----

**FORM      10-QSB**

**U.S.      SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,      D.C. 20549**

**x**
**QUARTERLY      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF      1934**

**For      the quarterly period ended **
**June      30, 2006**

**Commission      File Number 333-**
**135330**

**KH      FUNDING COMPANY**

**(Exact      name of small business issuer as specified in its charter)**

| **Maryland**                                                                                        | **6162**                                                                                      | **52-1886133**                                                            |
|-----------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|---------------------------------------------------------------------------|
| **(State                or other jurisdiction of****incorporation                or organization)** | **(Primary                Standard Industrial****Classification                Code Number)** | **(I.R.S.                Employer****Identification                No.)** |

**10801      Lockwood Drive, Suite 370**

**Silver      Spring, Maryland 20901**

**(301)      592-8100**

**(address      and telephone number of principal executive office)**

| **Class**                                              |   | **Outstanding                as of June 30, 2006** |
|--------------------------------------------------------|--------|----------------------------------------------------|
| Common                Stock, $0.01 par value per share |   | 2,729,951                                          |

|   |
|--------|

**PART      I**
**      - FINANCIAL INFORMATION**

| **ITEM                1.**  **FINANCIAL                STATEMENTS**                                                                                | **PAGE                NOS.** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------|
|                                                                                                                                                         |                         |
| BALANCE                SHEETS - as of June 30, 2006 (UNAUDITED) and December 31,                2005                                                         | 3                            |
|                                                                                                                                                         |                         |
| STATEMENTS                OF OPERATIONS (UNAUDITED), for the three and six month periods ended                June                30, 2006 and June 30, 2005 | 4                            |
|                                                                                                                                                         |                         |
| STATEMENTS                OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED), for the six                months ended June 30, 2006 and June 30, 2005            | 5                            |
|                                                                                                                                                         |                         |
| STATEMENTS                OF CASH FLOWS (UNAUDITED), for the six months ended June 30, 2006                and June                30, 2005                  | 6                            |
|                                                                                                                                                         |                         |
| NOTES                TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)                                                                                             | 7                            |

----

----

**KH      FUNDING COMPANY**

**BALANCE      SHEETS**

|                                                                                                                           |   |  **June                30,****2006** |       |  **December                31,****2005** |   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|------------|-----------------------------------------------|--------|
|                                                                                                                           |   |  **(unaudited)**                     |       |  ** **                              |   |
| **Assets**                                                                                                                     |   |                                 |       |                                     |   |
| Cash                                                                                                                           |   | $                                         | 5,372,631  |                                          | $      | 6,579,242 |   |
| Investments                Available for Sale:                                                                                 |   |                                      |       |                                          |   |   |   |
| Marketable                Securities - At Fair Value                                                                           |   |                                      | 644,834    |                                          |   | 598,609 |   |
| Other                                                                                                                          |   |                                      | 50,872     |                                          |   | 50,872 |   |
| Loans,                Less Allowance for Loan Losses                                                                           |   |                                      |       |                                          |   |   |   |
| (June                30, 2006) $426,124 and (December 31, 2005) $369,791                                                       |   |                                      | 50,642,969 |                                          |   | 40,678,941 |   |
| Accrued                Interest Receivable                                                                                     |   |                                      | 1,752,919  |                                          |   | 1,405,424 |   |
| Other                Receivables                                                                                               |   |                                      | 790,074    |                                          |   | 126,269 |   |
| Prepaid                Expenses                                                                                                |   |                                      | 345,909    |                                          |   | 374,762 |   |
| Property                and Equipment - Net                                                                                    |   |                                      | 131,880    |                                          |   | 137,623 |   |
| Real                Estate Owned:                                                                                              |   |                                      |       |                                          |   |   |   |
| Rental                Property                                                                                                 |   |                                      | 674,448    |                                          |   | 622,513 |   |
| Held                for Resale                                                                                                 |   |                                      | 308,098    |                                          |   | 180,302 |   |
| Other                Assets                                                                                                    |   |                                      | 26,832     |                                          |   | 15,988 |   |
|                                                                                                                           |   |                                      |       |                                          |   |   |   |
| **Total                Assets**                                                                                                |   | $                                         | 60,741,466 |                                          | $      | 50,770,545 |   |
|                                                                                                                           |   |                                      |       |                                          |   |   |   |
| **Liabilities                and Stockholders' Equity**                                                                        |   |                                      |       |                                          |   |   |   |
|                                                                                                                           |   |                                      |       |                                          |   |   |   |
| **Liabilities**                                                                                                                |   |                                      |       |                                          |   |   |   |
| Notes                and Accrued Interest Payable                                                                              |   | $                                         | 58,995,924 |                                          | $      | 49,681,335 |   |
| Other                Loans Payable                                                                                             |   |                                      | 31,500     |                                          |   | - |   |
| Long                Term Accrued Lease Obligation                                                                              |   |                                      | 12,581     |                                          |   | - |   |
| Accounts                Payable and Accrued Payroll Liabilities                                                                |   |                                      | 527        |                                          |   | 2,730 |   |
| Escrows                and Deposits                                                                                            |   |                                      | 208,086    |                                          |   | 171,673 |   |
|                                                                                                                           |   |                                      |       |                                          |   |   |   |
| **Total                Liabilities**                                                                                           |   |                                      | 59,248,618 |                                          |   | 49,855,738 |   |
|                                                                                                                           |   |                                      |       |                                          |   |   |   |
| **Stockholders'                Equity**                                                                                        |   |                                      |       |                                          |   |   |   |
| Common                Stock (5,000,000 shares authorized; 2,729,951 shares (June                30, 2006) and 2,555,556 shares |   |                                      |       |                                          |   |   |   |
| (December                31, 2005) issued and outstanding; $0.01 par value                                                     |   |                                      | 27,299     |                                          |   | 25,556 |   |
| Paid-in-Capital                                                                                                                |   |                                      | 1,980,184  |                                          |   | 1,603,852 |   |
| Accumulated                Deficit                                                                                             |   |                                      | (259,458   | )                                             |   | (429,688 | ) |
| Less                Subscription Note Receivable                                                                               |   |                                      | (185,450   | )                                             |   | (185,450 | ) |
| Accumulated                Other Comprehensive (Loss)                                                                          |   |                                      | (69,727    | )                                             |   | (99,463 | ) |
|                                                                                                                           |   |                                      |       |                                          |   |   |   |
| **Total                Stockholders' Equity**                                                                                  |   |                                      | 1,492,848  |                                          |   | 914,807 |   |
|                                                                                                                           |   |                                      |       |                                          |   |   |   |
| **Total                Liabilities and Stockholders' Equity**                                                                  |   | $                                         | 60,741,466 |                                          | $      | 50,770,545 |   |

*The      accompanying notes are an integral part of these statements.*

----

**KH      FUNDING COMPANY**

**STATEMENTS      OF OPERATIONS (UNAUDITED)**

|                                                                   |   | **For                the Three Months Ended June 30****,** |      | **For                the Six Months Ended June 30****,** |   |
|------------------------------------------------------------------------|--------|------------------------------------------------------------|-----------|----------------------------------------------------------|--------|
|                                                                   |   |  **2006**                                             |      |  **2005**                                           |   |  **2006** |   | **2005** |   |
| **Interest                Income**                                     |   |                                                  |      |                                                |   |    |   |   |   |
| Interest                and Fees on Loans                              |   | $                                                          | 1,423,895 |                                                     | $      | 759,512 |   | $ | 2,684,098 |   | $ | 1,422,289 |   |
| Interest                on Bank Accounts                               |   |                                                       | 53,887    |                                                     |   | 24,624 |   |   | 96,952 |   |   | 42,639 |   |
| Interest                on Investments - Marketable Securities         |   |                                                       | 7,737     |                                                     |   | 7,699 |   |   | 15,464 |   |   | 14,714 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| Total                Interest Income                                   |   |                                                       | 1,485,519 |                                                     |   | 791,835 |   |   | 2,796,514 |   |   | 1,479,642 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| **Interest                Expense**                                    |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| Interest                and Fees on Borrowing                          |   |                                                       | 985,041   |                                                     |   | 519,805 |   |   | 1,837,020 |   |   | 964,357 |   |
| Interest                on Participations                              |   |                                                       | -         |                                                     |   | 3,629 |   |   | - |   |   | 7,230 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| Total                Interest Expense                                  |   |                                                       | 985,041   |                                                     |   | 523,434 |   |   | 1,837,020 |   |   | 971,587 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| Net                Interest Income                                     |   |                                                       | 500,478   |                                                     |   | 268,401 |   |   | 959,494 |   |   | 508,055 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| **Provision                for Loan Losses**                           |   |                                                       | 61,920    |                                                     |   | 29,000 |   |   | 119,272 |   |   | 65,000 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| **Net                Interest Income after Provision for Loan Losses** |   |                                                       | 438,558   |                                                     |   | 239,401 |   |   | 840,222 |   |   | 443,055 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| **Non-Interest                Income**                                 |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| Rental                Income                                           |   |                                                       | 14,243    |                                                     |   | 16,010 |   |   | 24,759 |   |   | 32,606 |   |
| Loss                on Sale of Real Estate                             |   |                                                       | (25,687   |                                                     |   | - |   |   | (25,687 |   |   |   |   |
| Other                                                                  |   |                                                       | 4,284     |                                                     |   | 3,976 |   |   | 9,428 |   |   | 10,341 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| Total                Non-Interest Income (Loss)                        |   |                                                       | (7,160    |                                                     |   | 19,986 |   |   | 8,500 |   |   | 42,947 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| **Non-Interest                Expense**                                |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| Salaries                and Wages                                      |   |                                                       | 98,347    |                                                     |   | 86,834 |   |   | 193,955 |   |   | 174,672 |   |
| Professional                Fees                                       |   |                                                       | 54,231    |                                                     |   | 37,084 |   |   | 83,679 |   |   | 56,142 |   |
| Offering                Costs                                          |   |                                                       | 57,617    |                                                     |   | 45,375 |   |   | 113,825 |   |   | 88,080 |   |
| Administration                                                         |   |                                                       | 43,835    |                                                     |   | 23,396 |   |   | 81,452 |   |   | 44,394 |   |
| Real                Estate Maintenance                                 |   |                                                       | 25,391    |                                                     |   | 9,627 |   |   | 45,791 |   |   | 17,083 |   |
| Insurance                                                              |   |                                                       | 18,906    |                                                     |   | 18,141 |   |   | 38,291 |   |   | 33,994 |   |
| Depreciation                                                           |   |                                                       | 14,273    |                                                     |   | 12,430 |   |   | 29,136 |   |   | 23,580 |   |
| Rent                                                                   |   |                                                       | 28,679    |                                                     |   | 11,208 |   |   | 60,494 |   |   | 22,416 |   |
| Bank                Charges                                            |   |                                                       | 5,964     |                                                     |   | 7,147 |   |   | 12,408 |   |   | 13,043 |   |
| Other                                                                  |   |                                                       | 9,059     |                                                     |   | 5,263 |   |   | 19,461 |   |   | 10,561 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| Total                Non-Interest Expense                              |   |                                                       | 356,302   |                                                     |   | 256,505 |   |   | 678,492 |   |   | 483,965 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| **Net                Income (Loss)**                                   |   | $                                                          | 75,096    |                                                     | $      | 2,882 |   | $ | 170,230 |   | $ | 2,037 |   |
|                                                                   |   |                                                       |      |                                                     |   |   |   |   |   |   |   |   |   |
| Basic                Earnings Per Share                                |   | $                                                          | 0.03      |                                                     | $      | - |   | $ | 0.06 |   | $ | - |   |
| Diluted                Earnings Per Share                              |   | $                                                          | 0.03      |                                                     | $      | - |   | $ | 0.06 |   | $ | - |   |
| Cash                Dividends Paid Per Common Share                    |   | $                                                          | 0.02      |                                                     | $      | 0.02 |   | $ | 0.04 |   | $ | 0.06 |   |

*The      accompanying notes are an integral part of these statements.*

----

**KH      FUNDING COMPANY**

**STATEMENTS      OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)**

**FOR      THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005**

|                                                           |   |  **Common                  Stock** |      | **Paid-In**      |   |  **Accumulated** | **Subscription****Note** | **Accumulated                  Other                  Comprehensive****(Loss)** | **Total ****Stockholders'** |
|----------------------------------------------------------------|--------|-----------------------------------------|-----------|------------------|--------|-----------------------|--------------------------|---------------------------------------------------------------------------------|----------------------------------|
|                                                           |   | ** Shares**                        |      | ** Amount** |   | ** Capital**     |                     |                                                                            | ** Deficit**                |   |   | ** Receivable** |   |   | **Income** |   |   | ** Equity** |   |
|                                                           |   |                                    |      |             |   |                  |                     |                                                                            |                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Balances                  at January 1, 2006**               |   |                                    | 2,555,556 |             | $      | 25,556                |                     | $                                                                               | 1,603,852                        |   |   | $ | (429,688 | ) |   | $ | (185,450 | ) |   | $ | (99,463 | ) |   | $ | 914,807 |   |
|                                                           |   |                                    |      |             |   |                  |                     |                                                                            |                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Additional                  Stock Issued**                   |   |                                    | 174,395   |             |   | 1,743                 |                     |                                                                            | 481,441                          |   |   |   | - |   |   |   | - |   |   |   | - |   |   |   | 483,184 |   |
| **Dividend                  Declared**                         |   |                                    | -         |             |   | -                     |                     |                                                                            | (105,109                         | ) |   |   | - |   |   |   | - |   |   |   | - |   |   |   | (105,109 | ) |
|                                                           |   |                                    |      |             |   |                  |                     |                                                                            |                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Comprehensive                  Income**                      |   |                                    |      |             |   |                  |                     |                                                                            |                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                  Income for Period Ended June 30, 2006     |   |                                    | -         |             |   | -                     |                     |                                                                            | -                                |   |   |   | 170,230 |   |   |   | - |   |   |   | - |   |   |   | 170,230 |   |
| Change                  in Fair Value of Investments           |   |                                    | -         |             |   | -                     |                     |                                                                            | -                                |   |   |   | - |   |   |   | - |   |   |   | 29,736 |   |   |   | 29,736 |   |
|                                                           |   |                                    |      |             |   |                  |                     |                                                                            |                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total                  Comprehensive Income for the Period** |   |                                    | -         |             |   | -                     |                     |                                                                            | -                                |   |   |   | - |   |   |   | - |   |   |   | - |   |   |   | 199,966 |   |
|                                                           |   |                                    |      |             |   |                  |                     |                                                                            |                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Balances                  at June 30, 2006**                 |   |                                    | 2,729,951 |             | $      | 27,299                |                     | $                                                                               | 1,980,184                        |   |   | $ | (259,458 | ) |   | $ | (185,450 | ) |   | $ | (69,727 | ) |   | $ | 1,492,848 |   |

|                                                   |   |    |      |    |   |    |   |   |           |   |   |    |     |   |    |   |     |    |   |
|--------------------------------------------------------|--------|--------------|-----------|--------------|--------|--------------|--------|--------|-----------|--------|--------|--------------|----------|--------|--------------|--------|----------|--------------|--------|
| **Balances                at January 1, 2005**         |   |         | 2,505,556 |         | $      | 25,056       |   | $      | 1,750,443 |   |   | $            | (385,373 | )      |         | $      | (185,450 | )            |   | $ | (8,824 | ) |   | $ | 1,195,852 |   |
|                                                   |   |         |      |         |   |         |   |   |      |   |   |         |     |   |         |   |     |         |   |   |   |   |   |   |   |   |
| **Dividend                Declared**                   |   |         | -         |         |   | -            |   |   | (146,069  | )      |   |         | -        |   |         |   | -        |         |   |   | - |   |   |   | (146,069 | ) |
|                                                   |   |         |      |         |   |         |   |   |      |   |   |         |     |   |         |   |     |         |   |   |   |   |   |   |   |   |
| **Comprehensive                Income**                |   |         |      |         |   |         |   |   |      |   |   |         |     |   |         |   |     |         |   |   |   |   |   |   |   |   |
| Net                Loss for Period Ended June 30, 2005 |   |         | -         |         |   | -            |   |   | -         |   |   |         | 2,037    |   |         |   | -        |         |   |   | - |   |   |   | 2,037 |   |
| Change                in Fair Value of Investments     |   |         | -         |         |   | -            |   |   | -         |   |   |         | -        |   |         |   | -        |         |   |   | (49,509 | ) |   |   | (49,509 | ) |
|                                                   |   |         |      |         |   |         |   |   |      |   |   |         |     |   |         |   |     |         |   |   |   |   |   |   |   |   |
| **Total                Comprehensive Loss**            |   |         | -         |         |   | -            |   |   | -         |   |   |         | -        |   |         |   | -        |         |   |   | - |   |   |   | (47,472 | ) |
|                                                   |   |         |      |         |   |         |   |   |      |   |   |         |     |   |         |   |     |         |   |   |   |   |   |   |   |   |
| **Balances                at June 30, 2005**           |   |         | 2,505,556 |         | $      | 25,056       |   | $      | 1,604,374 |   |   | $            | (383,336 | )      |         | $      | (185,450 | )            |   | $ | (58,333 | ) |   | $ | 1,002,311 |   |

*The      accompanying notes are an integral part of these      statements.*

----

**KH      FUNDING COMPANY**

**STATEMENTS      OF CASH FLOWS (UNAUDITED)**

|                                                                                                    |   | **For                the Six Months Ended June 30,** |        |
|---------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------|-------------|
|                                                                                                    |   |  **2006**                                       |        |  **2005** |   |
| **Reconciliation                of Net Income to Net Cash from Operating                Activities**    |   |                                            |        |    |   |
| Net                Income                                                                               |   | $                                                    | 170,230     |   | $ | 2,037 |   |
| Adjustments                to Reconcile Net Income to Net Cash from Operating                Activities |   |                                                 |        |   |   |   |   |
| Depreciation                                                                                            |   |                                                 | 29,136      |   |   | 23,580 |   |
| Amortization                of Loan Fees                                                                |   |                                                 | (80,000     | ) |   | (31,873 | ) |
| Provision                for Loan Losses                                                                |   |                                                 | 119,272     |   |   | 65,000 |   |
| Stock-based                Compensation                                                                 |   |                                                 | 15,425      |   |   | - |   |
| Increase                in Accrued Late Charges                                                         |   |                                                 | (7,323      | ) |   | 12,508 |   |
| Loss                on Sale Of Real Estate Owned                                                        |   |                                                 | 25,687      |   |   | - |   |
| Increase                In Prepaid Expenses                                                             |   |                                                 | (103,718    | ) |   | (67,008 | ) |
| Recovery                of Prior Write-Off                                                              |   |                                                 | -           |   |   | 6,500 |   |
| Increase                in Accrued Interest Receivable                                                  |   |                                                 | (341,419    | ) |   | (48,552 | ) |
| Increase                in Interest Payable (included in notes payable)                                 |   |                                                 | 1,059,680   |   |   | 620,452 |   |
| (Decrease)                Increase in Accounts Payable and Accrued Payroll                Liabilities   |   |                                                 | (2,203      | ) |   | 1,214 |   |
| Increase                in Other Assets                                                                 |   |                                                 | (10,844     | ) |   | - |   |
| Decrease                (Increase) in Prepaid Offering Costs                                            |   |                                                 | 113,825     |   |   | (88,080 | ) |
| Deferred                Loan Origination Costs                                                          |   |                                                 | (12,523     | ) |   | - |   |
| Long                Term Lease Obligation                                                               |   |                                                 | 12,581      |   |   | - |   |
|                                                                                                    |   |                                                 |        |   |   |   |   |
| **Net                Cash Provided by Operating Activities**                                            |   |                                                 | 987,806     |   |   | 495,778 |   |
|                                                                                                    |   |                                                 |        |   |   |   |   |
| **Cash                Flows from Investing Activities**                                                 |   |                                                 |        |   |   |   |   |
| Principal                Repayments from Borrowers                                                      |   |                                                 | 13,762,291  |   |   | 9,523,597 |   |
| Loans                made directly to Borrowers                                                         |   |                                                 | (17,875,678 | ) |   | (15,044,744 | ) |
| Loans                Purchased                                                                          |   |                                                 | (6,106,550  | ) |   | (3,702,551 | ) |
| Purchase                of Marketable Securities and Other Investments                                  |   |                                                 | (22,565     | ) |   | - |   |
| Payments                for Other Receivables                                                           |   |                                                 | (663,805    | ) |   | 332,688 |   |
| Purchase                of Property and Equipment                                                       |   |                                                 | (13,181     | ) |   | (35,107 | ) |
| Proceeds                from Sale of Other Real Estate Owned                                            |   |                                                 | 28,000      |   |   | - |   |
| Payments                on Other Real Estate Owned                                                      |   |                                                 | (7,147      | ) |   | (13,409 | ) |
|                                                                                                    |   |                                                 |        |   |   |   |   |
| **Net                Cash Used in Investing Activities**                                                |   |                                                 | (10,898,635 | ) |   | (8,939,522 | ) |
|                                                                                                    |   |                                                 |        |   |   |   |   |
| **Cash                Flows from Financing Activities**                                                 |   |                                                 |        |   |   |   |   |
| Proceeds                from Investor Notes                                                             |   |                                                 | 65,067,038  |   |   | 45,593,198 |   |
| Principal                Payments on Investor Notes                                                     |   |                                                 | (56,808,808 | ) |   | (35,594,492 | ) |
| Proceeds                from Sale of Common Stock                                                       |   |                                                 | 483,184     |   |   | - |   |
| Increase                in Participation Loans                                                          |   |                                                 | -           |   |   | (550 | ) |
| Payment                on Borrowings                                                                    |   |                                                 | 31,500      |   |   | (66,000 | ) |
| Payment                of Dividends                                                                     |   |                                                 | (105,109    | ) |   | (146,069 | ) |
| Decrease                in Escrow and Security Deposits                                                 |   |                                                 | 36,413      |   |   | 63,084 |   |
|                                                                                                    |   |                                                 |        |   |   |   |   |
| **Net                Cash Provided by Financing Activities**                                            |   |                                                 | 8,704,218   |   |   | 9,849,171 |   |
|                                                                                                    |   |                                                 |        |   |   |   |   |
| **Net                (Decrease) Increase in Cash**                                                      |   |                                                 | (1,206,611  | ) |   | 1,405,427 |   |
|                                                                                                    |   |                                                 |        |   |   |   |   |
| **Cash                Balance, Beginning of Period**                                                    |   |                                                 | 6,579,242   |   |   | 2,669,845 |   |
|                                                                                                    |   |                                                 |        |   |   |   |   |
| **Cash                Balance, End of Period**                                                          |   | $                                                    | 5,372,631   |   | $ | 4,075,272 |   |
|                                                                                                    |   |                                                 |        |   |   |   |   |
| **Supplemental                Cash Flow Information**                                                   |   |                                                 |        |   |   |   |   |
| Cash                Paid for Interest                                                                   |   | $                                                    | 778,064     |   | $ | 374,050 |   |
| Transfer                of Loans to Real Estate Owned                                                   |   | $                                                    | 236,483     |   | $ | 106,399 |   |

*The      accompanying notes are an integral part of these statements.*

----

**NOTE      A—**
**ACCOUNTING      POLICIES AND OTHER DATA**

**Earnings      Per Share**

|                                                                |   | **For                the Three Months Ended June 30,** |      | **For                the Six Months Ended June 30,** |   |
|---------------------------------------------------------------------|--------|--------------------------------------------------------|-----------|------------------------------------------------------|--------|
|                                                                |   |  **2006**                                         |      |  **2005**                                       |   |  **2006** |   |  **2005** |   |
| Basic:                                                              |   |                                              |      |                                            |   |    |   |    |   |
| Net                Income                                           |   | $                                                      | 75,096    |                                                 | $      | 2,882 |   | $ | 170,230 |   | $ | 2,037 |   |
| Weighted                Average Common Shares Outstanding           |   |                                                   | 2,701,929 |                                                 |   | 2,505,556 |   |   | 2,638,435 |   |   | 2,505,556 |   |
| Basic                Earnings Per Share                             |   | $                                                      | 0.03      |                                                 | $      | - |   | $ | 0.06 |   | $ | - |   |
|                                                                |   |                                                   |      |                                                 |   |   |   |   |   |   |   |   |   |
| Diluted:                                                            |   |                                                   |      |                                                 |   |   |   |   |   |   |   |   |   |
| Net                Income                                           |   | $                                                      | 75,096    |                                                 | $      | 2,882 |   | $ | 170,230 |   | $ | 2,037 |   |
| Weighted                Average Common Shares Outstanding           |   |                                                   | 2,701,929 |                                                 |   | 2,505,556 |   |   | 2,638,435 |   |   | 2,505,556 |   |
| Dilutive                Effect of Stock Options                     |   |                                                   | 98,749    |                                                 |   | - |   |   | 105,000 |   |   | - |   |
| Weighted                Average Common Shares Outstanding - Diluted |   |                                                   | 2,800,678 |                                                 |   | 2,505,556 |   |   | 2,743,520 |   |   | 2,505,556 |   |
| Diluted                Earnings Per Share                           |   | $                                                      | 0.03      |                                                 | $      | - |   | $ | 0.06 |   | $ | - |   |

**Use      of Estimates in Preparing Financial Statements**

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**KH        FUNDING COMPANY**

**NOTES        TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)**

**FOR        THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND        2005**

**Nature      of Operation**

**NOTE      B—**
**IMPAIRED      LOANS AND ALLOWANCE FOR LOAN LOSSES**

*Accounting      by Creditors for Impairment of a Loan*

**Information      with respect to impaired loans and the related allowance for loan losses is      shown below:**

|                                                                                                                                    |   |  **Six                Months Ended June 30, 2006** |    |  **Year                Ended December 31,****2005** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------|---------|----------------------------------------------------------|--------|
|                                                                                                                                    |   |                                                         |    |                                                          |   |
| Total                Recorded Investment in Impaired Loans at End of Period                                                             |   | $                                                       | 919,191 |                                                     | $      | 836,390 |   |
| Amount                of that Recorded Investment for which there is a Related Allowance                for                Loan Losses  |   | $                                                       | 898,586 |                                                     | $      | 836,390 |   |
| Amount                of Related Allowance for Loan Losses Associated with such                Investment                               |   | $                                                       | 284,330 |                                                     | $      | 228,493 |   |
| Amount                of that Recorded Investment for which there is no Related Allowance                for                Loan Losses |   | $                                                       | 20,605  |                                                     | $      | - |   |

|                                                                                                                                       |   |  **Six                Months Ended June 30, 2006** |    |  **Year                Ended December 31,****2005** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------|---------|----------------------------------------------------------|--------|
|                                                                                                                                       |   |                                                         |    |                                                     |   |
| Average                Recorded Investment in Impaired Loans during Period                                                                 |   | $                                                       | 877,790 |                                                     | $      | 709,871 |   |
| Related                Amount of Interest Income Recognized within Period when Loans were                Impaired                          |   | $                                                       | -       |                                                     | $      | - |   |
| Amount                of Income Recognized Using Cash Basis during Time Within Period that                Loan                was Impaired |   | $                                                       | -       |                                                     | $      | - |   |

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**KH        FUNDING COMPANY**

**NOTES        TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)**

**FOR        THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND        2005**

**Analysis      of the allowance for loan losses is as follows:**

|                                                    |   |  **Six                Months Ended****June                30,****2006** |    |  **Year                Ended****December                31,****2005** |   |
|---------------------------------------------------------|--------|------------------------------------------------------------------------------|---------|----------------------------------------------------------------------------|--------|
|                                                    |   |                                                                         |    |                                                                       |   |
| Beginning                Balance                        |   | $                                                                            | 369,791 |                                                                       | $      | 233,311 |   |
| Provision                for Loan Losses                |   |                                                                         | 119,272 |                                                                       |   | 251,048 |   |
| Loans                Charged Off                        |   |                                                                         | (62,939 |                                                                       |   | (121,068 | ) |
| Recovery                of Loans Previously Charged Off |   |                                                                         | -       |                                                                       |   | 6,500 |   |
| Ending                Balance                           |   | $                                                                            | 426,124 |                                                                       | $      | 369,791 |   |

**NOTE      C—**
**INVESTMENTS**

|                                            |   |                **June                30, 2006** |    |
|-------------------------------------------------|--------|------------------------------------------------------|---------|
|                                            |   |  **Amortized                Cost**              |    |  **Gross                Unrealized Gains** |   |  **Gross                Unrealized Losses** |   |  **Estimated                Fair****Value** |   |
| Corporate                Bonds (Net of Premium) |   | $                                                    | 619,315 |   | $ | - |   | $ | (69,727 | ) | $ | 549,588 |   |
| Money                Market Fund                |   |                                                 | 95,246  |   |   | - |   |   | - |   |   | 95,246 |   |
| Totals                                          |   | $                                                    | 714,561 |   | $ | - |   | $ | (69,727 | ) | $ | 644,834 |   |

|                                            |   |                **December                31, 2005** |    |
|-------------------------------------------------|--------|----------------------------------------------------------|---------|
|                                            |   |  **Amortized                Cost**                  |    |  **Gross                Unrealized Gains** |   |  **Gross                Unrealized Losses** |   |  **Estimated                Fair****Value** |   |
| Corporate                Bonds (Net of Premium) |   | $                                                        | 623,351 |   | $ | - |   | $ | (99,463 |   | $ | 523,888 |   |
| Money                Market Fund                |   |                                                     | 74,721  |   |   | - |   |   | - |   |   | 74,721 |   |
| Totals                                          |   | $                                                        | 698,072 |   | $ | - |   | $ | (99,463 |   | $ | 598,609 |   |

**NOTE      D—**
**RELATED      PARTY TRANSACTIONS**

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**KH        FUNDING COMPANY**

**NOTES        TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)**

**FOR        THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND        2005**

**NOTE      E—**
**STOCK      BASED COMPENSATION**

*Share-Based      Payment*

*Accounting      for Stock Issued to Employees*
*Accounting      for Stock-Based Compensation*

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**KH        FUNDING COMPANY**

**NOTES        TO INTERIM FINANCIAL STATEMENTS (UNAUDITED)**

**FOR        THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND        2005**

|                                                                                                                                               |   | **Three                Months****Ended****March                31, 2005** |    |  **Six                Months****Ended****June                30, 2005** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------|---------|------------------------------------------------------------------------------|--------|
|                                                                                                                                               |   |                                                                      |    |                                                                         |   |
| Net                (Loss) Income, as reported                                                                                                      |   | $                                                                         | (845    | )                                                                            | $      | 2,037 |   |
| Deduct: Total                stock-based employee compensation expense determined under fair value                based method for all awards |   |                                                                      | 59,249  |                                                                         |   | 59,249 |   |
|                                                                                                                                               |   |                                                                      |    |                                                                         |   |   |   |
| Pro                forma net loss                                                                                                                  |        | $                                                                         | (60,094 | )                                                                            | $      | (57,212 | ) |
|                                                                                                                                               |   |                                                                      |    |                                                                         |   |   |   |
| Earnings                (loss) per common share:                                                                                                   |   |                                                                      |    |                                                                         |   |   |   |
| Basic                - as reported                                                                                                                 |   | $                                                                         | -       |                                                                         | $      | - |   |
| Basic                - pro forma                                                                                                                   |   | $                                                                         | (0.02   | )                                                                            | $      | (0.02 | ) |
| Basic                - as reported                                                                                                                 |   | $                                                                         | -       |                                                                         | $      | - |   |
| Basic                - pro forma                                                                                                                   |   | $                                                                         | (0.02   | )                                                                            | $      | (0.02 | ) |

|                                                       |   | **Options** |                      |  **Weighted-Average                Exercise Price** |   |  **Aggregate****Intrinsic                Value** |   |
|------------------------------------------------------------|--------|-------------|---------------------------|----------------------------------------------------------|--------|-------------------------------------------------------|--------|
| Outstanding                at January 1, 2006              |   |        | 361,250                   |                                                     | $      | 2.07                                                  |   |   |   |   |
| Granted                                                    |   |        | -                         |                                                     |   |                                                  |   |   |   |   |
| Exercised                                                  |   |        | (40,000                   | )                                                        |   | 2.00                                                  |   |   |   |   |
| Forfeited                                                  |   |        | -                         |                                                     |   |                                                  |   |   |   |   |
|                                                       |   |        |                      |                                                     |   |                                                  |   |   |   |   |
| Outstanding                at June 30, 2006                |   |        | 321,250                   |                                                     | $      | 2.08                                                  |   | $ | 295,550 |   |
|                                                       |   |        |                      |                                                     |   |                                                  |   |   |   |   |
| Exercisable                at June 30, 2006                |   |        | 321,250                   |                                                     | $      | 2.08                                                  |   | $ | 295,550 |   |
|                                                       |   |        |                      |                                                     |   |                                                  |   |   |   |   |
| Weighted                Average Remaining Contractual Life |   |        | 2.95                Years |                                                     |   |                                                  |   |   |   |   |

----

**KH      FUNDING COMPANY**

**ITEM      2.**
**MANAGEMENT**
**'S      DISCUSSION AND ANALYSIS OR PLAN OF OPERATION**

**Management's      Discussion and Analysis or Plan of Operation and other sections of this Report      contain "forward-looking statements," as that term is defined in the Private      Securities Litigation Reform Act of 1995, that are based on management's      expectations, estimates, projections and assumptions. These statements may      be      identified by the use of forward-looking words or phrases such as "should",      "expects", "anticipates", "plans", "believes", "estimates", "might result",      "projects" and variations of such words and similar expressions. Such      forward-looking statements are made pursuant to the safe harbor provisions      of      the Private Securities Litigation Reform Act of 1995. These statements are      not      guarantees of future performance and involve certain risks and uncertainties      that are difficult to predict. Therefore, actual future results and trends      may      differ materially from what is indicated in forward-looking statements due      to a      variety of factors. Such risks and uncertainties include liquidity risks      associated with our investment Notes payable on demand by the holders,      delinquencies in our loan portfolio, changes in market interest rates, inability      to generate new loans, and competitive factors in our marketplace. Readers      are      cautioned not to place undue reliance on such forward looking statements, which      speak only as of the date of this Report. The Company assumes no obligation      to      update any forward looking statements even if experience or future changes      make      it clear that projected results expressed or implied in such statements will      not      be realized.**

**Overview**

**Recent      Developments**

**Critical      Accounting Policies**

----

**KH      FUNDING COMPANY**

**Comparison      of Financial Condition at **
**June      30, 2006 and December 31, 2005**

*Assets*

*Liabilities*

*Equity*

*Past      Due Loans*

*Non-Accrual      Loans*

----

**KH      FUNDING COMPANY**

**Compa**
**rison      of Operating Results for Three Months Ended June 30, 2006 and      2005**

*Net      Income*

*Interest      Income*

*Interest      Expense*

*Provision      for Loan Losses*

*Non-Interest      Income*

*Non-Interest      Expense*

*Income      Taxes*

----

**KH      FUNDING COMPANY**

**Compa**
**rison      of Operating Results for Six Months Ended June 30, 2006 and      2005**

*Net      Income*

*Interest      Income*

*Interest      Expense*

*Provision      for Loan Losses*

*Non-Interest      Income*

*Non-Interest      Expense*

*Income      Taxes*

**Liquidity      and Capital Resources**

----

**KH      FUNDING COMPANY**

| **Year**                                      |   |  **Notes                Sold** |       |  **Notes                Redeemed** |   | **Percentage** |   |
|-----------------------------------------------|--------|-------------------------------------|------------|-----------------------------------------|--------|----------------|--------|
| 2001                                          |   | $                                   | 10,367,351 |                                    | $      | 10,661,318     |   |   | 102.84 | % |
| 2002                                          |   | $                                   | 14,418,456 |                                    | $      | 11,280,177     |   |   | 78.23 | % |
| 2003                                          |   | $                                   | 22,926,619 |                                    | $      | 18,681,654     |   |   | 81.48 | % |
| 2004                                          |   | $                                   | 26,631,166 |                                    | $      | 24,697,776     |   |   | 92.74 | % |
| 2005                                          |   | $                                   | 49,008,102 |                                    | $      | 44,786,895     |   |   | 91.39 | % |
| Six                Months Ended June 30, 2006 |   | $                                   | 65,067,038 |                                    | $      | 56,808,808     |   |   | 87.31 | % |

*Redemption      of Notes *

*Plan      to Raise Additional Capital. *

**Known      Trends, Events of Uncertainties**

*Impact      of Inflation and Interest Rates*

----

**KH      FUNDING COMPANY**

*Stockholders'      Equity*

**ITEM      3.**
**CONTROLS      AND PROCEDURES**

**PART      II**
**      - OTHER INFORMATION**

----

**KH      FUNDING COMPANY**

|   | (a) | Exhibits |
|--------|-----|----------|

|  | Exhibit  31.1  |  - Certification                by the Chief Executive Officer Pursuant to Section 302 of the                Sarbanes-Oxley Act of 2002 |
|--|-------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |
|--------|--------|--------|
|   | Exhibit 31.2   | - Certification                by the Chief Financial Officer Pursuant to Section 302 of the                Sarbanes-Oxley Act of 2002 |
|--------|-------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |
|--------|--------|--------|
|   | Exhibit 32.1   | - Certification              by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 Adopted              Pursuant to Section 906 of the Sarbanes-Oxley Act of              2002 |
|--------|-------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |
|--------|--------|--------|
|   | Exhibit 32.2   | - Certification by              the Chief              Financial Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant              to              Section 906 of the Sarbanes-Oxley Act of 2002 |
|--------|-------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | (b) | Reports                  on Form 8-K |
|--------|-----|--------------------------------------|

----

**SIGNATURE**

|                                  | KH                FUNDING COMPANY                    |
|---------------------------------------|------------------------------------------------------|
|                                  | (Registrant)                                         |
|                                  |                                                 |
|                                  |                                                 |
| Dated:                August 14, 2006 | /s/                James E. Parker                   |
|                                  | James                E. Parker                       |
|                                  | Chief                Financial Officer and Treasurer |

----