COFI ARM (Cost of Funds Index Adjustable Rate Mortgage)

The index is the cost of the money to the lender and is what the interest rate of adjustable rate mortgage is based upon. COFI ARM is the rate that is fixed for a 3-month period. This sort of rate sometimes referred to as the teaser or start rate or the initial interest rate; it is lower than the sum of the current index value and the margin. After the 3-month period your rate is adjusted according to something called the “11th district cost of funds index” (COFI) that is then added to a pre-determined margin that typically ranges between 2.25-3.00% that changes to arrive a new monthly rate. This loan may also be paid through periodic payment caps. Periodic caps basically limit the amount your interest rate can increase from one adjustment period to the next one.

The cost of funds index (COFI) is not to be confused with an interest rate. The cost of funds index represents the median (average) interest paid by savings institutions for their different sources of money during a specific period of time.

When the funds are deposited into checking and savings accounts — including money market deposit accounts, transaction accounts, as well as passbook accounts — are the primary source of money for most banks (savings institutions). Other sources of funds come through loans that are obtained through the credit programs and money borrowed from other financial institutions.

Most of the time COFI does not move up or down as unexpectedly as market interest rates because many savings institutions are dependant on fixed rate deposits with medium and long-term maturity options (Retirement Saving Funds, Money Market certificates) – they are co-dependent. Because rates on these deposits are not affected by changing market interest rates until the certain money deposit matures, the complete interest expense paid by banks, in a particular month, is more relevant to interest rates that were prevalent in previous years or months.

Most people who get the COFI ARM (Adjustable Rate Mortgage) are buying a house that costs between $300,000 and $650,000. People with higher income, and those who work in the financial industry, really like this type of loan. People in a higher interest bracket have less to risk and they like it is because they consider things like deferred interest to be simply an extended loan at a perfect rate. Because they make the minimum payment they can invest their extra money elsewhere.

Naturally, people who are involved in finances are also attracted to this kind of loan because they’re able to observe market and inside trends and have a greater understanding about how special types of loan work.

Additionally, people whose income goes up and down – a freelance writer or a commission-based salesperson – are also into this loan since it gives them certain flexibility when making a monthly payment. If they are in the down of their income they can simply make the minimum payment if they like.

Finally, some buyers like this type of loan because it helps them with tax planning and the borrower is able to defer loan interest payments and be able to get a sense of their taxes. If it turns out that such loan is good for their tax purposes than the lump sump payment toward the interest that was previously deferred can be arranged and deducted for their tax purposes.

An ARM works the best when fixed rate loan rates begin to go up. Currently many lenders have introduced a number of creative loan programs that can give you an opportunity to be able to manage your mortgage payments in an almost customized way.

As mentioned before ARMs have a rate that is fixed for certain time that is later on adjusted within specific intervals. If you’re thinking about applying for an adjustable rate mortgage there are number of things in addition the rate that you may want to consider:

· First of all an ARM will always have a period of time where the rate is fixed and the fixed periods can range from 1 month to 10 years. However a number of lenders have dropped the maximum, 10 year offering because the pricing would turn out to be bigger than fixed rates.

· There are few different measures that you should pay attention to when looking at the fixed period, for example if you’re planning to ever resell your house and if you’re able to handle the rate change in the future. You may want to think about in terms of asking yourself who is taking the risk here, for example, in a 30 year fixed loan, the lender has taken all of the risk, and you have none so your loan will probably have the highest rate. Then there’s the 1 year ARM loan where you have assumed most of the risk and so your lender is as generous with interest rate as possible.

· The most important factor to consider is the index the loan is written against – this index will have an enormous effect on your loan rate after the loan fixed period. In the past, an adjustable rate mortgage was usually tied only to the 1 year constant maturity treasury index (the average cost of short term borrowing by the Federal Government). Today’s loans that are available are connected to other indexes such as: 12 MTA- which is a derivative of the 1 year treasury and is based on the average of the most recent 12 months. Another, 10 year Treasury Index Stable is indeed very stable, though it’s not a common index. COFI (Cost of Funds Index for the 11th Federal District) discussed above is probably the most stable.

· If you decide to go with an ARM you need to know about the margin which is the number that is added to the index to determine your interest rate after the initial fixed period. Your loan’s margin can differ from index to index and from lender to lender. The margin is basically the spread between the value of the loan index and the interest rate actually charged to you. This is the lender’s profit margin. This margin is set at the beginning of the loan and does not change for the life of the loan.

· All ARMs carry rate change caps – these are called “2/6”. Rate caps restrict the rate increase or decrease to 2% at any rate change point and no more than 6% over the life of the loan. For example, if your start rate is 3.5%, and the rates happen to go up, your rate at the change could never be more than 5.5% and your loan could never go above 9.5% at any time. Caps also differ from lender to lender and index to index. Your lender will quote you a life cap as an interest rate, for example: "six percent life cap" means the life cap is six percent over your initial interest rate.

The COFI ARM is attractive because its index moves slower than any other indexes – this is why it’s considered the most stable index. As mentioned before, because its tie with the savings institutions, it is also behind all the ups and downs in the interest rate market; the one disadvantage is that if the rates on the market go down, unfortunately, COFI may continue to go up.

You can apply for a COFI ARM that has an adjustable period of six months but it’s better to go for the monthly adjustment period in terms of obtaining lower margin. The margin plus the index is your actual rate so it may be better to go with less stable adjustable period if you can considered.

It’s true that monthly adjustments sound a bit risky but you need to remember that the COFI index moves slowly – since 1981 the most it has moved during any calendar year was 1.6%!

The most interesting feature of the ARM loan is that you don’t have to make the whole payment. Every month you will receive a bill that will have three different payment options: full payment at the current interest rate, only the interest that is due on the loan for the certain month but nothing toward the principal and then the “minimum payment” option.

It is understandable that if you are only able to make that minimum payment every month you are not paying the whole interest that is due that particular month and you’re deferring some of the interest till later. Your lender will keep track of this deferred interest and will add it to the loan and the loan balance will get bigger. Since this is not a good situation your minimum payments will increase bit by bit, every year.

The payment cap on the COFI ARM loan is 7.5%. This means that the most your minimum payment can increase from one year to the next is seven and a half percent. For example, if your minimum payment is $1200 this year, next year the most it could be is $1275. This continues each year until your payment is approximately equal to the payment at the full note rate.

If you go on making the only the minimum payment and your current balance ever reaches 110 percent of the beginning balance, the loan is re-amortized to make sure you pay it off in thirty years (or forty years, whichever option you chose). Every five years the loan is re-amortized to ensure that it is paid off within the term of the loan.

If you’re buying your house but plan to re-sell it , the COFI ARM will work for you as well. Because it has a low start payment you will most likely qualify for a larger home than you can initially, when applying for a fixed rate loan. This allows you to avoid the intermediate property purchase and move up immediately to the house that you really want.

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