Adjustable-rate mortgages (ARMs) are making a comeback. In 2021, when the average 30-year fixed mortgage rate was 2.65%, there was little demand for ARMs. With interest rates rising, ARMs are now more attractive. In mid-October, the average 30-year fixed mortgage rate was 6.92%.
With the median US home price at $389,500, in August, up 7.7% over the past year, the lower initial interest rate and lower monthly payments for ARMs are attracting more buyers.
Demand for ARM is higher than it has been for over a decade. ARM volume hit a 14-year high in May, when the MBA reported that ARMs accounted for nearly 11% of all mortgage applications. At the beginning of this year, this percentage was only 3%. A lender is now seeing pipelines that are 70% ARM.
An increase in ARMs means mortgage servicers have additional factors to consider when servicing loans. Managers should consider recent changes in interest rate calculations with the move from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Funding Rate (SOFR).
SOFR is a benchmark rate for derivatives and dollar-denominated loans based on transactions in the Treasury repurchase market. Instead of the estimated borrowing rates on which LIBOR was based, SOFR is based on actual data from observable transactions.
Most managers have software in place that helps them manage adjustable rate loans. However, the way managers are handling an increasing number of ARM loans in their portfolios, combined with their approach to moving from LIBOR to SOFR, will set industry leaders apart from the rest.
The move to SOFR and its impact on mortgage servicers
The Federal Reserve has already moved from LIBOR to SOFR. In December 2021, the The CFPB has finalized its replacement rules for LIBORrequiring all lenders to completely exit the old index by June 2023.
The problem is that most ARMs from the old index will not be adjusted until then.
Fortunately, the industry has been watching this change in the ARM index for some time. As a result, many lenders have already stopped offering loans that adjust for LIBOR. Additionally, many repairers opted for software that could easily support the move to the new benchmark. Overall, the switch to SOFR went relatively well.
Even so, any existing loan agreement that still includes LIBOR must be amended before the June 2023 deadline.
The Power of Good Maintenance Software
To adapt to massive changes in the types of loans taken out and adapt to government regulations on schedule, managers need comprehensive mortgage loan management software. Software vendors modified their systems in Q1 2021 to enable a smooth transition to SOFR with minimal disruption.
As part of this work, the software developers have updated their platform to meet the following essential requirements:
- Seamlessly integrate the new tariff codes of the different SOFR products
- Use an adjustment gap if necessary
- Easily modify old loans to SOFR specifications
- Ensure that interest rate adjustments can be determined using LIBOR or the new SOFR index
- Modify third-party reporting with new SOFR products
By including these capabilities in their platforms, service software vendors have given services options on how to handle old loans that have been closed under LIBOR. For some repairers, this decision is still under consideration.
Regulators expect LIBOR rates will not be released after June 30, 2023. The hope is that most existing contracts will mature or refinance by then, but the tenor of most loans Adjustable rate commercial mortgages are much longer than consumer loans. This is going to impact repairers with large commercial ARM wallets written in the old index.
Because adaptive management software is so important, lenders should work with their mortgage software partners throughout the LIBOR transition. Lenders may also need to discuss existing contracts with a lawyer to determine the institution’s risk exposure when LIBOR is eventually withdrawn.
Change can be difficult, but it is a reality in the real estate finance industry. How services respond to required changes will determine their success.
Sherri Carr is Vice President of Commercial Service Product Development for FICS (Financial Industry Computer Systems, Inc.)a mortgage software company that provides in-house mortgage origination, residential mortgage servicing and commercial mortgage servicing software to mortgage lenders, banks and credit unions.