Client Alert

Secured Overnight Financing Rate and the Future of the Mortgage Market

22 Jul 2019

On July 11, Fannie Mae and Freddie Mac (the GSEs) announced their plans to develop new adjustable rate mortgage products that would rely on the Secured Overnight Financing Rate (SOFR) instead of LIBOR.[1] Given the GSEs’ dominance in the mortgage market, their re-designed ARMs will undoubtedly have a significant impact on hybrid ARMs of the future. While the GSEs provided no details about the new products, both pledged to rely on a framework provided in the Alternative Reference Rate Committee’s (the ARRC) whitepaper entitled “Options for Using SOFR in Adjustable Rate Mortgages.”[2]

What Is the Secured Overnight Financing Rate?

The Secured Overnight Financing Rate is a rate produced by the New York Federal Reserve Bank based on overnight transactions in the U.S. Treasury repurchase market.[3] According to the ARRC, SOFR has benefits; for example, SOFR would be difficult to manipulate because it is based on an active, well‑defined and deep market, and it is based on observable transactions, in contrast to LIBOR, which is based on estimates. The ARRC further notes that SOFR can be produced in a range of economic conditions because it is based on a market that was able to withstand the global financial crisis.

How Would Reliance on SOFR Impact Hybrid ARMS and Regulatory Compliance?

According to the ARRC, ARMs based on SOFR would have different adjustment periods and caps than current ARMs. The ARRC recommends that ARMs rely on the value of SOFR at the beginning of the interest period (“in advance”) rather than at the end (“in arrears”) to ensure that consumers are not surprised by rate increases on short notice. However, to address investor concerns that “in advance” rates may be out of date, the ARRC notes that ARMs could require rate adjustments every 6 months instead of once a year. To further address concerns about “payment shock” when rates rise rapidly or are volatile, adjustments would be capped at 1% instead of the 2% caps widely used today.

Such changes to ARM structures would not appear to conflict with existing consumer protection regulations, such as the CFPB’s ability-to-repay and qualified mortgage rules. However, creditors and servicers will likely have to make system changes to accommodate the more frequent rate adjustments and caps. More potential regulatory impacts may emerge as the GSEs provide details of the ARM products.

What About Existing ARM Contracts That Rely on LIBOR?

Neither the GSEs nor the ARRC have addressed industry concerns about how to transition existing contracts from LIBOR to other rates. The ARRC has announced that it will do so “later in 2019.”[4] In addition, the ARRC is currently seeking public input on model contract language to address scenarios when reference rates become unavailable.[5] Comments are due by September 10, 2019.


[2] The ARRC, a public-private group that includes the GSEs, is chartered to facilitate the financial services industry’s transition from LIBOR to other reference rates.  The ARRC does not mandate the use of SOFR or attempt to dictate the shape of future products.


[4] ARRC Consultation Regarding More Robust LIBOR Fallback Contract Language for New Closed-End, Residential Adjustable Rate Mortgages, July 12, 2019,  

[5] Id.



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