February 24, 2020
We know that, week in and week out, the percent of overall applications for ARMs runs about 5 percent. And much of that is from banks and credit unions. But Orion knows that our brokers are keeping up on developments with adjustable rate mortgages since they impact previous ARM borrowers and future clients.
First, some background. The credibility of LIBOR (London Interbank Offered Rate) was undermined slightly by a price-fixing scandal a few years ago, and LIBOR will probably not be published after 2021. Millions of businesses and individuals have their borrowing costs tied to LIBOR (plus some spread, aka margin). In the U.S., the belief is that the new benchmark rate will be SOFR (Secured Overnight Financing Rate).
There are many technical differences between the two rates, but LIBOR and SOFR are highly correlated. Both benchmarks usually move in tandem with the effective fed funds rate, determined largely by the monetary policy stance of the Federal Reserve.
The sensitivity of SOFR versus LIBOR has some worried. However, the FOMC is expected to be on hold through 2020, with forecasts for real GDP growth and consumer price inflation likely not strong enough to induce Fed tightening. As a result, SOFR should remain largely unchanged over the next year or two at its current level of roughly 1.60 percent, easing apprehension over the transition, a good thing for Orion and our broker clients.
One proposed solution to the potential problem of more borrowing costs as a result of the volatility with SOFR rates is to have households and businesses borrow at a term SOFR rate that is determined in arrears. Although SOFR can be volatile on a daily basis, its one-month moving average tends to be more or less as smooth as 1-month LIBOR. So, a one-month SOFR rate would be the moving average of the daily SOFR rate over the past month. It is not a perfect relationship, and it is important to bear in mind that a one-month moving average of SOFR is inherently backward-looking, whereas 1-month LIBOR is an inherently forward-looking rate. But consumers should not worry the transition is going to have a material impact on their borrowing costs.
This year Fannie and Freddie will begin accepting mortgages backed by the secured overnight financing rate, or SOFR. And after Freddie and Fannie map this out, Orion and others will establish their policies. The FHFA issued a news release that highlighted certain changes affecting single-family and multifamily ARM products. Companies servicing mortgages are also watching these developments. Most existing ARM loans have notes that contain verbiage regarding an index change, and legal staffs are reviewing those as well.