How Mortgage Servicers Can Navigate Rising ARMs Successfully


Adjustable-rate mortgages (ARMs) are making a comeback. In 2021, when the average 30-year fixed mortgage rate was 2.65%, there was little demand for ARMs. With interest rates rising, ARMs are now more appealing. In mid-October, the average 30-year fixed mortgage rate was 6.92%.

With the median U.S. home price at $389,500, as of August, up 7.7% from a year ago, the lower initial interest rate and lower monthly payments for ARMs are attractive to more buyers.

Demand for ARMs is higher than it has been in more than a decade. ARM volume hit a 14-year high in May, when the MBA reported that ARMs made up nearly 11% of all mortgage applications. At the beginning of this year, that percentage stood at only 3%. One lender is now seeing pipelines made up of 70% ARMs.

An increase in ARMs means that mortgage servicers have additional factors to consider when servicing loans. Servicers must account for the recent changes in interest rate calculations with the shift away from the London InterBank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR).

SOFR is a benchmark rate for dollar-denominated derivatives and loans based on transactions in the Treasury repurchase market. Instead of the estimated borrowing rates that LIBOR was based on, SOFR is based on actual data from observable transactions.

Most servicers have software in place that helps them service adjustable-rate loans. However, the way servicers deal with an increasing number of ARM loans in their portfolios combined with their approach to shifting from LIBOR to SOFR will set the industry leaders apart from the rest.

The Move to SOFR and its Impact on Mortgage Servicers

The Federal Reserve has already transitioned from LIBOR to SOFR. In December 2021, the CFPB finalized its rules for replacing LIBOR, requiring all lenders to be completely transitioned away from the old index by June of 2023.

The problem is that most ARMs originated on the old index won’t be due to adjust until after that date. 

Fortunately, the industry has been watching this change in the ARM index coming for some time. As a result, many lenders have already stopped originating loans that adjust based on LIBOR. In addition, many servicers switched to software that could easily support the shift to the new benchmark. All in all, the shift to SOFR has been rolling out relatively smoothly.

Even so, any existing loan contract that still includes LIBOR must be altered ahead of the June 2023 deadline.

The Power of the Right Servicing Software

To accommodate wholesale changes in the types of loans closed and adjust to government regulations by their deadlines, servicers need comprehensive mortgage servicing software. Software vendors modified their systems in the first quarter of 2021 to enable a smooth transition to SOFR with minimal disruption.

As part of that work, software developers updated their platform to meet the following essential requirements:

  • Seamlessly integrate the new rate codes for the various SOFR products
  • Utilize an adjustment spread if necessary
  • Easily modify legacy loans to SOFR specifications
  • Ensure that interest rate adjustments can be determined using either LIBOR or the new SOFR index
  • Modify third-party reporting with the new SOFR products

By including these capabilities in their platforms, servicing software providers gave servicers options for how to handle legacy loans that were closed under LIBOR. For some servicers, that decision is still under consideration.

Regulators expect that LIBOR rates will not be published after June 30, 2023. The hope is that most existing contracts will mature or refinance by then, but the term on most commercial adjustable-rate mortgages is much longer than that on consumer loans. That’s going to have an impact on servicers with large portfolios of commercial ARMs written to the old index.

Because adaptive servicing software is so important, lenders should work with their mortgage software partners as they navigate the transition from LIBOR. Lenders may also need to discuss existing contracts with counsel to determine the institution’s risk exposure when LIBOR is finally retired. 

Change can be challenging, but it’s a fact of life in the real estate finance business. How servicers respond to required changes will determine how successful they will be.

Sherri Carr is vice president of commercial servicer product development for FICS (Financial Industry Computer Systems, Inc.), a mortgage software company that provides in-house mortgage loan origination, residential mortgage servicing and commercial mortgage servicing software to mortgage lenders, banks, and credit unions.

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