The Federal Housing Administration (FHA) on Wednesday published a new, long-awaited proposed rule regarding the Home Equity Conversion Mortgage (HECM) program’s transition away from the London Interbank Offered Rate (LIBOR) index to the Secured Overnight Financing Rate (SOFR) index.
The move comes after years of preparation by FHA, the reverse mortgage industry, and all stakeholders in between to facilitate a disruptive transition in a clear, timely and manageable manner as possible. Last year, the U.S. Department of Housing and Urban Development (HUD) published Mortgagee Letter 2021-08, indicating that the HECM program would move on from the LIBOR index and adopt SOFR for adjustable-rate mortgage (ARM) HECMs going forward.
The proposed rule
Regarding the HECM program specifically, the publication in the Federal Register details the circumstances that led to the adoption of LIBOR before ultimately choosing to phase it out in favor of SOFR, the industry’s long-approved index in the months leading up to the change.
“HUD proposes three changes,” the proposed rule reads. “First, HUD proposes to transition from LIBOR to a spread-adjusted SOFR index for existing forward and HECM ARMs, and to replace LIBOR with SOFR as a Secretary-approved index for new ARMs. Second, HUD proposes to clarify its regulations regarding the Monthly Adjustable Interest Rate HECMs [in existing regulations]. Third, HUD proposes to establish a five percentage point lifetime cap on the adjustment of the HECM monthly ARM interest rate.”
The proposed regulation update would “align forward ARM indices with the change made by Mortgagee Letter 2021-08,” the proposed rule reads. “HUD is also proposing to update [regulations] so that HUD’s HECM ARM regulations are consistent with the changes made by Mortgagee Letter 2021-08.”
These changes would establish zero as the “minimum for the index value used to determine the mortgage interest rate for all HECMs,” which is aimed to prevent against a negative interest rate environment.
Regarding existing HECM ARMs currently using LIBOR, the rule proposes to require such loans to transition to the spread-adjusted SOFR index, as well as requiring that borrowers be notified of the change.
“Before the Replacement Date, the loan documents for these mortgages govern the terms of the loan and, as long as the LIBOR index is available, mortgagees may not have flexibility to substitute a new index without a modification of the existing loan documents or executing new loan documents,” the proposed rule reads. “However, the LIBOR Act specifies that, on the Replacement Date, mortgagees will no longer be required to use LIBOR and must instead use a replacement index.”
The proposed rule makes for welcome news for the reverse mortgage industry according to Steve Irwin, president of the National Reverse Mortgage Lenders Association (NRMLA). While the proposed rule does require more time to digest, aspects of it are encouraging, Irwin said.
“Naturally, this proposed rule is new and we need to more fully digest it, but I am pleased to see that the Department is proposing that they transition to a spread-adjusted index, which would create a new index that better mimics the LIBOR indices as closely as possible,” Irwin explained to RMD. “We think this will minimize impacts to consumers, issuers and lenders.”
Adequate borrower communication remains an important factor to consider, which is an actionable item for certain elements of NRMLA membership, Irwin explained.
“I do want to amplify that NRMLA strongly encourages all of our servicer members to develop communication plans, and we strongly encourage HUD to engage with the Consumer Financial Protection Bureau (CFPB) to clearly communicate to consumers that this transition away from the LIBOR index is a market-driven change,” he said. “It is not a choice that lenders have, and we are hoping to coordinate with HUD and CFPB to speak authoritatively to s consumers to reduce any confusion this transition may cause.”
The industry has been waiting a long time for this guidance, so it is critical that servcers and agencies can develop their plans as substantially as possible, Irwin said.
“We’ve been anticipating this proposed rule, and we’re pleased to see it published as servicers and Ginnie Mae will need ample time to make system changes and execute on these communication plans,” he explained.
On the analyst side, Reverse Market Insight (RMI) President John Lunde adds that it’s helpful to see the potential end of this journey, though some questions still remain.
“What I’m curious to see is how they’re adjusting the SOFR index to approximate a 10-year tenor from the currently published 1-month tenor, and if they’ll also make any adjustment for perceived differences in character or level of LIBOR versus SOFR,” he said. “Regardless, it will be good to have this behind us a year from now if all goes smoothly. But there’s a clear communication challenge for the mortgage industry at large (well beyond reverse) to explain this change to borrowers in a way that minimizes confusion.”
Read the proposed rule at the Federal Register.