Cost of funds index (COFI)

What is the cost of funds index?

The cost of funds index, or COFI, is the weighted average of interest rates that banks pay on savings accounts held by their customers and money borrowed from other institutions. In turn, this rate is used to calculate how much interest these banks charge on loans, like adjustable-rate mortgages (ARMs).

Deeper definition

When someone takes out a mortgage or a loan with her bank, the interest rate she pays is in part determined by the index rate the bank uses. The three most common index rates are derived from one-year constant-maturity U.S. Treasury securities, the London Interbank Offered Rate (Libor), and the cost of funds index.

Think of the cost of funds as the cost of doing business, except the business is holding and lending out money, and banks need to make money for the expense of holding funds and paying interest on them. They may use the COFI to determine what they should charge in interest to make up for the interest they pay out, adding a few percentage points on top that are called a margin. Although the COFI has increasingly fallen out of style, it is frequently used to determine the cost of variable-rate loans, such as ARMs. Since March 2014, the COFI rate has hovered around 0.6 to 0.7 percent.

The COFI is calculated both regionally and federally. However, COFI almost always refers to the 11th District Cost of Funds Index, comprising interest rates reported by members of the Federal Home Loan Bank of San Francisco, which also publishes the index. The federal COFI is calculated and published by Freddie Mac.

In both cases, the indexes are published toward the end of the month, and can’t be adjusted again until the next release. That means interest rates pegged to the cost of funds index lag behind rates tide to other indexes, sometimes by several months. However, as with other indexes, if the COFI rate moves up, borrowers will most likely pay more interest, and they’ll pay less interest if the rate goes down.

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Cost of funds index example

In January 2010, at the height of the Great Recession, many people suddenly saw a huge jump in their interest rates. That was because there was an unusual leap in COFI rates that occurred at the end of that previous December: The FHL Bank of San Francisco had published a COFI rate of 2.094 percent, almost a full percentage point higher than the previous month.

A spokesperson for the bank told The Wall Street Journal that the increase was due to Wells Fargo’s acquisition of Wachovia, which subtracted Wachovia’s low borrowing rates from the COFI equation because Wells Fargo was not a member. As a result of the COFI rate increase, borrowers were left spending dozens more each month in interest payments on their variable-rate mortgages. However, the increase ended up being a temporary spike, as the COFI rate has only steadily decreased since then.

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