Secured Overnight Financing Rate (SOFR), defined and explained

Ready to apply for a mortgage? Then you need to decide what type of interest rate you want attached to your loan. If you choose a mortgage that comes with adjustable interest rates – ones that can rise or fall during the life of your loan – you’ll need to know about the Secured Overnight Financing Rate, better known by its acronym of SOFR.

Why is this important? Once your adjustable-rate mortgage enters its adjustable period, SOFR helps determine whether your loan’s interest rate will rise or fall during its scheduled adjustments and by how much.

Here is a closer look at how SOFR works and how its fluctuations could change the amount you pay each month for your adjustable-rate mortgage.

What is SOFR? 

SOFR is the interest rate set by the U.S. Treasury that determines how much it costs for banks to borrow overnight through Treasury repurchase agreements, known as repos in the finance world.

That might sound like something only finance professionals and traders need to know. But SOFR is important to homeowners with adjustable-rate mortgages, or ARMs. That's because the interest-rate fluctuations of ARMs are often tied to SOFR. If the rate rises and your ARM's interest rate is ready to adjust, the interest rate on your mortgage might increase, too.

SOFR wasn't always this important for borrowers with ARMs. There was a time when the interest rates of most ARMs were instead tied to another benchmark rate, the London Interbank Offered Rate, better known as LIBOR.

The Alternative Reference Rates Committee of the Federal Reserve Bank of New York, though, recommended that lenders stop using LIBOR as guidance for loan interest rates as of Dec. 31, 2021. June 30 of last year marked the end of all LIBOR use by banks and other lenders. Today, SOFR is the dominant U.S. dollar interest-rate benchmark, according to the Federal Reserve Bank of New York.

How does the SOFR work?

SOFR is based on the overnight cost of borrowing through the repurchase of U.S. Treasuries. The Federal Reserve Bank of New York then publishes the daily SOFR on its website at or near 8 a.m. Eastern time each business day.

If you have a fixed-rate mortgage, SOFR may not affect you. That’s because your mortgage's interest rate is locked in place throughout the life of your mortgage.

But, as stated above, if you’re repaying an adjustable-rate mortgage, SOFR probably matters.

An adjustable-rate mortgage comes in two phases. During the first several years, often 5 or 7, your interest rate will remain locked. It can't rise or fall during this time. But after that period ends, your ARM enters its adjustable phase. During this phase, which can last more than 20 years depending on your loan's term, your interest rate can rise or fall, often once a year.

Whether it rises or falls depends upon what economic index it is tied to. If your ARM is tied to SOFR, its interest rate during your loan's adjustable period will rise or fall according to where SOFR stands.

Here's how Rocket Mortgage® handles ARMs tied to SOFR: Rocket uses a 30-day rolling average of SOFR that is published by the Bank of New York to reset ARM interest rates. Rocket Mortgage resets the 30-day rolling average to the nearest 0.125%.

Say SOFR's 30-day rolling rate is 4.975% on the day on which your ARM's interest rate is scheduled to adjust. Rocket Mortgage will round up your SOFR average to 5%. If you had a 2% margin in your loan contract, your new interest rate would be 7%. Your new rate, though, will never rise higher than whatever cap is listed in your loan agreement.

History of the secured overnight financing rate

Why did the Federal Reserve make the switch from LIBOR to SOFR?

According to the Federal Reserve Board, the London Interbank Offered Rate was not based on actual market activity. Traders, then, determined a way to fix the price of LIBOR. This indirectly hurt consumers whose loans or credit cards had interest rates tied to the ups and downs of an easily manipulated LIBOR.

SOFR’s replacement of LIBOR

The Alternative Reference Rates Committee of the Federal Reserve and Federal Reserve Bank of New York in 2017 unanimously selected SOFR as its recommended alternative to LIBOR. In 2021, U.S. banking regulators stated that financial entities should stop the new use of LIBOR as of Dec. 31, 2021. And on June 30, 2023, all banks and financial institutions formally stopped using LIBOR. SOFR is now the main U.S. dollar interest-rate benchmark.

SOFR today

The Alternative Reference Rates Committee says that SOFR is a more reliable benchmark than LIBOR largely because more than $1 trillion in daily transaction volumes underly this rate. As the committee says, the volumes underlying SOFR are far larger than the number of transactions in any other U.S. money market.

This sheer volume of transaction activity protects SOFR from manipulation by traders. Because of this, it's likely that the rates committee will continue recommending that financial institutions rely on SOFR when setting their own interest rates on products such as adjustable-rate mortgages.

The bottom line

While it’s not necessary for homeowners to understand the intricacies of SOFR, knowing the basics of how this financing rate works can better help you prepare for the interest rate changes that usually come when adjustable-rate mortgages enter their adjustment period. If you’re debating between a fixed-rate or adjustable-rate mortgage, you can apply for a mortgage with Rocket Mortgage today. Our loan experts can help you find the mortgage loan that’s best for you.