An Overview of COFI Loans

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What is a COFI Loan?

A COFI (pronounced coffee) loan is a type of adjustable-rate mortgage (ARM) where the interest rate is fixed to the Cost of Funds Index. Unlike a fixed-rate mortgage, where the interest rate remains constant for the entire loan term, an ARM has an interest rate that can fluctuate periodically based on changes in the underlying index.

A Cost of Funds Index represents an average of the interest rates paid or charged on certain financial products or services offered by institutions included in the COFI. One of the most commonly used indices for ARMs is the 11th District Cost of Funds Index, which comprises a weighted average of interest rates paid on savings and checking accounts offered by banks in Arizona, California, and Nevada.

Another is the Federal Cost of Funds Index, which is based on an average of interest rates paid on marketable Treasury bills and notes. Both the 11th District and Federal COFIs are calculated monthly.

COFI Loan Rates

COFI loans (and most ARM loans in general) often have an initial fixed-rate period, during which the interest rate remains stable. After this initial period, which can last for a few years, the interest rate will start adjusting at regular periods, usually annually. The interest rate change is based on fluctuations in the COFI index.

COFI interest rates tend to fluctuate slower than other indexes used as ARM benchmarks. This makes them particularly appropriate to use with ARMs that have rate reset frequently, such as once a month, compared to other ARMs that may keep the same interest rates for years.

History of COFI Loans

COFI mortgages used to be fairly common, but they’ve largely disappeared since the collapse of the housing bubble. Prior to that, they were primarily used as a rate benchmark for option ARMs, a type of loan that offered flexible monthly payments, allowing borrowers to choose and switch among various payment levels. Some of these options included interest-only payments and even negative amortization (in which the payments didn’t even cover the total monthly interest charges), so borrowers would make no progress on paying down the loan or even see their loan balance grow.

The Housing Bubble

Unfortunately, in the early 2000s, COFI loans began to be widely sold to borrowers of limited means. The loans mainly emphasized the low monthly payments initially available, with little attention given to the higher payments these loans would eventually require. Not surprisingly, many of these borrowers could not afford the new, higher payments, and option ARMs were widely blamed as one of the “exotic” loan types responsible for the housing bubble and crash.

These days, COFI mortgages and option ARMs are hard to find. Lenders who do offer them are likely to be those dealing in specialty niches for well-qualified clients. If you read the financial press, you’ll still see regular reports on the latest rates for the 11th District COFI, which continues to serve as a benchmark for many existing loans that are still out there, even though few new COFI mortgages are currently being originated.

The mortgage market does move in cycles, and it is likely that COFI loans and option ARMs will eventually make a comeback of sorts. However, they will likely be limited to well-qualified buyers who understand and are prepared to handle the risks inherent in such loans.

David Mully

David Mully is president and CEO of Lender Insider, a mortgage consulting firm. With 26 years in the mortgage industry, he has worked as both a mortgage loan officer and in the business-to-business sector of the industry. He is the former author of the weekly “Mortgage Search” column for Observer and Eccentric Newspapers. You can read his blog at http://www.lenderinsider.com/blog.

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