SOFR Mortgage 2026: How the LIBOR Replacement Affects Adjustable Rate Loans

SOFR (Secured Overnight Financing Rate) replaced LIBOR as the benchmark index for adjustable-rate mortgages after LIBOR was discontinued. If you are originating ARMs or advising borrowers with existing LIBOR-indexed ARMs that transitioned to SOFR, understanding how SOFR is calculated and how it compares to LIBOR is essential for accurate payment projections.

How SOFR Is Calculated

SOFR is published daily by the Federal Reserve Bank of New York. It represents the overnight cost of borrowing cash collateralized by US Treasury securities. Unlike LIBOR, which was a panel-based rate subject to manipulation, SOFR is transaction-based and reflects actual overnight repo market activity. Mortgage ARM products typically use the 30-day average SOFR or the 1-year SOFR, not the overnight rate directly.

SOFR vs. LIBOR: What Changed for Borrowers

• ✦SOFR is generally lower in volatility than LIBOR was, which reduces ARM payment shock potential
• ✦LIBOR had a credit risk premium built in; SOFR does not, so margins were adjusted upward during transition to compensate
• ✦Existing LIBOR-indexed ARMs transitioned using the ARRC (Alternative Reference Rates Committee) spread adjustment methodology
• ✦ARM margins on new SOFR products typically run 2.5% to 3.0%, higher than the legacy LIBOR margin to account for SOFR being lower on average

Practical Impact at Adjustment

When a SOFR ARM adjusts, the new rate equals the applicable SOFR term rate plus the margin, subject to the cap structure. For a borrower with a 2.75% margin and 30-day average SOFR at 4.50%, the fully indexed rate is 7.25%. If they have a 2/2/5 cap and their initial rate was 6.00%, the first adjustment cap limits them to 8.00%, not 7.25% -- the cap allows adjustment to the lower of the cap limit or the fully indexed rate. Project both scenarios at application so the borrower understands the worst case.