LIBOR CFPB FAQ ARMs 10 – What index should be identified in the ARM interest rate adjustment notices if the interest rate is scheduled to change while the creditor is transitioning the account to a replacement index for existing loans?

Compliance > Regulation Z - TILA > LIBOR Transition
Q:  What index should be identified in the ARM interest rate adjustment notices if the interest rate is scheduled to change while the creditor is transitioning the account to a replacement index for existing loans?
 
A:   Regulation Z, 12 CFR §§ 1026.20(c)(2) and (d)(2) require that ARM interest rate adjustment notices disclose the index used in making interest rate adjustments and explain how payments are determined. The disclosures must reflect the legal obligations of the consumer and creditor when the notices are provided. Comment 17(c)(1)-1.
 
In some cases, the contract has a scheduled interest rate adjustment that will occur while the creditor is transitioning the account from LIBOR. In these cases, disclosures must reflect the legal obligations of the consumer and creditor when the disclosures are provided. 12 CFR § 1026.17(c)(1); Comment 17(c)(1)-1. Specifically, the interest rate adjustment notices may need to identify LIBOR, not the replacement index, as the index applicable to the account at the time the notices are provided, even if the payment adjustment (based on LIBOR) will occur after the account has subsequently transitioned from LIBOR. The replacement index will not be identified until the next scheduled adjustment when that Subsequent Interest Rate Adjustment Notice is sent.
 
For example, assume a consumer’s ARM contract currently states that the next annual interest rate adjustment will be based on a LIBOR index and that this contract term is legally binding under state law. The contract states the rate will adjust on May 15, 2023, and the first payment at the adjusted level is due on October 1, 2023. Assume also that the creditor is working to complete the steps in each of its mortgage contracts to transition all of its mortgage accounts away from LIBOR indices, and for this account, completes those steps, including selecting the replacement index, on June 1, 2023. Under these facts, on the rate adjustment date (May 15, 2023), for this particular consumer’s account, the creditor has not yet taken those contractual steps to change the index. Thus, when the servicer sends the Subsequent Interest Rate Adjustment Notice on June 15, 2023, it must reference LIBOR, even though after the rate adjustment date, but before the notice was sent, the account was transitioned from LIBOR. This is because the index used to adjust the interest rate for the calculation of the new payment amount due on October 1 was the LIBOR index, not the replacement index. The replacement index will apply to the next scheduled adjustment for the account, which will be on May 15, 2024. The Subsequent Interest Rate Adjustment Notice sent on June 15, 2024, will be based on, and disclose, the replacement index, and will determine the payment due on October 1, 2024.
 
Similar requirements apply if the contract has the initial scheduled interest rate adjustment that will occur while the creditor is transitioning the account from LIBOR. In those cases, remember that for the Initial Interest Rate Adjustment Notice, because the notice is typically sent before the interest rate for the new payment at the adjusted level has been calculated, the new interest rate (and the new payment calculated from the new interest rate) are not known as of the date of the notice, and the notice should include estimated amounts that are labeled as estimates. 12 CFR § 1026.20(d)(2).
 
For example, assume the same facts above, but assume this is the first interest rate adjustment under the ARM contract. If the interest rate will adjust on May 15, 2023, and the new payment will be due on October 1, 2023, the creditor must provide the Initial Interest Rate Adjustment Notice before the interest rate adjustment occurs. Assume the creditor provides this notice on February 15, 2023. Because the index used to adjust the interest rate for the calculation of the new payment amount on October 1 will be the LIBOR index when the rate is adjusted on May 15, Regulation Z requires that the interest rate adjustment notice disclosure reference the LIBOR-based index. This is true even though the transition to the replacement index will occur on June 1, before the new payment amount is due on October 1. Additionally, because the notice is sent on February 15, before the interest rate is set on May 15, the creditor must disclose that the interest rate and payments based on LIBOR are estimates. The replacement index will apply to the next scheduled adjustment for the account, which will be on May 15, 2024. The Subsequent Interest Rate Adjustment Notice on June 15, 2024, will be based on the replacement index, and will determine the payment due on October 1, 2024.
 
But assume instead the creditor will complete the steps to transition to the replacement index on April 15, 2023, instead of June 1, 2023, before the interest rate is scheduled to adjust (May 15, 2023). In that case, the Initial Interest Rate Adjustment Notice sent on February 15, 2023, will still reference the LIBOR-based index because that is the index applicable to the account at the time the disclosure is provided. However, because the notice is provided before the rate adjustment occurs, the creditor will label the interest rate and payment amount as estimates. On May 15, 2023, the interest rate will adjust based on the replacement index, not LIBOR, because the transition occurred on April 15, 2023, and the replacement index is the index for the account at the time of the rate adjustment. The new payment on October 1, 2023, will be based on the replacement index interest rate.
 
For more information on the ARM interest rate adjustment notices, see Section 6 of the Mortgage Servicing Small Entity Compliance Guide.
 
 
This Q&A was created based on information from the Consumer Financial Protection Bureau’s website (which may be updated from time to time) that provides Answers to Frequently Asked Questions on the Transition Away from LIBOR.  This information may be found here:  https://files.consumerfinance.gov/f/documents/cfpb_libor-transition_faqs.pdf
 

Add Feedback