What Will Replace LIBOR? SOFR and the LIBOR Act

LIBOR was replaced by the Secured Overnight Financing Rate, known as SOFR, for U.S. dollar contracts. Other major currencies moved to their own overnight benchmarks on the same timetable. If you had a loan tied to LIBOR, the switch happened without any action on your part, either because your contract contained fallback language or because the federal Adjustable Interest Rate (LIBOR) Act stepped in automatically. A small spread adjustment was added on top of the new benchmark so your rate would stay close to what you were paying before.

What SOFR Measures

SOFR tracks the cost of borrowing cash overnight using U.S. Treasury securities as collateral. In the Treasury repurchase market, one party sells Treasuries to another and agrees to buy them back the next day at a slightly higher price. That price difference works out to an overnight interest rate, and SOFR is the volume-weighted median of those actual trades.1Federal Reserve Bank of New York. Transition From LIBOR

Two things set it apart from the benchmark it replaced. Every input is a completed transaction rather than a bank’s estimate of what it might pay to borrow. And the underlying market is large: daily volumes regularly exceed $3 trillion, which makes the rate very difficult for any single institution to influence.2Federal Reserve Bank of New York. Secured Overnight Financing Rate Data Because the collateral is U.S. government debt, SOFR is a near-risk-free rate and does not carry the bank credit risk premium that LIBOR did.

Term SOFR vs. Daily Simple SOFR

If you look at your loan documents, you will probably see one of two versions of SOFR.

Daily Simple SOFR adds up the actual overnight rate published each business day during your billing period. The final interest charge is only known once the period ends, because each day’s rate feeds in one at a time. It reflects real market conditions precisely, but you cannot calculate your exact payment in advance.

Term SOFR is a forward-looking rate published daily by CME Group in one-month, three-month, six-month, and twelve-month tenors. It gives both sides a single rate at the start of the interest period, which mirrors how LIBOR worked. More than 2,870 firms globally now use it, and for most consumer and commercial loans, Term SOFR is what shows up in the contract.3CME Group. CME Term SOFR Rates

What Happened to Existing LIBOR Loans

Many older contracts had no workable fallback language. Some contained fallback provisions that pointed to another LIBOR-based rate, which solved nothing once LIBOR itself disappeared. Congress addressed this with the Adjustable Interest Rate (LIBOR) Act, codified at 12 U.S.C. Chapter 55.

The law applies to contracts that either contain no fallback provisions or whose fallback provisions fail to identify a specific replacement benchmark or someone authorized to pick one.4Office of the Law Revision Counsel. 12 USC 5803 – LIBOR Contracts For those contracts, the statute automatically substitutes a SOFR-based benchmark selected by the Federal Reserve Board.5Federal Reserve Board. Federal Reserve Board Adopts Final Rule That Implements Adjustable Interest Rate (LIBOR) Act Fallback provisions that would have required polling banks about interbank lending rates, or that pointed to another LIBOR-based rate, are voided and replaced by the Board-selected benchmark.

The Act also contains a safe harbor shielding lenders and servicers from breach-of-contract claims for implementing the Board-selected replacement.6Office of the Law Revision Counsel. 12 USC 5804 – Continuity of Contract and Safe Harbor That protection has limits. It does not excuse servicing errors, so if your payment is miscalculated or the wrong rate is applied to your account, your existing rights to demand a correction still apply.

The Spread Adjustment

Because SOFR is a near-risk-free rate and LIBOR included a credit risk component, a straight swap would have lowered the rate on every affected contract. To preserve the economics the parties originally agreed to, the Act requires a fixed spread adjustment on top of SOFR, keyed to the tenor of the LIBOR rate being replaced:7eCFR. Part 253 – Regulations Implementing the Adjustable Interest Rate (LIBOR) Act (Regulation ZZ)

  • Overnight: 0.00644 percent
  • One-month: 0.11448 percent (about 11.4 basis points)
  • Three-month: 0.26161 percent (about 26.2 basis points)
  • Six-month: 0.42826 percent (about 42.8 basis points)
  • Twelve-month: 0.71513 percent (about 71.5 basis points)

Consumer loans got a softer landing. Rather than jumping to the full statutory spread on day one, the regulation phased it in over twelve months. The spread started at the actual difference between LIBOR and the new SOFR-based rate on the day before the switchover, then moved gradually toward the statutory figure.8Federal Register. Regulations Implementing the Adjustable Interest Rate (LIBOR) Act That cushioned the impact for borrowers whose payments would otherwise have shifted noticeably on a single date.

How This Shows Up on Common Loans

Adjustable-rate mortgages are the most visible example. After the initial fixed-rate period, the loan resets periodically to a benchmark plus a margin. Mortgages that referenced LIBOR now reference a version of SOFR, and no refinance or borrower action was required.

Private student loans with variable rates transitioned the same way. Servicers handled the mechanics on the back end, and borrowers did not have to do anything to keep their loans in good standing.9Federal Reserve Bank of New York. LIBOR-Based Private Student Loan Transition Resource Guide

Credit cards and personal lines of credit with variable rates also moved to the new benchmarks. Because SOFR does not carry a bank credit risk component, lenders typically adjusted the margin so the total interest rate stayed roughly the same.

Commercial loans and corporate credit facilities make up the largest dollar volume of affected contracts. Parties in that space generally had the bargaining power to negotiate which SOFR variant and which spread adjustment ended up in their amendments.

The Notice You Should Have Received

Federal law requires your lender to notify you before changing the benchmark on your loan, with timelines that depend on the product.

For adjustable-rate mortgages, the first rate adjustment after the initial fixed period requires disclosures at least 210 days (but no more than 240 days) before the first adjusted payment is due. Later adjustments require notice between 60 and 120 days before the new payment takes effect. Switching from LIBOR to a comparable replacement like the Board-selected SOFR benchmark does not count as adding a new variable-rate feature, so the switch alone does not trigger a fresh round of initial disclosures.10Consumer Financial Protection Bureau. Disclosure Requirements Regarding Post-Consummation Events

Home equity lines of credit require at least 15 days’ advance notice before an index or margin change takes effect. Credit card accounts require at least 45 days’ notice. Both notices must disclose the replacement index and any adjusted margin, even if the margin went down.11Federal Register. Facilitating the LIBOR Transition (Regulation Z) If the exact replacement rate had not yet been published when notice went out, lenders were allowed to send a clearly labeled estimate indicating the rate would be substantially similar to what the borrower was already paying.

What Replaced LIBOR in Other Currencies

LIBOR existed in multiple currency versions, and each major economy adopted its own overnight replacement. If your contract is in a currency other than U.S. dollars, SOFR does not apply to it.

All five share SOFR’s core design: overnight rates built from actual transactions rather than bank estimates, with the credit risk premium LIBOR carried stripped out. Cross-border lenders typically add a spread on top of the relevant benchmark to account for credit risk, much as they did before.