The Federal Housing Administration (FHA) on Thursday officially announced that the Home Equity Conversion Mortgage (HECM) program is moving on from the London Interbank Offered Rate (LIBOR) index for adjustable-rate HECMs, and will instead adopt the Secured Overnight Financing Rate (SOFR). This was made official with the publication of Mortgagee Letter (ML) 2021-08 released on Thursday morning.
In long-awaited guidance from the federal government, the new ML “removes approval for use of the LIBOR index for adjustable interest rate HECMs,” approving the industry’s preferred index of SOFR while providing a timeline for how and when the changes will be implemented.
SOFR as an approved new index
“[This ML] approves the Secured Overnight Financing Rate (SOFR) index and permits mortgagees to commingle index types for newly originated annual adjustable interest rate HECMs when establishing the expected average mortgage interest rate using the U.S. Constant Maturity Treasury (CMT) and the initial mortgage interest rate (Note rate) and periodic Note rate adjustments using the SOFR index,” reads an FHA INFO notice about the new guidance.
The ML also announces new model Note language, included in the revised model loan documents for first and second HECM Adjustable Interest Rate Notes and incorporates the changes as described in the new ML. Revised model loan documents are now available as a resource on FHA’s dedicated webpage for Single Family Mortgages Model Documents.
In the ML itself, the guidance details that regulations are revised and in points of conflict are superseded by the new guidance.
“Mortgagees may no longer originate adjustable interest rate HECMs using the LIBOR index but may use the CMT or SOFR indexes,” the ML reads. “For all adjustable interest rate HECMs, the mortgagee must use the 10-Year CMT to establish the expected average mortgage interest rate. For annual adjustable interest rate HECMs using the SOFR index, the mortgagee must use the 30-day average SOFR, as published by the Federal Reserve Bank of New York.”
The Federal Reserve Bank of New York publishes the 30-day average SOFR on their website.
The letter also “sets zero as the ‘floor’ for the index value used to determine the Note rate to mitigate against uncertainty and risks posed by negative index rates,” the notice continued. Additional details are published in the ML.
“HUD has now established zero as the minimum for the index value used to determine the Note rate for all HECMs to prevent against below-zero interest rates in a negative interest rate environment,” the ML reads. “HUD has provided model loan documents to include the requirements defined in this ML, including the fallback language for future adjustable interest rate index transition events.”
Timeline for changes
For LIBOR loans still in the pipelines of lenders and brokers, FHA specifies guidance for relevant transactions with a slight amount of leeway.
“Mortgagees may use the 30-Day Average SOFR for annually adjustable HECMs where the HECM will close on or after May 3, 2021, provided that the 10-Year CMT is used to determine the expected average mortgage interest rate,” the ML says. “Mortgagees must conform their mortgage documents to satisfy the requirements of this ML.”
Additionally, existing LIBOR-based HECM loans closed prior to May 3, 2021 “remain unaffected by this ML,” it reads. “FHA will issue policy regarding existing LIBOR contracts at a future date.”
The new ML also details the timeline for the discontinuation of FHA insurance eligibility for new LIBOR-based adjustable interest rate HECM loans, though FHA specifies that it is important for mortgagees to, “consider the requirements of the HECM investor and Ginnie Mae’s All Participant Memorandum 20-19 regarding the March 1, 2021, deadline for making LIBOR-based adjustable interest rate HECM products ineligible for Ginnie Mae securitizations.”
One organization that has been front and center in discussions about the impending index transition has been the National Reverse Mortgage Lenders Association (NRMLA), which worked in consultation with the Alternative Reference Rates Committee (ARRC) and the Government National Mortgage Association (GNMA, or “Ginnie Mae”) in keeping these authorities appraised of the preferences of and impacts on the reverse mortgage industry that stem from an index change.
NRMLA praised the decision handed down by HUD, saying it will help to secure the HECM program for some time to come.
“NRMLA, on behalf of its members, appreciates the guidance issued by HUD via Mortgagee Letter 2021-08,” said Steve Irwin, president of NRMLA in a statement to RMD. “Through its appropriate use of the authority granted via the Reverse Mortgage Stabilization Act, HUD has promulgated policy that will strengthen HECM’s place in a more broadly accepted and mainstream mortgage market. This policy will also continue to bolster the safety and soundness of the HECM program, which is always a key consideration in the development of HECM policies.”
When reached for comment, representatives of both American Advisors Group (AAG) and Finance of America Reverse (FAR) deferred to the statement provided by NRMLA. Representatives from Reverse Mortgage Funding (RMF) and Longbridge Financial declined to comment, citing a need to fully absorb the contents of the ML.
Earlier this year, ARRC Vice Chairman Tom Wipf described the necessity to move quickly on an end to the LIBOR index, and the stated preference to move to SOFR in as expedient a manner as possible.
“The ARRC has focused on facilitating a smooth transition from USD LIBOR to a more robust alternative, called the Secured Overnight Financing Rate, or SOFR,” Wipf said in a column at Bloomberg. “With the official sector’s support, our members are committed to making this transition a success because it ultimately affects everyone.”
SOFR was selected as the replacement index after over two years of research in determining best practices and the potential ease or difficulty of such a shift, finding through it consultation and information gathering that it proposed goals and the ability of SOFR to fulfill them are “consistent,” Wipf described in his column.
For the reverse mortgage industry’s part, Ginnie Mae announced last September new restrictions on the eligibility of Home Equity Conversion Mortgage (HECM)-backed Securities (HMBS) for adjustable rate loans operating off of the LIBOR index, effective for all HMBS issuances dated on or after January 1, 2021, nearly a year ahead of the then-planned sunset of the index.
However, the January 1 date was revised to March 1, 2021 shortly thereafter, a new timeline reportedly reached in consultation with the reverse mortgage industry. Just last week, the United Kingdom Financial Conduct Authority, which regulates the LIBOR index, announced it will cease publication of the one-week and two-month LIBOR indices after December 31, 2021 and for all remaining LIBOR contracts after June 30, 2023, effectively spelling out the definitive endgame for the LIBOR index. By that point, though, the reverse mortgage industry still awaited action from FHA.
The official recommendation from NRMLA regarding the selection of a new index was to adopt SOFR, due to its wider use in the realm of financial services according to Michael McCully, partner at New View Advisors.
“We believe that moving to a niche index [like the CMT] for a niche product is the opposite direction [we want to be moving in] that we all are attempting to avoid,” McCully said at the NRMLA Annual Meeting in November, 2020. “We’re really working very hard to make our industry [the providers of] a more mainstream financial solution, and we don’t believe that remaining with CMT, for the long term, will have that intended effect.”
Read ML 2021-08 at the U.S. Department of Housing and Urban Development (HUD).