The cost of funds is the interest financial institutions pay to use money, subject to government laws. Mortgages are a common example, with interest costs passed on to the borrower. The Federal Home Loan Bank system calculates costs, including non-interest expenses, which can be affected by economic conditions.
The cost of funds has to do with the amount of interest that any financial institution is required to pay in exchange for the privilege of using money. The calculation of interest cost that is part of this general expense is generally done on a monthly basis and is subject to laws set by various government entities. As with many types of expenses associated with doing business, the cost of funds can take more than one form.
One of the most common examples of this cost has to do with the extension of mortgages by credit institutions. The use of money to extend these types of loans to consumers is available with a certain degree of interest. Often some or all of that interest cost is passed on to the recipient of the loan.
When applied to the business of making home loans in the US, the cost of funds is generally calculated using criteria established by the Federal Home Loan Bank (FHLB) system. Depending on the circumstances, the calculation may be based on regional or national guidelines. The output of data collected and submitted to the FHLB is often useful to lenders, as the data can be used to determine if rate adjustments are needed on ARM loans issued by the lender.
Along with interest, the cost of funds may also include non-interest costs associated with issuing and holding debt and equity funds. These non-interest costs may cover factors such as labor costs, various license fees that the lending institution is subject to in a local or regional jurisdiction, or any other non-interest costs that the jurisdiction deems is under this classification. General economic conditions can affect the actual cost of funds over a period of time, which is one reason economic factors directly affect the interest rate that lenders will charge when extending a mortgage loan.
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