**Title: Understanding the Transition from LIBOR to SOFR: What Mortgage Borrowers Need to Know**
**Introduction**
When you get an adjustable-rate mortgage (ARM), the interest rate is determined by adding a margin to an index. One of the most prominent indexes used until recent years was the London Interbank Offered Rate (LIBOR). This article will explain why LIBOR was replaced, what replaced it, and how this change affects mortgage borrowers.
**What Was the London Interbank Offered Rate (LIBOR)?**
LIBOR was an index used to establish the interest rate for many adjustable-rate consumer financial products. Leading banks in London and globally would submit estimates of what they would be charged if they borrowed from other banks. Although LIBOR has been phased out, it was in use as recently as 2023. According to the Consumer Financial Protection Bureau (CFPB), in 2019, about $1.3 trillion in consumer loans were backed by LIBOR.
**Why Was LIBOR Phased Out?**
LIBOR originated in 1969 with a loan between Manufacturers Hanover and the Iranian Shah, facilitated by a Greek banker named Minos Zombanakis. Despite its wide adoption, LIBOR had several shortcomings and was tainted by scandal and fraud. The index relied on predictions rather than past transactions, making it susceptible to manipulation. In 2012, a scandal revealed that traders had exploited the system, leading to regulatory changes and the eventual decision to phase out LIBOR.
**What Replaced LIBOR?**
In the U.S., LIBOR was replaced by the Secured Overnight Financing Rate (SOFR). SOFR is based on the cost of funding determined mainly through repurchase volume for U.S. Treasuries. Unlike LIBOR, which was based on estimates, SOFR is harder to manipulate because it is based on actual transactions.
**Why Does the LIBOR Change Matter?**
The change from LIBOR to SOFR matters because LIBOR was the index underlying the cost of many consumer loans, including adjustable-rate mortgages. If you had a fixed-rate loan, you wouldn’t have been impacted by the discontinuation of LIBOR. However, if you had an adjustable-rate loan or line of credit based on LIBOR, your lender would have needed to switch to a different index.
**How Did the LIBOR Phase Out Affect Me?**
If you had an adjustable-rate mortgage (ARM) or other loans based on LIBOR, you might have experienced changes in your interest rate due to the switch to a different index. The mortgage industry worked to ensure minimal disruption in your payment process. ARMs were often switched to SOFR, but other indexes like the constant maturity treasury or the prime rate published by the Wall Street Journal were also used.
**How Does LIBOR Differ from SOFR?**
SOFR is based on transactions that have already happened, primarily U.S. Treasury repurchases. In contrast, LIBOR was based on estimates of the cost of funding, making it more susceptible to manipulation.
**How Did LIBOR Rates Work?**
When you applied for a mortgage, the first metric lenders checked to price various types of ARM loans used to be LIBOR. Your interest rate was determined by adding a margin to the LIBOR rate. For example, your rate might have been stated as LIBOR + 2, with the LIBOR part varying with economic changes and the “2” as the margin, which stayed the same.
**How Was LIBOR Calculated?**
LIBOR was calculated based on estimates submitted by 11 to 16 banks each day. The highest and lowest estimates were dropped, and a mean average of the rest was used to determine the LIBOR rate for that day.
**The History of LIBOR**
LIBOR was always based on projections rather than past transactions, leading to issues that ultimately resulted in its demise. Before reforms, each bank set its own methodology for LIBOR submission, making it susceptible to manipulation. After the 2008 financial crisis, trading volume dropped, and expert opinion was relied on more, leading to further manipulation.
**Changes to LIBOR Over Time**
In the wake of the manipulation scandal, the ICE Benchmark Association moved to tie submissions more closely to transactions. They created a hierarchy for submissions, prioritizing actual transactions, historical data, and finally, expert opinion.
**The Bottom Line**
LIBOR was a benchmark that asked major banks what the cost would be to fund their operations through borrowing each day. It served as the basis for rate changes in many consumer loans, including ARMs. However, due to its susceptibility to manipulation, it was replaced by SOFR in the U.S. If you had an ARM, your transition to a different benchmark rate has most likely already happened. If you have questions, you should contact your servicer.
For more information or to apply for a mortgage, visit [O1ne Mortgage Inc.](https://o1nemortgage.com) or call us at 888-372-8820.
**Keywords:** LIBOR, SOFR, adjustable-rate mortgage, ARM, mortgage rates, mortgage index, mortgage loan, O1ne Mortgage Inc.
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