SOFR (Secured Overnight Financing Rate)
The Secured Overnight Financing Rate (SOFR) is a benchmark interest rate based on overnight loans backed by U.S. Treasury securities, published daily by the Federal Reserve Bank of New York. It replaced LIBOR as the main reference rate for U.S. floating-rate loans, including most commercial real estate bridge and construction loans.
Why SOFR matters
Floating-rate commercial real estate loans are priced as SOFR plus a spread. When SOFR rises, the borrower's interest payments rise with it, which lowers debt service coverage and can strain properties still in transition.
Lenders often require floating-rate borrowers to buy an interest rate cap, which limits how high the effective rate can go. Underwriters test DSCR at the capped rate to see how the loan performs if rates climb.
Most loans reference Term SOFR, a forward-looking rate for one-month or three-month periods, instead of the daily overnight rate, because it lets borrowers know their rate at the start of each interest period.
SOFR vs. LIBOR
LIBOR was based on bank estimates of their own unsecured borrowing costs and was phased out in the United States in 2023. SOFR is based on actual overnight transactions secured by Treasury securities, which makes it harder to manipulate. Because SOFR is a secured rate, it tends to run lower than LIBOR did, so loan spreads were adjusted during the transition.
How Smart Capital Center handles SOFR-based loans
Smart Capital Center's AI agents read the rate terms in each floating-rate loan, including the SOFR index, the spread and any rate cap, and recalculate debt service and DSCR as rates change, flagging loans nearing covenant limits.
Frequently asked questions
How is SOFR used in commercial real estate loans?
Floating-rate loans set the interest rate as SOFR plus a fixed spread, such as SOFR plus 3 percent. The rate resets each period, usually monthly, based on the current SOFR or Term SOFR value. Bridge loans, construction loans and many bank loans use this structure.
What is Term SOFR?
Term SOFR is a forward-looking version of SOFR for set periods, such as one month or three months, derived from futures markets. It lets borrowers and lenders know the interest rate at the start of each period, which makes payments easier to plan than a rate based on daily compounding.
Why do lenders require interest rate caps on SOFR loans?
A rate cap pays the borrower when SOFR rises above a set strike rate, which limits how much debt service can increase. Lenders require caps on floating-rate loans so the property can keep covering its payments if rates climb sharply during the loan term.