LCEF News, Personal Finance

What Is Cost of Funds?

February 10, 2017 | Posted by LCEF

Loans are a part of life, particularly for large purchases like automobiles and homes. Yet, they are far from simple. Take the loan concept cost of funds, for example.

In laymen terms, cost of funds (COF) is the interest that a financial institution must pay to investors for the use of their money to make loans to borrowers.

Let me explain.

Imagine you inherited $5,000 from an aunt. You’re not sure what you want to do with the money, but you know you’ll need it in less than five years. So you put it in a money market account at your local bank.

You are now an investor. And the interest rate the bank pays you for using your money (say 0.60%) is the cost of funds.

How cost of funds are determined

Lutheran Church Extension Fund (LCEF) determines its COF by calculating the amount of interest paid on each investment and then dividing the total interest paid by the total dollars invested.

Different from other financial institutions, LCEF uses its COF as a basis for setting loan rates. In doing so, LCEF has more control over the rates offered to borrowers.

Many banks base their loan rates off of external indicators such as the 5-Year Treasury bill LIBOR or the prime rate.

According to the Wall Street Journal, the prime rate does not change at regular intervals. It changes only when the nation’s largest banks decide on the need to raise or lower their base rate. The prime rate may not change for years, but it also has changed several times in a single year.

This type of volatility does not occur with rates based on cost of funds at LCEF.

Who should you invest with: LCEF or local bank?

So what are some of the benefits of partnering with LCEF vs. a local financial institution? There are two main benefits.

As explained above, one major advantage of having your loan rate based on LCEF’s COF over your local bank’s rate is its stability. The COF at LCEF remains fairly stable over time and is not subject to the rapid fluctuations often experienced in the commercial market.

Secondly, LCEF is a ministry of The Lutheran Church—Missouri Synod (LCMS). Unlike your local bank, through the blessings of our many investors, we have countless opportunities to support the sharing of the Gospel throughout the world.

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AUTHOR
LCEF