Q: For existing adjustable-rate mortgage loans, are there regulatory limitations on selecting the index replacement under Regulation Z?
A: Generally, no. While there may be potential contractual limitations, Regulation Z does not place restrictions on the circumstances under which a creditor may replace the index for existing (i.e., legacy) ARMs.
However, certain Regulation Z origination-related requirements for closed-end loans are triggered if a comparable index is not selected when a creditor changes the index on a closed-end loan. If a creditor chooses an index that is not comparable, that index replacement adds a variable rate feature to the transaction and results in the refinance of the transaction. Comment 20(a)-3.ii.B.
To determine whether a replacement index is comparable for purposes of the LIBOR transition, a creditor must use the historical data or future expectations to look at certain factors, which include, but are not limited to, whether:
The movements (increases and decreases in value) of the two indices over time are comparable;
The replacement index will have a comparable impact on the consumers’ payments (if there is sufficient data for this analysis);
The index levels are comparable (i.e., although indices may increase and decrease at the same rate, is one index always a certain number of basis points higher than another or does it require a spread-adjustment);
The replacement index is publicly available; and
The replacement index is outside the control of the creditor.
These factors are not an exhaustive list. Additionally, the relevant factors to be considered in determining whether a replacement index is comparable to a particular LIBOR index will depend on which replacement index is being considered and the LIBOR index being replaced. For example, a creditor may need to consider whether the replacement index is a backward-looking rate (e.g., historical average of rates) such that timing aspects of the data may need to be adjusted to match up with the particular forward-looking LIBOR term-rate being replaced.
More information on which indices may be comparable to replace tenors of LIBOR are discussed in LIBOR Adjustable-Rate Mortgage FAQ 5.