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The cost of funds has to do with the amount of interest that any financial institution is obligated to pay in exchange for the privilege of using money. Calculating the interest cost that is part of this overall expense is usually conducted on a monthly basis, and is subject to laws set in place 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 more common examples of this cost has to do with the extension of mortgages by lending institutions. The use of money in order to extend these types of loans to consumers is made available with a degree of interest cost involved. Often, a portion or all of that interest cost is passed on to the loan recipient.
When applied to the business of extending mortgage loans in the US, the cost of funds is usually calculated using a criterion that is established by the Federal Home Loan Bank (FHLB) system. Depending on the circumstances, the calculation may be based on regional or national guidelines. The result of the data collected and submitted to the FHLB is often helpful for lenders, in that the data can be used to determine if there is a need to make rate adjustments on ARM loans issued by the lending institution.
Along with interest, the cost of funds may also include any non-interest costs that are associated with the task of issuing and maintaining debt and equity funds. These non-interest costs can cover such factors as labor costs, various licensing fees that the lending institution is subject to in a local or regional jurisdiction, or any other non-interest cost that is considered to fall under this classification by the jurisdiction. General economic conditions can impact the actual cost of funds over a period of time, which is one of the reasons that economic factors directly impact the rate of interest that lending institutions will charge when extending a mortgage loan.