Home mortgage giants Fannie Mae and Freddie Mac, as the Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corp. (FHLMC) are commonly called, have announced that they will stop purchasing adjustable-rate mortgages tied to the London Interbank Offered Rate (LIBOR) after 2020. Meanwhile, both Fannie and Freddie indicate that they soon will start accepting mortgages linked to the Secured Overnight Financing Rate (SOFR), which the Federal Reserve has been promoting as a replacement for LIBOR.

Key Takeaways

  • Fannie Mae and Freddie Mac will stop buying LIBOR-linked mortgages.
  • This decision takes effect at the end of 2020.
  • They will soon accept mortgages tied to SOFR, a benchmark from the Fed.
  • Mortgage originators are likely to follow suit.

Significance For Investors

Both Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs) with implicit guarantees from the U.S. federal government. They also have publicly-issued stock that trade under the symbols FNMA and FMCC, respectively. Both entities also served on the committee formed by the Fed to explore alternatives to the LIBOR.

The reputation of LIBOR remains tarnished by a 2012 scandal, in which leading financial institutions manipulated it. LIBOR is based on banks' estimates of what it costs to borrow from each other over short periods of time. SOFR, by contrast, is based on the actual rates charged on overnight repurchase agreements (repos).

The interest rates on an estimated $200 trillion of financial products worldwide, including loans, swaps, and credit cards, among others, are based on LIBOR. Mortgages originated in the U.S. account for approximately $1.2 trillion of that total.

Looking Ahead

Taken together, Fannie Mae and Freddie Mac are the leading secondary market for home mortgages in the U.S. Therefore their decision to shun LIBOR and embrace SOFR is likely to spur a similar shift among loan originators, both banks and non-bank mortgage lenders. Since Fannie and Freddie will cease accepting LIBOR-linked mortgages after 2020, the secondary market value of such loans will likely fall significantly, because these two major buyers will no longer be a source of demand.