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Cost of funds index questions
Is a COFI loan misunderstood? What are the good things about a COFI
loan? What are the bad things?
COFI stands for cost of funds index. COFI is one of the indexes
used in pricing adjustable-rate mortgages (ARMs). Most adjustable-rate
mortgages that are priced based on a COFI use the cost of funds
for the 11th district of the Federal Home Loan Banks in San Francisco,
but there are 12 districts in the Federal Home Loan Bank System.
The 11th district describes the COFI in its FAQ
The cost of funds index (COFI) is not an interest
rate. It reflects the average interest paid by savings institutions
for their various sources of funds over a specified period of
time. Deposits in checking and savings accounts -- including certificates
of deposit, money market deposit accounts, transaction accounts,
and passbook accounts -- are the primary source of funds for most
savings institutions. Other sources of funds include loans obtained
through the credit programs of the Federal Home Loan Bank of San
Francisco (known as "advances") and money borrowed from
other financial institutions.
The index tends to follow or lag changes in interest
rates in the financial marketplace. That characteristic makes them
less popular when interest rates are heading lower and more popular
as interest rates head higher. The index also tends to be less volatile
than LIBOR or Treasury bills, making the mortgage rate less volatile.
There is a monthly COFI index that is released on
the last business day of the month following the index month. That
means that the index for April is released on the last business
day of May. There's also a semiannual COFI index that is released
approximately six weeks after the end of the six-month period.
Negative amortization on an adjustable-rate loan means
that any interest expense not covered by the mortgage payment is
added to the loan balance. This typically happens when the mortgage
payment is capped over a period but the interest rate is not. COFI-based
ARMs often have a payment cap but not a periodic rate cap.
Along those lines, borrowers can choose between making
a fully indexed payment or a minimum payment. Any resulting negative
amortization is deferred interest. The deferred interest option
can help when it comes to budgeting or tax planning by shifting
expenses into another tax year. Consult your tax adviser to confirm
the tax deductibility of the mortgage interest expense.
As they would with any adjustable-rate mortgage, the
borrower needs to understand how the interest rate adjusts, how
that adjustment affects the payment and, in the case of negative
amortization, the loan balance. Interest rate movements can be limited
by periodic or lifetime caps and floors. When you borrow using an
adjustable-rate mortgage, you're taking on interest rate risk. You
need to understand the risks you face before committing to the loan.
You can follow changes in COFI and other interest
rates using Bankrate's
Track Rates feature. Bankrate's
Mortgage Decision Tools can also help you decide if an adjustable-rate
mortgage is right for you.