Looking for a Mortgage with Lower Payments and More Flexibility? Consider a COFI Loan.

By WSJ. Custom Content Studios for First Republic Bank

Buying a home is exciting, but comes with challenges. Among them: Homebuyers need to figure out what type of loan best fits their personal situation—factoring in interest rates, how long they plan to stay in the home and how much cash they have on hand.

Over the long term, COFI loans have shown to carry better rates than other types of ARMs—and even fixed-rate mortgage loans.

Many of today's homebuyers are flocking to fixed-rate mortgages because interest rates have been rising. But there is one type of adjustable rate mortgage (ARM) that may be a good choice in a rising-rate environment: one that's particularly attractive to borrowers seeking low monthly payments and flexible payment terms.

"COFI" loans are ARMs with rates tied to the 11th District Cost of Funds Index. They can provide borrowers with several advantages over other types of loans. Most COFI mortgage loans, for example, carry lower introductory rates and monthly payments than do fixed-rate mortgages or ARMs tied to other indices. COFI is also less volatile than other ARM indices, meaning borrowers can expect steadier payments on COFI mortgage loans as U.S. interest rates rise or fall.

The Lagging-Rate Advantage

The COFI is based on the weighted average of interest rates paid by banking institutions in the three Western U.S. states that comprise the 11th Federal Home Loan Bank District: California, Nevada and Arizona. Because the rates paid on savings accounts tend to adjust slowly, COFI rates typically lag behind other common mortgage indices—including the London Interbank Offered Rate (LIBOR) and U.S. Treasury rates.

This rate lag means COFI mortgage loans generally offer lower rates to borrowers than other types of loans as interest rates rise. They may also fall more slowly when interest rates decrease, but borrowers can make up for that as interest rates increase.

Over the long term, COFI loans have shown to carry better rates than other types of ARMs—and even fixed-rate mortgage loans. For example, over the past 20 years, the highest rate a COFI loan has carried is 6.9%, while comparable one-month LIBOR mortgage loans had rates as high as 8.14%, according to data compiled by First Republic Bank. The 6.9% peak rate for COFI loans is only slightly higher than the average rate for 30-year fixed-rate loans of about 6.3% over that same 20-year period. This means that many borrowers would have paid less interest on a COFI ARM over that same 20-year period than had they locked in a 30-year fixed rate.

Beyond rates, there’s another advantage to consider:  Since COFI is a monthly adjustable product, the payments change to reflect the lower principal balance as amortization occurs. This is not the case with long-term, fixed-rate loans.  On a 15- or 30-year fixed-rate mortgage, for example, the borrower can pay off the loan more quickly by paying down principal, but the regular payment does not adjust to reflect the reduced principal.

Choosing Right

With interest rates expected to rise in coming years, it’s a good time for buyers to consider what type of mortgage is the best fit for them in today’s environment. A COFI loan may provide more flexibility than a fixed-rate loan, with less sensitivity to rising rates than other types of ARMs.

Interested in learning more about historical interest rates? View rates here.

By WSJ. Custom Content Studios for First Republic Bank. The Wall Street Journal news department was not involved in the creation of this content.

The views of the authors of these articles do not necessarily represent the views of First Republic Bank.