After June 30, 2023, the 1-month and 1-year LIBOR indices will no longer be published. Therefore, existing borrowers with LIBOR-based loans must be notified, prior to their next rate adjustment, that the variable portion of their interest rate will be tied to an alternate index.
What can you tell me about the LIBOR Transition?
The most popular reverse mortgage product is the federally insured Home Equity Conversion Mortgage or HECM. Most HECMs in service are variable-rate loans where the rate is adjusted periodically using an established lender margin plus a published index. Loan originators currently sell HECM ARMs tied to the Constant Maturity Treasury (CMT), but that was not always the case. Many HECMs originated prior to 2021 utilized an international index known as the London Interbank Offered Rate or LIBOR index.
Here are some of the questions I’ve received on this topic as well as my best efforts to answer them:
WHY IS THE LIBOR GOING AWAY?
First, the LIBOR index was somewhat inaccurate, as it didn’t accurately measure the cost of institutional borrowing. More problematic, however, is that the LIBOR was open to manipulation. This is because 1) It relied on self-reporting, and 2) Large banks could make money by strategically trading at the right time. In fact, it was the source of the largest banking scandal in history at the time.
Fortunately, this scandal had no apparent impact on reverse mortgage borrowers. But in 2017, British officials announced their plan to eventually close the published index.
IS THE LENDER AUTHORIZED TO CHANGE THE INDEX?
Yes. Every HECM ARM borrower signed a HECM ARM NOTE at closing. Section 5 of the NOTE states, “If the Index is no longer available, Lender will use as a new Index any index prescribed by the Secretary (HUD). Lender will give Borrower notice of the new Index.” These notices will be sent in 2023 and 2024 depending on the borrower’s adjustment date.
WHAT DID HUD’S 2021 MORTGAGEE LETTER ACCOMPLISH?
When HUD published Mortgagee Letter 2021-08, HUD officially removed the LIBOR index as an option for originating new HECM loans. While the industry had already shifted to the CMT index, HUD also approved the Secured Overnight Financing Rate or SOFR index.
In addition, HUD chose to 1) update the HECM Model Note, 2) remove a comingling prohibition that would allow the SOFR to use the 10-year CMT for calculating expected rates, and 3) eliminate negative index values if rates were to drop that low in the future.
WHAT IS THE REPLACEMENT INDEX?
The U.S. Department of Housing and Urban Development (HUD) announced on March 1, 2023, the establishment of a “spread-adjusted SOFR” index. This was identified as the HUD-approved replacement index when transitioning away from the LIBOR.
The SOFR is a U.S.-based LIBOR substitute. The reason it is “spread-adjusted” is because the SOFR is designed to be an overnight rate. The spread accurately accounts for differences between the SOFR when compared to the 1-month and 1-year LIBOR. This makes the spread-adjusted SOFR the most appropriate replacement index available.
WILL ALL OTHER TERMS OF THE MORTGAGE APPLY?
Yes. According to HUD’s announcement on 3/1/23, “For existing mortgages that transition to spread-adjusted SOFR, we do not anticipate a significant economic impact. For all existing FHA-insured ARMs, the per-adjustment and lifetime caps on total adjustments will continue to apply, minimizing the impact to borrowers or mortgagees as a result of the transition to SOFR.”
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