Secured Overnight Financing Rate (SOFR): A Complete Guide

If you have a loan with an adjustable or variable rate, there are many different indexes the rate changes may be tied to. One of them is the Secured Overnight Financing Rate (SOFR). We’ll go over how SOFR is set and its impact on consumer interest rates.

What Is SOFR?

SOFR represents the cost for lenders to borrow money overnight backed by purchases of U.S. treasuries. The rate is based on trades in securities that have already taken place, so a key feature is that the index is based on a look back rather than a prediction of the future. It’s a volume-weighted average of rates associated with the repurchase of U.S. Treasury securities.

Rather than being subject to a guess at market movements, each treasury transaction is negotiated at the lender level and rolls up into an overall average along with other transactions having taken place that day.

What Is The SOFR Today?

The current SOFR rate as of July 18, the latest available at the time of writing, was 5.34%. Along with the main rate, rates are published based on negotiated treasury prices in various percentiles – 25th, 75th, etc. – so that the rate may be higher or lower depending on what’s being used. Alternatively, lenders may look at an average over time to control for daily volatility.

SOFR Vs. LIBOR

SOFR is the replacement for the London Interbank Offered Rate (LIBOR). Ending on June 30, 2023, LIBOR was considered one of the primary indexes used as a benchmark for various instruments that have adjustable rates. LIBOR was a forward-looking index based on the estimates of 17 banks regarding the cost to borrow money in various currencies overnight.

To set the daily LIBOR rate, the four highest and four lowest estimates were thrown out and the rate was based on the remaining average. In contrast, because it’s based on treasury repurchases (also known as repos), the transactions underlying SOFR have already happened. The advantage of this is it’s based on actual vs. assumed market fluctuations.

SOFR History

SOFR was recommended by the Alternative Reference Rates Committee (ARRC) as the reference rate to replace LIBOR on June 22, 2017. The first trades underlying the interest rate were completed in May 2018 and the rate was referenced beginning July 2018 for indexing. It was finally recommended for implementation as a reference rate on July 29, 2021.

Why the urgency to find a replacement? Because LIBOR wasn’t based in any actual market movements, it was vulnerable to manipulation. Basically, the LIBOR rate was whatever the 17 institutions responsible for setting it said it was, regardless of whether market activity supported that rate. It was found that the rate was indeed being manipulated, necessitating a replacement.

How Does The SOFR Affect You?

Upon effectively replacing LIBOR, SOFR became the new reference rate for many loan contracts that had previously been tied to the London-based index. While that could theoretically impact any rate relying on consistent adjustment, one of the most obvious examples from a consumer perspective is the adjustable-rate mortgage (ARM).

An ARM has a fixed rate for some time near the beginning of the loan – usually 5, 7 or 10 years. At the end of that time, it adjusts up or down based on market rates at specified intervals for the remainder of the loan, subject to caps and floors on movement.

Regardless of the type of loan you’re dealing with, in an adjustable-rate situation, the index value is added to a margin specified in your loan documents to come up with your new rate. No matter how low rates go, they won’t fall below the margin and won’t be higher than any specified lifetime limits that may be included as part of your contract.

FAQs: Secured Overnight Financing Rate

We’ve gone over all the basics, but let’s clarify a few more details you might be wondering about.

How often does the SOFR change?

The SOFR is posted each business day at 8 a.m. ET by the Federal Reserve Bank of New York. Because it deals with movements in the treasury market, it’s going to change any day that market is open.

What is the SOFR forward curve?

Just because the current SOFR rate is based on transactions that have already happened doesn’t mean there isn’t a market in predicting where it’s going to be in the future. There is a forward curve tracking futures contracts based on the rate and market swaps in which parties agree to pay a certain amount to do the transaction in a private contract.

What is the 3-month SOFR?

In addition to the main SOFR index, the New York Fed also publishes averages of the rate over various time periods. One of these is the 3-month SOFR. It’s common for ARMs to be tied to a 30-day average of SOFR. In these cases, the idea is to guard against the short-term ups and downs of everyday trading.

Are there alternatives to SOFR?

There are other rates besides SOFR that can be used. As an example, an alternative in the mortgage space is the 1-year constant maturity treasury. Credit cards might be tied to the prime rate index that’s published by the Wall Street Journal.

The Bottom Line

SOFR is a benchmark interest rate put in place by the Fed’s ARRC as a replacement for the defunct LIBOR index. It’s based on a weighted average of all the treasury repurchases that take place between banks in a given day. Because it’s based on actual negotiated transactions and not predictions, it doesn’t suffer from the same manipulation vulnerabilities of LIBOR.

SOFR is a common index for interest rates, but even in the case where your interest rate is tied to it, it’s far from the only factor impacting your interest rate. Factors like your credit and the amount you put down upfront have a big impact on the interest rate you receive.

Importantly, unlike SOFR, these are in your control. Download the Rocket Money℠ app to get a handle on your personal finances.