By 2021, big changes for interest rates could spell trouble for borrowers
By 2021, the most popular and widely-used interest-rate benchmark, the London Interbank Offered Rate (LIBOR), will no longer exist as a benchmark for the $2 trillion in outstanding loans in the United States. Nearly every borrower in the country that is paying off debt that is set based on the LIBOR will be affected by this change.
To address this issue, regulators, banks and consumer groups are taking part in a massive project to help lenders and consumers shift to a new, more stable rate. NCRC is a consumer group participant on the Alternative Reference Rates Committee (ARRC), a Federal Reserve sponsored group of private-sector stakeholders tasked with coordinating the end of LIBOR and the rate alternative. We are committed to ensuring that consumer concerns are voiced and any excessive negative impacts or challenges are rectified in an equitable manner.
The new rate identified in the U.S. that is set to replace LIBOR is the Secured Overnight Financing Rate (SOFR), broadly considered to be more robust and realistic than LIBOR. Since SOFR is based on actual transactions, it is considered to be less susceptible to market manipulation.
When index rates change, it normally impacts relatively few consumers. But LIBOR has been around for over 30 years, and was so widely used as an index that almost every type of loan, line of credit or other financial product relied on it to some extent. This means that moving off of LIBOR will impact far more people and in ways that we are not likely to fully understand until it happens. What does this change in interest rate mean to you? If you own a home, business or have student and/or car loans, you will likely be affected by this new rate switch. However, fixed rate loans and adjustable loans that are set by another index such as the Prime rate are not affected.
Homeowners and mortgage borrowers with adjustable-rate mortgages, reverse mortgages and home equity lines of credit will likely see changes in the interest rate and, therefore, an impact on the interest paid.
There are 2.8 million homeowners today with a mortgage that is tied to the LIBOR index. These loans encompass over $1 trillion in unpaid balances, most of which is held by bank and private investors that may have a harder time converting to the new SOFR index. Many of those borrowers may not even make payments to the entity that owns the loan, but instead deal with a servicing company that takes their payments in exchange for a fee. This adds another layer of complexity to this transition. As the LIBOR is phased out, every one of these lenders and servicers must communicate with their borrowers and recalculate the rate those borrowers pay.
A reverse mortgage is a complicated financial product that allows homeowners aged 62 and older to take equity from their home in a lump sum or via installments while still living in the home. For many older adults, reverse mortgages provide needed financial support at a time when most older adults see increases in health care costs, require home improvements or accessibility modifications or simply wish to have added income during retirement, all factors that facilitate aging in place. With institutional care costing on average over $40,000 a year, remaining in one’s home as long as feasible can be a distinct savings for many older adults.
A majority of reverse mortgages are indexed to LIBOR. Most of the reverse mortgages that are linked to the LIBOR index are insured by the Federal Housing Administration (FHA), with oversight responsibilities delegated to The Department of Housing and Urban Development (HUD). Older adults, a vulnerable population due to potential health considerations, average age of cognitive decline and their reduced earning capacity, will be highly affected.
Federal student loans use a fixed rate and are unaffected by the LIBOR to SOFR transition. Private student loans are a different story. Like any variable-rate loan, a private student loan would be susceptible to variability in the interest rate. Notably, over half of all private student loans are indexed to the LIBOR. Private loans comprise about 7.6 percent of the $1.5 trillion student loan market. That means that perhaps as many as 3.3 million borrowers could be impacted. In recent years, there has been a significant uptick in older adults carrying student loan debt. According to the Federal Reserve, 2.8 million older adults over the age of 60 carry student loan debt (both public and private). Evidence points to delays in retirement, minimized quality of life and lack of sufficient health care as a result of carrying student loan debt. With impending loan adjustments based on the new interest rate, seniors with private student loans may see increases in their payments.
The number of products that are tied to the LIBOR index are diverse and not always easy to understand. The ARRC committee is feverishly trying to ascertain every kind of product in the market that will be impacted, but if you have a credit card or any type of loan that you are paying off, or if you receive payments on a regular basis that adjust periodically, check and see if the payment is derived from the LIBOR.
What Can We Do?
NCRC is committed to closely following the rate transition. We will provide periodic updates as new information is provided.
Regarding reverse home mortgages, the secretary of HUD has the authority to choose a new index when LIBOR is phased out in 2021, and while SOFR is the likely replacement, to date, there has not been any guidance from HUD on the process of recalculation.
If consumers have concerns around individual types of debt, such as credit cards or certificates of deposits, consumers should review their initial documentation (the “fine print”) to determine whether a rate change is possible. Lenders and the servicing companies that accept payments for a lot of these loan products will be notifying consumers about the possible impact of these changes, but consumers should call their servicer if they have questions.
As members of the ARRC committee, NCRC has asked that a common sense process is established and communicated clearly so consumers who feel they are harmed by this transition can submit complaints.
Jason Richardson is Director of Research and Evaluation and Karen Kali is Program Manager, Special Initiatives at NCRC.
Photo by the Nick Youngson