# How Is Cost of Funds Calculated?

By Staff WriterLast Updated Mar 24, 2020 6:53:47 PM ET Justin Lewis/Stone/Getty Images

Cost of funds is calculated by taking the total annualized interest expense divided by average interest bearing deposits and other interest bearing borrowings, plus non-interest bearing deposits. This equation does not include capital, although many financial institutions will include capital in an assets calculation.

Cost of funds refers to the interest rate paid by financial institutions for the funds they use in their business. When financial institutions have a lower cost of funds, they are able to offer consumers lower interest rates for short-term and long-term borrowing.

When a consumer refers to cost of funds, they are generally referring to the true cost of a loan. In that case, a simple loan calculator, such as the one found Bankrate.com, can quickly provide consumers with the approximate total cost of a loan. The total cost of a loan is the loan amount (known as the principal) plus all of the accumulated interest that will be paid on the loan if it is held to maturity. The formula for calculating the simple interest cost of a loan is i = Prt, where i (the total interest on the loan) = Principal x rate of interest x length of time.

For example, if \$25,000 were to be borrowed at 6 percent for five years, the formula would look like this:

i = Prt

i = \$25,000 x 0.06 x 5

i = \$7,500

The total amount of the loan can be found by taking the original principal amount (\$25,000) and adding the total interest amount (\$7,500). The resulting figure (\$32,500) is the total cost of the loan. When dealing with compound interest calculations, it is better to consult a financial professional to ensure the figures are correct.