The Secured Overnight Financing Rate (SOFR) is the new standard that is used to determine the current variable interest rate on loans. SOFR replaced the London Interbank Offered Rate (LIBOR) index as the go-to standard for new loans originated in the United States at the end of 2021. While LIBOR will no longer be used to price new loans starting in 2022, it will formally stick around until at least 2023.
Financial institutions use LIBOR and SOFR as tools for pricing corporate and consumer loans. SOFR bases its rate on what financial institutions pay one another for overnight loans, which is why the source is named overnight financing. The SOFR rate is published daily by the Federal Reserve Bank of New York which can be found here.
Why the switch?
The LIBOR Index was a common metric used to determine the variable interest rates on setting commercial and consumer loans. However, in 2021, the U.K. Financial Conduct Authority (FCA) announced it would cease publication of the London Interbank Offered Rate (LIBOR) on new loans originated in 2022. As a result, any loan product that references LIBOR would need to transition to an alternative index by June 2023.
SOFR has become the new industry benchmark because it’s more risk-averse, holistic, and transparent to borrowers and lenders. This is because the standard is based on more than $1 trillion in cleared marketplace transactions which are all observable. The SOFR Index is intended to be more dependable and has a stronger emphasis on comprehensibility. The change should positively impact borrowers who are needing new private student loans, refinance existing ones, or even those who are wanting to take out a mortgage.
How is the rate determined?
The largest financial institutions will lend money to each other using the Treasury repurchase market. They do this by using Treasury bond repurchase agreements which have become known as repos. These repo agreements allow institutions to use their Treasuries as collateral to make overnight loans to ensure they’re meeting liquidity and reserve requirements. The SOFR rate is then determined by taking the weighted average of all the interest rates of these repo transactions.
The variable interest rate on new Earnest loans originated after December 15, 2021, will be based on the 30-Day Average SOFR as published by the Federal Reserve Bank of New York on the twenty-fifth day, or the next business day of the preceding calendar month, and using the daily interest rate based on actual days in the year and rounding up. If you have a variable interest rate, the SOFR will be added to your base rate to set the effective rate beginning on the 1st of the following month.
How will this impact my Earnest loan?
Your loan will continue to utilize the LIBOR Index for the time being while we work to transition all loans over to SOFR by June 2023. At that time, the 30-Day Average SOFR will be used for future accrual, and any changes to your loan will be reflected on your monthly statements. We’ll notify any client impacted by this transition via email prior to the change occurring.
If you have an existing Earnest loan, no action is needed from you. Loan documents and disclosures will not need to be replaced as outlined in Section E. Interest in your loan agreement. In addition, we will check the 30-Day Average SOFR Index on the 25th of each month (or the next business day), then add SOFR (rounded up) to the base rate to set the effective rate for the next month on the 1st.
If you’re a new Earnest client, the variable interest rates you’re quoted in the Rate Check Tool and the final rate at signing will be based on the 30-Day Average SOFR as published by the Federal Reserve Bank of New York on the twenty-fifth day of the previous month and then rounded up. All new loan documents and disclosures will reflect this source.