Understanding the Cost of Funds Index (COFI) for ARMs

The Cost of Funds Index (COFI) is a financial indicator used by lenders to determine the interest rates on adjustable-rate mortgages (ARMs) and other variable-rate loans. Specifically, it reflects the average interest expense financial institutions pay for the funds they use in their lending and other business operations. This index is particularly associated with banks and other savings institutions in the Western United States. It is one of several indexes used to adjust interest rates on floating-rate loans.

Key Takeaways

How COFI Works

1. Calculation: The COFI is calculated based on the actual interest expenses reported by a specific group of financial institutions, such as the members of the Federal Home Loan Bank (FHLB) system. It considers the interest these institutions pay on sources of funds like savings accounts, checking accounts, other deposits, and borrowings.
2. Usage in ARMs: For adjustable-rate mortgages tied to the COFI, the loan's interest rate adjusts periodically based on changes in the COFI rate. If the COFI goes up, the interest rate on the loan may increase within the limits set by the loan terms. Conversely, if the COFI goes down, the loan's interest rate may decrease.
3. Advantages for Borrowers: The COFI is often considered a more stable index than others, like the London Interbank Offered Rate (LIBOR) or the Treasury Index, because it is less sensitive to short-term market fluctuations. This can result in more gradual changes in adjustable loan rates, providing borrowers with a degree of predictability and stability.

Considerations

• Regional Focus: The COFI is primarily relevant in the Western U.S. and may not be applicable or available for borrowers in other regions.
• Comparison with Other Indexes: Borrowers should compare ARMs based on the COFI with those tied to other indexes to determine which offers the most favorable terms based on their financial situation and risk tolerance.
• Loan Terms: As with any ARM, it's essential to understand the loan terms, including the frequency of rate adjustments, caps on how much the rate can change, and the loan's margin over the index rate.

Conclusion

The Cost of Funds Index offers a unique option for adjusting interest rates on variable-rate loans. It provides benefits and considerations that borrowers and lenders must carefully evaluate.

FAQs

1. How frequently does the COFI rate change, and how does this impact my ARM?

The COFI rate is updated monthly, but the impact on your ARM depends on the terms of your loan, including the adjustment frequency and caps on rate changes. Your loan agreement will specify how often your rate can adjust and how changes in the COFI influence your interest rate.

2. What happens if the COFI significantly increases or decreases?

Significant changes in the COFI will affect the interest rate of loans tied to it, within the limits set by the loan's terms. Loans typically have rate caps that limit the degree of change to protect both the borrower and lender from drastic fluctuations.

3. Can I choose the index my ARM is tied to when I take out a loan?

Generally, the lender determines the index to which an ARM is tied based on their loan products. However, borrowers can shop around and compare different loan options from various lenders to find an ARM based on an index that suits their preferences and financial outlook.