Why Your SOFR Index Is Not “The SOFR Index”

TLDR: The adjustable mortgage loan index you will have is most likely the 30 Day Average SOFR Rate. What the NY Fed calls “The SOFR Index” is not even a loan index and not relevant to you as a borrower.

Adjustable Rate Loan Indexes

Adjustable rate mortgage loans (ARMs) use an index as a base rate and add to that a margin to calculate the interest rate of a loan. For example, let’s say you have an ARM loan with an index based on the 1-year Treasury rate and a margin of 2%. On your rate reset date, if the 1-year Treasury rate is 3%, your interest rate would be 5% (3% index + 2% margin). If the 1-year Treasury rate goes up to 4%, your interest rate would go up to 6% (4% index + 2% margin). Lenders use the term “Index” to refer to the “base rate” of loans they make. This index can be any type of rate but usually will be a treasury rate, the prime rate, or a SOFR rate.

SOFR Rates In Mortgage Lending

The Secured Overnight Financing Rate (SOFR) is a benchmark interest rate that is used as an index to price mortgage loans. It is based on the overnight borrowing costs of banks and is designed to replace the London Interbank Offered Rate (LIBOR) as the benchmark interest rate index for the mortgage industry. The “Daily SOFR Rate” is calculated by taking the weighted average of the overnight borrowing rates of banks that participate in the Treasury repurchase market. The rates are weighted based on the volume of trades that occur in the market. The SOFR Rate is a more accurate reflection of the borrowing costs of banks, as it is based on actual market transactions.

The “30 Day Average SOFR Rate” is a calculation of the average SOFR Rate over a 30-day period. This rate is calculated by taking the average of the daily SOFR rates over the previous 30 calendar days, with imputed rates for non-business days. This average “Rate” is used as the “Index” to calculate the interest rate charged to borrowers on adjustable rate mortgage loans.

Basically, SOFR Rates are expressed in four ways: as the daily rate, a 30 day average of the daily rate, a 60 day average of the daily rate, or a 90 day average of the daily rate. Lenders are now primarily making loans using the 30 day average rate as the index they use as the base rate of their mortgage loans.

“The SOFR Index”

As stated, SOFR Rates are used by lenders as an index to calculate interest payments, but it is not the same as what the New York Fed calls “The SOFR Index.” (The New York Fed is the agency that calculates and keeps track of the SOFR.) What they call “The SOFR Index” is not important for mortgage borrowers to know or understand as it has nothing to do with what your interest rate will be. But if you want to know, The SOFR Index is the cumulative measure of the returns that would have been earned by investing in overnight repurchase agreements collateralized by Treasury securities since the inception of the index in April 2018. This is a number generally only of interest to a very small subset of investors, is a number and not expressed as a percentage, grows every day, and currently nears 1.08 after starting at 1.00 five years ago. So please disregard this number in relation to your loan.

What You Can Do

Always read your ARM loan documents and disclosures to find out exactly what “Index” your lender will use for your loan. And if someone tells you the lender is using “The SOFR Index” or “The SOFR Rate” as your index you will know what they are talking about.

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