The LIBOR to SOFR Transition

Mortgage Concepts is a recurring video series covering best practices and compliance education for California mortgage loan originators (MLOs). This video breaks down the LIBOR scandal and why lenders have transitioned to SOFR. For course credit toward renewing your NMLS license, visit

What was the LIBOR?

The London Interbank Offered Rate (LIBOR) was a frequently used benchmark interest rate common in the mortgage market prior to the Millennium Boom.

The LIBOR was set by the British Bankers’ Association (the BBA) to estimate the cost of borrowing between banks, an essential practice for banks to maintain liquidity to lend funds to consumers.

The LIBOR was used as an international benchmark for pricing a myriad of financial products and services. A separate calculation was made for each currency, with the U.S. dollar-denominated LIBOR being the most widely used.

How did the LIBOR work?

Large institutional lenders would estimate how much they would charge one another on the following day for interbank loans. They then submitted these estimated best guesses, based on current market volatility, to Thomson Reuters, an independent third party, who calculated the average and published the rate daily.

Since it was an estimate based on the previous day’s market behavior, the actual rate at which banks charge one another for short term loans varied. In this way, the LIBOR acted as a guide – updated daily – but not a rule for interbank loans.

The LIBOR was frequently used as a starting point to price other financial products and services: think “LIBOR plus X percent.”

The mortgage market was primarily concerned with the LIBOR-indexed adjustable rate mortgage (ARM).

Related article:

Mortgage Concepts: Types of ARMs

Why was the LIBOR so popular?

It was believed that since banks relied on one another for the liquidity crucial to their businesses, no individual bank would cook their estimates.

Further, since the LIBOR was an average of many banks’ estimates, any discrepancies from one estimate to the other would be worked out in the average.

However, in 2008, scrutiny of the LIBOR was triggered when market perceptions of financial risk began soaring, sending interest rates through the roof. But despite this, the LIBOR remained static.

ARMs were held down not just to keep investors confident, but also to remain enticing to borrowers, including homebuyers.

Even when it was abundantly clear the real estate market was inflating into an unprecedented bubble, the lure of easily attainable financing at low ARM rates kept the buyers coming in.

And what happened to those buyers who jumped in due to the rate manipulation? For many, job loss, default, foreclosure and bankruptcy.

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Why is the LIBOR rising?

After news of the scandal broke, the main financial regulator in the UK initiated a sweeping review of the LIBOR process.

The review determined that among the most questionable aspects of the LIBOR was the fact that bankers set the rate themselves, resulting in an ultimately disastrous conflict of interest.

The BBA was removed from the equation and LIBOR was handed over to an independent third party.

What comes after the LIBOR?

The LIBOR began to be phased-out in 2021, being replaced in 2023 by the Secured Overnight Financing Rate (SOFR).

The SOFR is published daily by the Federal Reserve Bank of New York, and is based on completed transactions, specifically on overnight funds collateralized by Treasury Securities.

Thus, the SOFR is more reliable than LIBOR and less susceptible to fraud. As a result, it provides greater protection for consumers and homeowners with ARMs.

Related article:

Guidance for the LIBOR transition

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