Remember Libor? For decades, the London interbank offered rate was the benchmark for pricing a wide variety of loans, including adjustable-rate mortgages. But over recent years, it’s been completely replaced by SOFR, the Secured Overnight Financing Rate.

Enough with the acronyms. Why does it matter for you? One big reason is that if you’re shopping for an adjustable-rate mortgage, it’s important to understand the basics of how SOFR works as some ARMs are tied to this benchmark. When such an ARM reaches its adjustment period, the Secured Overnight Financing Rate plays a big role in determining whether your loan’s interest rate gets cheaper—or more expensive.

SOFR is one of those highly technical financial concepts that is worth understanding, and we’ll break down the details for you below. Today it’s a benchmark used for pricing countless financial products, including variable-rate loans and lines of credit.

Priyank Gandhi, an associate professor of finance at Rutgers Business School, explains that there are three basic reasons why the average consumer should pay attention to SOFR.

“SOFR may determine how much it costs you to borrow money from a bank,” Gandhi says. “It can influence how much banks pay on deposits or money invested with them; and it can be an early indicator of the health of the banking sector.”

What is SOFR? How does it work?

Financial market participants use SOFR to guide them in setting interest rates for certain types of loans. It is based on the overnight cost of borrowing via repurchase agreements for U.S. Treasuries. The Federal Reserve Bank of New York publishes SOFR rates on its website at approximately 8 a.m. Eastern Time each business day.

If you hold a fixed-rate mortgage, SOFR likely won’t impact you. This is because the interest rate on your mortgage remains unchanged for its entire term. However, as mentioned above, SOFR is relevant if you have an adjustable-rate mortgage.

An ARM has two distinct phases. For the initial period—typically five or seven years—the interest rate is fixed and remains constant. After this phase ends, the loan transitions into its adjustable period. This phase, which may span over 20 years depending on the loan’s term, allows the interest rate to fluctuate, typically once per year.

The direction of these adjustments depends on the economic index to which the loan is tied. If your ARM is linked to SOFR, the interest rate during the adjustable phase will increase or decrease based on SOFR’s movement.

What does SOFR stand for?

All the components outlined above feed into the name: Secured Overnight Financing Rate.

Secured: Treasuries secure the repo agreements, similar to how your home secures a mortgage.
Overnight financing: SOFR depends on overnight transactions from several Treasury repo markets.
Rate: The difference between the purchase and resale price of the Treasury determines the rate.

SOFR is a broad measure because it depends on a large volume of transactions between thousands of institutions. For example, the daily repo volume exceeded $2 trillion dollars every day in October 2024.

How SOFR is calculated?

You can review SOFR’s formula and calculations on the FRBNY’s website, which also has an example of rate calculations. But in—relatively—simple terms, SOFR is calculated based on the volume-weighted median rate for transactions from three different U.S. Treasury repo markets. And it’s published the morning after the overnight agreements are negotiated.

SOFR and mortgage rates

“Banks are of course in the business of lending this money to their customers,” notes Gandhi. “So, the SOFR influences the interest rate banks will charge consumers, businesses, and governments to lend money. To use some made up numbers, if today the SOFR is 5%, the average bank has to pay an interest rate of 5% to raise money today. If that bank lends out this money—say for a mortgage—they will take that 5% cost, add on a profit margin—say 2%—and lend you money for a mortgage at 7%.”

A range of factors affect the interest rate you get for a mortgage: the size of your down payment, the loan-to-value ratio, the choice of lender, your credit score, and more. SOFR won’t be one of those factors if you get a fixed-rate mortgage, unlike with an ARM.

There are two parts to the interest rate on your ARM: an index rate, also called a benchmark rate, plus a margin. After an initial fixed-rate period, the ARM’s interest rate changes based on fluctuations in the benchmark rate, typically SOFR, although some lenders use the prime rate. Those that reference SOFR tend to look at a 30-day or 60-day average rate as their benchmark, rather than the daily rate.

How often your ARM’s rate adjusts depends on your loan terms. With a 5/1 ARM, your rate is fixed for five years and then changes annually. With a 7/6 ARM, your rate is fixed for seven years and then changes every six months

SOFR and HELOC rates

SOFR is used as a benchmark rate for other types of variable-rate loans, like private student loans, reverse mortgages, and home equity lines of credit (HELOCs). Credit cards have variable rates, too, but they generally reference the prime rate.

If you take out a HELOC, the loan’s variable rate might be based on SOFR. The interest rates on some home equity lines are updated monthly, and lenders apply the new rates to both our current balance and new draws. When SOFR rises, you’ll accrue more interest and your monthly payment could increase.

SOFR as a measure of economic health

In a hypothetical scenario where a large majority of banks are struggling for some reason, one bank would likely only lend to another at a very high rate, Gandhi explains.

“As a bank, it knows when other banks are in trouble,” he says.

If all banks follow this practice, the average SOFR then goes up in this scenario.

“So, an increase in SOFR can sometimes—not always—indicate that banks are finding it hard to borrow money from other banks and it could indicate trouble ahead for banks and the economy,” Gandhi says.

A brief history of SOFR

The New York Fed and the Federal Reserve Board of Governors selected SOFR as the replacement for Libor in 2017.

Libor had been a widely used benchmark rate for decades, but it depended on banks’ own self reporting of the estimated interest rate that they would charge other banks for overnight loans—making it ripe for manipulation. It was phased out for several reasons, including a major scandal.

In 2012, investigators discovered that bankers had for years been setting Libor for their own benefit by reporting incorrect rates. In 2017, the regulator that oversaw Libor also announced that it wouldn’t require banks to submit their estimated rates after 2021.

The Fed evaluated several Libor alternatives, but it ultimately chose SOFR for several reasons:

Its rates are generated by observing real transactions rather than estimates.
The New York Fed can calculate and report SOFR independently.
It relies on a large market that involves a very high volume of transactions.
Experts believe it would remain dependable across a wide range of market conditions.

In the U.S., regulators urged financial institutions to stop basing rates for new loans on Libor starting in 2022. The transition was completed by June 2023. Outside the U.S., similar transitions happened to other benchmarks, such as the Tokyo Overnight Average Rate (TONA) in Japan and the Sterling Overnight Index Average (SONIA) in the U.K.

Frequently asked questions about SOFR

How often does SOFR change?

The New York Fed publishes the new SOFR every business day. The new rates are posted in the morning and include the latest overnight rate along with the 30-, 90-, and 180-day average rates. The SOFR Index also gets updated, which shows the cumulative effect of compound interest on the average SOFR since April 2, 2018—when the FRBNY first reported the SOFR.

Does SOFR impact my fixed-rate mortgage?

No, SOFR does not impact fixed-rate mortgages or other types of fixed-rate loans. The rate you receive when you first get your mortgage will be your rate for the life of the loan. Other factors that may affect that rate could include your credit score, down payment, loan-to-value ratio, the lender, current market rates, and the type of loan.

What does SOFR mean for my ARM with a Libor rate?

If you had an ARM tied to Libor, the lender likely transitioned your index rate to a different rate during or before June 2023. You might not have noticed the change because lenders added a spread adjustment to the SOFR rate to calculate a new rate that was equivalent to Libor at that time. Then, going forward, your ARM’s rate would move up or down based on changes in the SOFR.

Does SOFR affect credit card or student loan debt?

Most credit cards have a variable interest rate, but they tend to use the prime rate as a benchmark instead of SOFR. It also won’t affect you if you took out federal student loans. However, if you have a variable-rate private student loan, your loan’s interest rate might depend on SOFR.

Is SOFR connected to the federal funds rate or the prime rate?

SOFR is similar to the federal funds rate in that it’s a measure of risk-free overnight lending rates. In this case, the federal funds rate is the rate that banks charge each other to borrow money overnight. The Federal Reserve can influence and set a target for the Fed rate.

The prime rate is the interest rate that lenders charge to the most creditworthy—or “prime”—borrowers. It’s similar to SOFR because it’s a benchmark for some financial products. However, banks set their prime rates, and they may use the federal funds rate as a starting point and then add a margin.

Louis DeNicola contributed to this article.

Here’s how the Secured Overnight Financing Rate works and why it might matter for your mortgage