What is a Cost of Funds Index?

The Cost of Funds (COFI) Index is one of the indices that lenders and banks use to calculate interest rates when the rate changes over time. When a bank uses this index for bank accounts, the bank typically calculates the interest it pays account holders on accounts such as savings accounts. When a mortgage lender uses the COFI index, the lender uses the index as the basis for the interest rate that the borrower will pay on an adjustable rate mortgage each time the rate adjusts.

The COFI index is derived from the interest expenses that banks, financial institutions and mortgage lenders report. There are specific banks and lenders that report the interest each institution pays, including those in the states of Nevada, Arizona and California. In addition, the savings institutions that are members of the Federal Home Loan Bank of San Francisco also report interest expenses to calculate the Cost of Funds Index on a monthly basis.

The movement of the index is caused by a number of different factors. Some of the factors that are included in the calculation of the Cost of Funds Index include market interest rates, the sources that the reporting members have for obtaining money, mergers and acquisitions, and the accounting rules for the institutions. Typically, this index stays in line with other indices such as the prime, LIBOR or U.S. Treasury Bill.

Since the Cost of Funds Index is the foundation or basis of the interest rate set by these various institutions, a margin is added to the index to determine the rate. For example, if the COFI is 2.75 percent and the margin is 2.5 percent, then the interest rate that the bank pays on a savings account or charges on a loan is 5.25 percent. When an account is established where interest is paid or earned, the way the interest rate is calculated is an important factor.

The index is especially important when establishing variable rate loans. Most account holders can determine their rate by using the Cost of Funds Index, and adding the margin that the lender tacks on.