As LIBOR phases out, should lenders still originate ARMs?

The uncertain replacement once LIBOR ends in five years

With the looming end to the London Interbank Offered Rate coming up as U.K. authorities phase it out over the next five years, it creates a lot of uncertainty around the future of adjustable rate mortgages.

According to an article in The Wall Street Journal by Christina Rexrode, ARMs, where the interest rate rises and falls with broader indexes, will be hit the hardest once LIBOR, goes away since they are closely tied.  

Currently, ARMs aren’t as prevalent in the mortgage market since rates are favorably low, but they still account for roughly $1.33 trillion of mortgages outstanding, the article stated.

From the WSJ:

“In a fairly short amount of time, no one is going to know how to compute what the next payment is going to be” for this kind of mortgage, said Lou Barnes, a capital markets analyst with Premier Mortgage Group in Boulder, Colo. ”And that’s why it’s important.”

“One issue is, should we be changing our product line now?” said Kirstin Hammond, who runs capital markets for United Wholesale Mortgage, one of the 20 largest mortgage lenders in the U.S. “Does it make sense to offer a [seven-year] ARM tied to Libor when Libor is not going to be around in seven years?”

Lenders have a vague blueprint for what to do when Libor disappears. Most ARM contracts specify that if the underlying index is no longer available, the lender or investor will pick a new “comparable” index.

The article added that both industry officials and investors would like Fannie Mae and Freddie Mac to mandate a replacement to minimize the impact of the change.  

For added perspective, according to the most recent mortgage application report from the Mortgage Bankers Association, the adjustable-rate mortgage share of activity sat at 6.4% of total applications.

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