HUD recently issued a proposed rule to address the transition away from the London Interbank Offered Rate (LIBOR) in connection with determining interest rate adjustments for adjustable-rate mortgages (ARMs).
HUD is authorized to insure both forward and reverse (HECM) ARMs. HUD’s existing regulations generally require that the amount of a borrower’s interest rate adjustment must be based on an interest rate index approved by the Secretary of HUD. The two currently permissible indexes are LIBOR and the U.S. Constant Maturity Treasury (CMT). However, publication of LIBOR is being discontinued, with an anticipated cessation date of June 30, 2023.
In anticipation of the end of LIBOR, HUD is seeking a new interest rate index which may be used in connection with determining the interest rate adjustments for FHA-insured ARMs. One alternative index which is being widely adopted by private companies, legislators, and regulators as a replacement for LIBOR is the Secured Overnight Financing Rate (SOFR), which is published by the Federal Reserve Bank of New York in conjunction with the U.S. Treasury’s Office of Financial Research.
HUD’s proposed rule provides that for new FHA-insured forward and HECM ARMs, the interest rate adjustments must correspond to either the weekly average yield on the CMT adjusted to a constant maturity of one year, the 30-day average SOFR adjusted to a constant maturity of one year, or such other SOFR-based indexes which may be approved by the Secretary of HUD in the future. Further, for existing FHA-insured forward and HECM ARMs whose interest rate adjustments are indexed to LIBOR, these loans will be transitioned to a spread-adjusted SOFR replacement index which will be approved by the Secretary prior to the cessation of publication of LIBOR. The proposed rule also provides additional clarity regarding adjustments to HECM ARMs which occur monthly (as opposed to annually), including that adjustments to HECM ARM monthly interest rates may never exceed five percentage points from the initial contract interest rate.
HUD had previously issued a mortgagee letter which provided that LIBOR could no longer be used as the index rate for adjustments to HECM ARMs, and that the SOFR is an acceptable replacement. The new rule is designed to bring HUD’s HECM regulations in line with that mortgagee letter as well as to address the LIBOR transition in connection with forward ARMs. Further, HUD’s new rule is being made against the backdrop of the Adjustable Interest Rate (LIBOR) Act, which was enacted by Congress earlier this year. This Act generally provides that, for consumer credit contracts which rely on LIBOR as a benchmark rate and which do not otherwise provide for the replacement of LIBOR after its discontinuance, these contracts will automatically be deemed to switch to the SOFR as their new benchmark rate.