HUD takes next step to replace Libor

The Department of Housing and Urban Development published a proposed rule governing the transition away from the Libor index for both forward and adjustable rate mortgages — something the conforming market accomplished two years ago.

Both Fannie Mae and Freddie Mac stopped taking Libor-indexed ARM mortgage applications on Sept. 30, 2020, as confirmed by the Mortgage Credit Availability Index. Both stopped acquiring these loans by the end of the year.

This proposal, which calls for use of the Structured Overnight Finance Rate, comes almost 10 months after HUD closed comments on an advanced notice of proposed rulemaking.

"FHA encourages all market participants to provide their comments on the proposed rule," a HUD spokesperson said in a statement. "While we are not able to discuss FHA's internal deliberations nor speculate on other alternatives beyond what is in the proposed rule, we believe that our proposal is appropriate for the industry to consider relative to FHA-insured adjustable rate mortgages."

The Federal Housing Administration first approved using Libor as an ARM index in October 2007. Until then, the only available index for originators to use for FHA loans was the Constant Maturity Treasury.

The previous notice brought in nine comments by the time the period closed on Dec. 9, 2021. Those comments "were mostly supportive of transitioning away from Libor and multiple commenters specifically suggested the use of SOFR as a replacement index," the agency said in the Federal Register.

For existing forward and Home Equity Conversion Mortgages insured by the FHA, Libor would be replaced by a spread-adjusted SOFR index for any future changes.

Any fluctuation in existing borrowers' rates because of the switch would be mitigated by per adjustment or life of loan caps, the proposal stated.

"Furthermore, the applicable SOFR tenors will be identified by the Federal Reserve Board prior to the replacement date and HUD believes that the spread-adjusted SOFR will provide a comparable interest rate consistent with the rate that would have been generated by the Libor index," the proposal states.

Under the Libor Act, the replacement date was established as the first London banking date after June 30, 2023, unless the Federal Reserve Board specifies a different time.

The Alternative Reference Rates Committee designated SOFR as its preferred Libor replacement, although some market observers feel it is flawed in terms of determining various tenors.

HUD previously approved SOFR as an index for newly originated reverse mortgages starting on May 3, 2021 in a mortgagee letter. The latest proposal will align forward mortgages with that letter. It also updates the agency's regulations for reverse mortgages so they are consistent with that letter.

"This rule proposes to use the 30-day average SOFR tenor adjusted to a constant maturity of one year," the proposal states. "However, HUD anticipates that it may decide to approve additional SOFR tenors besides the 30-day average when additional SOFR tenors are published or more information about existing tenors is made available." In the future, HUD wants to be able to approve those through a notice.

The proposed rule still allows originators to use the CMT as an index for Federal Housing Administration adjustable rate mortgages.

Also included in the rule is a five-percentage-point lifetime cap for HECMs as well as a clarification regarding monthly adjustable interest rate reverse mortgages.

This new proposal has a 30-day comment period, which is half of the normal 60-day timeframe, in large part to allow a final rule to be ready by the June 30, 2023 replacement date.