided by the CFPB, that changeover to the new rate will be significant. The agency said that there is an estimated $1.3 trillion in consumer loans with an interest rate based on LIBOR, the bulk which are for residential mortgages.

“LIBOR is based on transactions among banks that don’t occur as often as they did in prior years, making the index less reliable and credible,” according to the bureau’s blog post. “The UK (United Kingdom) regulator that oversees the LIBOR panel has stated that it cannot guarantee LIBOR’s availability beyond the end of 2021.”

The CFPB pointed out that adjustable-rate loans are typically calculated using an index (like LIBOR) and the margin (the number of percentage points added to the index by the lender to calculate the total interest rate).

The bureau stated that loans or lines of credit based on LIBOR may be changed to a different index (including SOFR), “likely around the anticipated date of LIBOR’s discontinuation.”

This past summer, Federal Reserve Board Vice Chair for Supervision Randal Quarles said the transition to SOFR is ahead of schedule. He also noted that the ARRC has recognized that the transition to the index rate has to be made “as easy as it can be.”

Quarles also said then that, in an effort to encourage the use of SOFR in cash markets where “it is appropriate,” the Federal Reserve could consider “publishing a compound average of SOFR that market participants could then use.” He said a suggested name could be “SAFR,” for “secured average financing rate.”

You might have heard that LIBOR is going away. Here’s what you need to know about LIBOR and adjustable-rate loans