What it means
The index covers the 11th District of the Federal Reserve System, a region on the west coast of the country that includes California. It was historically calculated from the weighted average interest rates that savings institutions in that district paid on their funding, including customer deposits and money borrowed from the Federal Home Loan Bank.
Lenders used COFI as the base for adjustable-rate mortgages. The borrower's rate was set as the index plus a fixed margin (the lender's markup) written into the loan agreement, so when the index changed, so did the rate and, in time, the monthly payment.
COFI behaves differently from rates that follow the market day by day. Because it is built from an average of funding costs that were locked in over many months, it rises more slowly when rates go up and falls more slowly when they go down.
Borrowers on COFI loans therefore tended to see smoother, but more delayed, rate changes. The index was particularly associated with payment-option adjustable-rate mortgages, in which a borrower could choose to pay less than the interest due.
The unpaid interest was added to the balance, a feature known as negative amortisation, and this made such loans controversial after the financial crisis. Use of COFI has declined sharply as lenders moved to other benchmarks.
Anyone with an older loan that references it should read the loan documents carefully to see which replacement index applies if the original is no longer published. For non-specialists, COFI is best seen as a case study in how benchmark choice affects borrowers.
A slower-moving index can cushion short-term shocks, but it can also leave a borrower paying more for longer when market rates are falling.
In practice
Real-world examples.
Example
A homeowner in California has an older adjustable-rate mortgage tied to COFI with a margin of 2.75%. The lender sends a notice each year showing the new rate, calculated as the latest index plus 2.75%. He compares the change with the interest rate on a new fixed-rate loan before deciding whether to refinance.
Example
A mortgage analyst at a bank is valuing a portfolio of old adjustable loans. Because COFI moves slowly, she assumes the rates on those loans will lag the market by several months. This changes her forecast of interest income for the next two years.
Example
A financial journalist writes about borrowers who struggled with payment-option loans after house prices fell. She explains that the slow movement of the index delayed the rise in payments but that the unpaid interest had been building up in the meantime. The article advises readers with similar loans to check their statements for growing balances.
Formula
Calculation
Fully indexed rate = Index value + Margin
Suppose a $300,000 adjustable-rate loan has a margin of 2.50% and the index currently stands at 2.00%. Fully indexed rate = 2.00% + 2.50% = 4.50%, so interest for a year is 300,000 x 0.045 = $13,500, or $1,125 a month. If the index later rises to 3.00%, the rate becomes 3.00% + 2.50% = 5.50%, and annual interest is 300,000 x 0.055 = $16,500, or $1,375 a month. The index increase of one percentage point therefore adds $250 a month to the interest cost.Case study
Seen in the real world.
Sandcrest Savings is an illustrative, fictional lender that funded most of its mortgages with customer deposits. Its finance team preferred loans linked to COFI because the index tracked its own funding costs, which kept its interest margin steady when market rates moved.
A rapid rise in short-term market rates showed the benefit. Sandcrest's deposit costs rose slowly, and so did the COFI-linked rates on its loans, so the gap between the two stayed close to 2.5 percentage points.
When rates later fell, however, borrowers on competitors' loans saw their payments drop faster, and some left Sandcrest to refinance. The illustrative lesson is that an index linked to the lender's own funding costs protects the lender's margin but can leave customers feeling slow to benefit.
Watch out
Common mistakes.
- Assuming COFI moves in step with market interest rates, when it lags because it is based on an average of past funding costs.
- Forgetting the margin, which means the borrower's actual rate is always higher than the index alone.
- Ignoring payment-option features on older COFI loans, which could allow the loan balance to grow instead of shrink.
Questions
People also ask.
Is COFI a fixed or a variable rate?
It is an index that changes over time, and a loan tied to it has a variable rate that equals the index plus the lender's margin.
Who published the index?
It was historically published by the Federal Home Loan Bank of San Francisco for the 11th District, although borrowers should check the loan documents for the current arrangement.
What happens if the index is no longer available?
The loan agreement normally names a replacement index, so check the documents or ask the lender which benchmark now applies.
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