Do you think you’re telling yourself the truth about money? We may think we know the facts about our finances. But our beliefs can often overshadow the facts.
Our wishes, hopes and fears can tip the scales away from the truth. This makes it easier for us to believe what we want to about money — and it can happen without us even realizing it.
The “money lies” we tell ourselves can change the way we think and act when it comes to finances. And since most of us rarely talk about money with our friends and family, the money lies we tell ourselves stick around. That can lock us into destructive beliefs and reinforce poor financial habits.
But no matter what money lies we tell ourselves, it’s never too late to set the record straight. Let’s look at some of the most common money lies we all buy into at some point — and the truth behind them.
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1. I’ll be happier when I have $_____.
“With $___ in the bank (whatever amount you think is ideal), many of my problems would go away, and I’d be happier.”
Does this sound familiar?
Goals and target numbers for earnings, savings and budgets are great. But if you make the mistake of thinking some magic number will flip a happiness switch for you, think again.
When we tell ourselves this money lie, we put too much emotion into a single number. And we may be setting ourselves up for disappointment — both if we never get $__, and if we do get $__ and realize it doesn’t make us as happy as we thought it should.
The good news? Studies show that making progress toward our goals can be incredibly satisfying, regardless of whether we hit the target.
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2. I deserve it, regardless of whether I can afford it.
“I work hard, and I don’t treat myself often.”
“I could kick the bucket tomorrow (YOLO).”
“I’m getting a great deal!”
These are just some of the rationalizations we use to convince ourselves that it’s OK to buy something.
Whatever legs this money lie stands on, it’s usually used to soothe the sting of expensive purchases — those that aren’t really essential — and perhaps items we know, deep down, we don’t really need.
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3. I have strong financial willpower.
When faced with temptation, most of us lie to ourselves that we’re great at resisting it. But, when was the last time you chose not to buy something you really wanted? When was the last time you made an impulse buy?
The average American spends at least a couple of hundred dollars a month on impulse purchases.
And we’re more likely to buy on impulse and spend more when we’re stressed. That’s probably why impulse spending shot up about 18% in 2020.
Plus, those of us who are shopping with credit cards are probably spending more on the regular basis than we realize. The average credit card shopper spends about 10% more with their cards than they would with cash. And that’s not even counting the cost of interest if the balance isn’t paid in full.
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4. I’ll save more later.
Most folks focus on buying what we need and want now, and we tell ourselves we’ll start saving for the future later. If we save anything at all, it’s likely to be whatever we have left over. In fact, fewer than 1 in 6 of us are saving more than 15% of our income, and 1 in 5 aren’t saving any money.
No matter the reason, when we tell ourselves this money lie and put off saving, we’re prioritizing the present over the future.
That can catch up with us on a “rainy day” or whenever we do start thinking seriously about retiring. By that time, there can be a lot of heavy lifting to play “catch up” with our savings — or it may even be too late.
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5. I have plenty of time to plan for my financial future (& I don’t need to think about it yet).
The future can seem really far away when we’re looking 10, 20 or even more years out. When we feel like we have a lot of room between now and then, it’s easy to make excuses to not plan or save for it.
This money lie is an excuse for procrastination. It’s the rationale we use when we have a hard time managing our negative feelings or uncertainties about our financial futures. And it makes us turn a blind eye to the years of interest that we lose out on when we don’t plan.
Benjamin Franklin may have spoken best about the truth behind this money lie when he wisely said, “by failing to prepare, you are preparing to fail.”
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6. There is good and bad debt.
We tend to assign moral value to debt, thinking of mortgages and student loans as “good” debt, and considering credit card debt as “bad.”
This money lie gets us to think the wrong way about debt. All debt comes with some cost, and it’s critical to understand how every loan affects our current and future selves.
Instead of focusing on whether debt is “good” or “bad,” concentrate on the total cost of the interest over time (it’s often higher than you think) and on deciding whether the loan is really helping you achieve your goals.
About half of us seem to already be on track with that thinking, saying that we expect to be out of debt within one to five years.
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7. Wanting more is bad.
While I think we can all agree that obsessive greed is wrong, it’s not a bad thing to want more for you and your loved ones.
When we tell ourselves we shouldn’t want more than we have, we agree to settle for less. And we may be tricking ourselves into thinking it’s OK that we’re not doing something (or enough) to improve our financial situation.
This money lie holds us back and can make it hard to improve our financial behaviors.
When we frame wanting more as a positive motivator, it can be easier to take the chances or do the work needed to get to that next financial level we may want.
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How to Stop Losing Out to Costly Money Lies
How many of these money lies sound like something you’ve told yourself?
At some point, I think we’ve all tricked ourselves with at least one of them. Maybe we were rationalizing a decision, or we were trying to make ourselves feel better about what we wanted to do with our money. And we probably didn’t make the best financial choices as a result.
Here’s the truth: Honesty goes a long way with finances.
What we tell ourselves and what we believe about money influences our financial behaviors. If we’re not telling ourselves the truth, our money lies won’t just drain our wallets. They can affect our financial awareness and inflate our confidence. And they get in the way of maintaining or growing wealth.
When we recognize the money lies that we believe, we can reset our thinking, change our mindset and start taking action. And that sets us up to make better choices and make more progress toward our big financial goals.
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This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. The content is developed from sources believed to be providing accurate information; no warranty, expressed or implied, is made regarding accuracy, adequacy, completeness, legality, reliability or usefulness of any information. Consult your financial professional before making any investment decision. For illustrative use only.
Investment advisory services offered through Virtue Capital Management, LLC (VCM), a registered investment advisor. VCM and Reviresco Wealth Advisory are independent of each other. For a complete description of investment risks, fees and services, review the Virtue Capital Management firm brochure (ADV Part 2A) which is available from Reviresco Wealth Advisory or by contacting Virtue Capital Management.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
Founder & CEO, Reviresco Wealth Advisory
Ian Maxwell is an independent fee-based fiduciary financial adviser and founder and CEO of Reviresco Wealth Advisory. He is passionate about improving quality of life for clients and developing innovative solutions that help people reconsider how to best achieve their financial goals. Maxwell is a graduate of Williams College, a former Officer in the USMC and holds his Series 6, Series 63, Series 65, and CA Life Insurance licenses.Investment Advisory Services offered through Retirement Wealth Advisors, (RWA) a Registered Investment Advisor. Reviresco Wealth Advisory and RWA are not affiliated. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.
Tired of looking for a branch or navigating a clunky app when you need to manage your bank account?
For anyone who’s ready to walk away from traditional branch banks, an industry of online challenger banks has blown up over the past decade. Technology companies have swooped in to respond to the need for more mobility, better apps and lower fees.
Varo and Chime, two of the top players in the online banking space, compete for customers with no-fee bank accounts and high-yield savings you can set up and manage from your smartphone.
Which is a better fit for you? See how they compare:
Varo vs. Chime Comparison
Varo (previously Varo Money) and Chime each offer checking and savings accounts through user-friendly mobile apps and online banking. Here’s how we rated each company.
Chime and Varo offer most of the same account options aimed at simplifying banking and savings for anyone who’s ready to say goodbye to traditional banks.
Small Business Banking
$2.50 + third-party fees for out-of-network ATMs; up to $5.95 retailer fee for over-the-counter deposit or withdrawal
$2.50 + third-party fees for out-of-network ATMs; up to $5.95 retailer fee for over-the-counter deposit; $2.50 + up to $5.95 retailer fee for over-the-counter withdrawal
Varo Bank Review
Chime Bank Review
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Chime is the leader in online banking, offering a no-frills account with features meant to simplify your money management and help you reach savings goals.
Chime Features and Fees
Chime offers fee-free online spending and saving accounts. It includes built-in automatic saving features, SpotMe fee-free overdraft protection, access to two fee-free ATM networks and more.
Chime is known for fee-free services, so you won’t pay for much. You’ll just pay a $2.50 out-of-network ATM fee, plus any fee charged by the ATM operator. And you could pay up to $4.95 to withdraw or deposit cash through your debit card at a Green Dot retail location.
Chime Bank Review
Is Chime right for you? Read our full Chime review to learn more about its features and see what it has to offer.
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As of July 2020, Varo is the first banking app to gain approval for a full bank charter in the U.S. That means it’s its own bank, unlike other banking apps, which provide technology and work with national banks to provide the financial services and accounts behind the scenes.
It hasn’t yet taken full advantage of its status to offer a full suite of financial services, but it does offer services beyond its original stripped-down checking and savings account, including a forthcoming credit builder program and small cash advance loans.
Is Varo a good bank? Read our full review to learn more about its features and decide whether it’s a good fit for you.
Varo Features and Fees
Varo offers an online, app-based checking and savings account with built-in automatic savings tools, optional overdraft protection called Varo Advance, access to a network of fee-free ATMs and more. It also offers cash advance loans and is developing a credit builder program called Varo Believe for qualifying customers.
Nearly all Varo features are fee free. You’ll just pay $2.50 to Varo to use an out-of-network ATM, plus third-party ATM fees. And you could pay a third-party fee up to $4.95 to the retailer if you deposit or withdraw cash over-the-counter at a Green Dot location. If you use Varo Advance, you’ll pay a fee between $0 and $5, depending on how much cash you draw.
Varo Bank Review
Is Varo a good bank? Read our full Varo review to learn more about its features and decide whether it’s a good fit for you.
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More Details: Chime and Varo Bank Account Features
Both accounts offer these features:
Fee-Free Checking and Savings Accounts
Both Chime and Varo include a debit account (a.k.a. checking) and optional savings account, both with no monthly fees.
Automatic Savings Tools
Both accounts include simple ways to automatically build your savings account by setting rules to move money from checking to savings when you get paid and when you shop.
Both savings accounts offer higher-than-average APY on your savings account balance.
Chime offers 0.50% APY on savings with no minimum balance requirement.
Varo offers 0.20% APY on savings to any customers, and you can earn 3.00% APY in a given month if you receive at least $1,000 in direct deposits, maintain a minimum balance of $5,000 and keep both of your accounts above a $0 balance during that month.
Early Direct Deposit
As with many online banks, both accounts make your paycheck available up to two days early if you get paid through direct deposit. The money is available in your account as soon as your employer processes payroll, which could be up to two days before the scheduled payday.
Through Chime’s SpotMe overdraft protection program, the company will spot you up to $20 with no fee as long as your account has at least $500 per month in direct deposits. That limit can go up to $200 based on your account activity.
Through Varo Advance, you can add instant overdraft protection through the app with a small cash advance loan of $20, $50, $75 or $100, for a fee of $0, $3, $4 or $5, respectively.
With both Varo and Chime, you can deposit money into your bank account at more than 60,000 retail locations with Green Dot, which is a function many online banks don’t allow.
With either account, you can pay bills through ACH transfer by giving companies your bank account and routing numbers, or mail a paper check.
Both companies provide FDIC-insured accounts up to $250,000 (the typical amount for any bank account). Chime partners with The Bancorp Bank and Stride Bank, N.A., and Varo Money is backed by its own Varo Bank.
Instant Money Transfer
With both Chime and Varo, you can send money instantly with no fees to others who use the same app. Varo Bank also works with Zelle for money transfers to folks who use other banks, though it admits the connection isn’t always reliable (and is working to fix that).
Neither company uses ChexSystems, which many traditional financial institutions use to determine your eligibility for a bank account, so a bad banking history won’t necessarily disqualify you for these accounts. Neither company checks your credit report for a banking account or credit builder card, either.
Free ATM Withdrawals
A Chime account gives you access to 38,000 fee-free ATMs in the United States through the MoneyPass and Visa Plus Alliance networks. Varo’s account connects you to more than 55,000 fee-free Allpoint ATMs in the U.S.
Live Customer Support
Talk to a real person from either company via chat in the app, email or on the phone seven days a week.
Reach Chime customer service via email at [email protected], or by phone at 844-244-6363 during business hours: Monday through Friday 6 a.m. to 10 p.m. Central, and Saturday and Sunday 7 a.m. to 9 p.m.
Reach Varo customer service via email at [email protected], or by phone at 800-827-6526 during call center hours: Monday through Friday 8 a.m. to 9 p.m. Eastern, and Saturday and Sunday 11 a.m. to 7 p.m.
Stay on top of your Varo account balance with optional notifications anytime money moves in or out of your account. Chime gives you the option to receive a push notification when a direct deposit hits.
Credit Building Programs
Both companies offer a new, secure way to build credit.
Chime’s Credit Builder Visa credit card is a secured credit card with no annual fee, no credit check to apply and no minimum required deposit (an unusual feature for a secured card). It works like a debit card that lets you build credit.
Through the program, Chime members can move money into their Credit Builder account to back the card, make purchases with the card and have the balance automatically paid off from their Credit Builder account. Chime reports activity to credit bureaus, so the card is a less risky way to build or rebuild your credit.
Varo’s forthcoming Varo Believe program is nearly identical, backing a secured credit card with a dedicated amount of your choice from your Varo Bank account.
What They Don’t Offer
Neither platform offers these features:
Joint accounts or additional authorized debit card users.
Other financial products, like personal loans, auto loans and mortgages.
Small business banking services.
Paper checks (though you can use bill pay to have the banks send checks for you,
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Which Is Better: Varo or Chime?
Chime and Varo bank account features are nearly identical, with details that could sway you one way or the other.
Varo Bank Account: A
Chime Spending Account: A-
Both banks offer a fee-free checking account for deposits and spending. In both cases, you’ll automatically apply for this account when you set up your account in the app (or online). You can fund it through direct deposit or transferring money from an external bank account.
Both Chime and Varo eschew traditional banking fees, including monthly maintenance fees, minimum balance fees and overdraft fees.
Both accounts let you get your paycheck up to two days early compared with a traditional bank, because they release the funds as soon as your employer initiates the deposit.
Both accounts come with a Visa debit card you can use for transactions anywhere Visa is accepted, and for ATM withdrawals. Both are also connected to the Green Dot network, so you can deposit or withdraw cash at retail locations around the U.S.
Both Chime and Varo charge no overdraft fees and offer optional overdraft protection — but eligibility and details vary.
Chime SpotMe: Chime will spot you for an overdraft up to $200 and take it out of your next deposit. To be eligible, you just have to receive $500 in direct deposits every month.
Varo Advance: You can opt into overdraft protection as you need it with Varo Advance, a small paycheck advance you select instantly through the app. Choose an advance of $20, $50, $75 or $100, and pay a fee of $0, $3, $4 or $5, respectively. You’ll choose an automatic repayment date anytime between 15 and 30 days of the advance. To qualify, you have to have at least $1,000 in direct deposits within the past 31 days.
Varo Savings Account: A+
Chime Savings Account: B
Both Varo and Chime offer optional savings accounts that facilitate automatic savings and yield competitive interest rates.
Funding the Account
You can only fund a Chime Savings account by transferring money from your Chime Spending account — not through direct deposit or an external bank account. To add money from another source, you must first deposit it into your Spending account, then make an instant transfer.
You can deposit money into a Varo Savings account from your Varo Bank account in the app or directly from an external account through ACH transfer.
Savings Account Interest Rates
Both Chime and Varo savings yield interest at an annual percentage yield (APY) above the 0.06% national average for savings accounts reported by the FDIC.
Chime Savings offers a 0.50%% APY with no additional requirements.
Varo Savings offers a 0.20% APY with no requirements. You can earn up to 3.00% APY on balances up to $10,000 by receiving at least direct deposits of at least $1,000, maintaining a minimum $5,000 balance and keeping both your Bank and Savings accounts above $0 for the month.
Chime and Varo each let you select one or both of two savings “rules” that automatically move money into your savings account. Varo’s options are slightly broader than Chime’s.
Chime: Save when you get paid by transferring 10% of any direct deposit of $500 or more into savings. Save when you spend by rounding up Chime debit card transactions to the nearest dollar and depositing the digital change into savings.
Varo:Save Your Pay lets you set a percentage of your direct deposits to automatically transfer to savings. Save Your Change rounds up every transaction from your Varo Bank account — including debit card purchases, bill payments and transfers — to the next dollar and deposits the difference into your savings account.
All online-only banks are convenient relative to traditional branch banks, unless you prefer face-to-face service from bank tellers at a brick-and-mortar bank.
Each bank’s mobile app lets you manage your account 24/7, including mobile check deposit and money transfers, and live customer service agents are available if you need questions answered.
Varo and Chime accounts offer features many online banks don’t, including cash deposits via Green Dot, early paycheck access and flexible overdraft protection.
Varo App: A
Chime App: B
Chime and Varo both offer mobile banking apps that are more user-friendly and easier to navigate than what you’ll get for most traditional bank accounts. However, both are pretty simplistic, lacking the budgeting tools you’d find in a lot of mobile apps.
In both apps, you can:
View and manage your accounts.
Transfer money between savings and checking, to and from external accounts, and to other customers of the same bank.
Deposit checks using your smartphone camera.
Locate in-network ATMS.
Freeze your debit cards.
Manage overdraft protection.
Contact customer support (via chat or email).
Both apps give you the option to stay on top of your bank account balance by receiving a push notification every time money moves in or out of your account — via deposit or withdrawal, debit card purchase, or over-the-counter or ATM cash withdrawal. Chime also sends daily account balance alerts.
Small Business Banking
Neither Varo nor Chime offer small business banking accounts or products and services.
Both companies tout fee-free banking that eliminates many of the costs associated with traditional banks — largely because they don’t bear the expense of running brick-and-mortar locations.
You’ll pay no maintenance fees, overdraft fees or foreign transaction fees, and you can avoid ATM fees by using in-network ATMs.
With both banks, you’ll just pay for:
Out-of-network ATM: $2.50 for using an out-of-network ATM, plus any fee the ATM owner charges.
Cash deposit: You’ll pay a retailer fee up to $5.95 to deposit cash via Green Dot.
OTC cash withdrawal: You’ll pay a retailer fee up to $5.95 for a cash withdrawal via Green Dot. Chime also charges a $2.50 fee for over-the-counter withdrawal, while Varo does not.
Varo Advance: You’ll pay between $0 and $5 to use overdraft protection with Varo, while Chime’s SpotMe overdraft protection is free.
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How They Differ: Choosing the Right Bank for You
Overall, Chime and Varo offer similar banking products that will likely appeal to the same types of banking customers — but each has slight differences that might appeal to certain customers.
Who Should Join Either Bank?
You might prefer either account over traditional banks if:
You prefer the easy access and mobility of online banking.
You regularly run your account balance close to $0 or live paycheck to paycheck.
You’re often paid through direct deposit — you could benefit from an early payday!
You’re often paid in cash but want an online bank account.
You want an easy way to save money automatically.
You want a flexible and secure way to build credit without the risk of accruing debt.
A traditional bank or credit union is probably a better fit if you want to manage your checking, savings, loans, credit cards and investment accounts all in one place.
Who Should Join Varo?
Varo is better than Chime if:
You want to build an emergency fund. Varo’s Save Your Pay rule lets you set aside any percentage of your paychecks you want, so you can set it above Chime’s 10% Save When You Get Paid rule to help you reach your savings goals faster.
You want to make the most of your savings. Varo offers six times Chime’s interest rate on savings for qualifying account holders, though the rate comes with balance requirements.
You live in the Mountain states. Although services in general tend to be limited in this region, Allpoint’s ATM network has a little more coverage than both MoneyPass and Visa Plus Alliance in Montana, Idaho, Wyoming, Colorado, Utah and Nevada.
Who Should Join Chime?
Chime is better than Varo if:
You run on a tight budget. Chime provides overdraft protection with just $500 in monthly direct deposits compared to Varo’s $1,000-deposit requirement. It covers you up to $200 compared to Varo’s $100 and doesn’t charge a fee for the service.
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Are Chime and Varo the same?
Chime and Varo are distinct companies operating online banking apps, but they each offer similar services.
Is Varo Bank a good bank?
Varo Money is a reputable and popular banking app backed by FDIC-insured accounts through Varo Bank. The mobile bank is a good option for anyone who likes online banking and has simple banking needs that don’t require all financial services to live under one roof.
Is Varo an actual bank?
Yes, Varo Bank, N.A. received approval for a U.S. bank charter in July 2020 and is an FDIC member. Varo Bank is a wholly-owned subsidiary of the financial technology company Varo Money, Inc., which operates the Varo Money banking app.
Which bank is better: Current or Chime?
Current is an online bank account that offers many of the same features as Chime and other neo bank competitors. Current stands out for offering “savings pods,” which help you save toward specific goals, and separate accounts for teens; but it charges fees to access those unique features.
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You can sign up for either Varo or Chime by downloading their mobile apps or visiting their websites.
Neither account requires a minimum opening deposit, but you can connect an external bank account to transfer money in right away or set up direct deposit to fund your account when you get paid.
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Our Bank Review Methodology
The Penny Hoarder’s editorial team considers more than 25 factors in its bank account reviews, including fees, minimum daily balance requirements, APYs, overdraft charges, ATM access, number of physical locations, customer service support access and mobile features.
To determine how we weigh each factor, The Penny Hoarder surveyed 1,500 people to find out what banking features matter most to you.
For example, we give top grades to banks that have low fees because our survey showed that this is the No. 1 thing you look for in a bank. Because more than 70% of you said you visited a physical bank branch last year, we consider the number of brick-and-mortar locations. But more than one-third of you use mobile apps for more than 75% of your banking, so digital features are also considered carefully.
Ratings are assigned across the following categories:
Personal checking accounts
Personal savings accounts
Credit card and loan products are not currently considered.
Dana Sitar (@danasitar) has been writing and editing since 2011, covering personal finance, careers and digital media.
Compound interest is an incredibly powerful force. It allows your money to start growing on its own, with the returns exploding in value over time, if you have the patience.
While the idea is easy to understand, the actual application of it can be tricky. Does it make a difference if money is compounded monthly or quarterly? How does one teach the idea to young children? Are there any places that offer steady compound interest with a high interest rate? Let’s dig in!
In this article
Impact of bank compounding quarterly
I used to keep my savings at one bank but I didn’t like their service so I switched everything to a new bank. The new bank is great except that they only put interest in my checking account quarterly. The APR on both accounts is the same. I’m trying to figure out how much I’m losing and if it is worth it to find another bank.
It’s probably not worth it to find another bank if you like the customer service at your current bank.
Let’s say you have a large amount in savings — $100,000. Let’s also say that the bank offers 0.5 percent APR on their savings account, which is a reasonable amount in the current banking world. I’m guessing that your old bank compounded monthly, as that’s very common in banking, and your new bank compounds quarterly.
At your old bank, with monthly compounding, you would earn $501.15 in interest in a year. At your new bank, with quarterly compounding, you would earn $500.94 in interest in a year. That’s right, over the course of a year, with $100,000 in the account at 0.5 percent APR, the difference between the two is about 20 cents.
With interest rates as low as they are, different compounding rates don’t make a huge difference. However, if interest rates rebound strongly, you may want to pay attention. Let’s say that interest rates were 5 percent instead of 0.5 percent. In that case, the monthly compounded account would generate $5,116.19 in interest, whereas the quarterly compounded account would generate $5,094.53 in interest. Suddenly, you’re talking about $22, which might be enough to be concerned with.
Unless interest rates rebound a lot, I wouldn’t worry too much about the rate of compounding in your savings account. If you have a big enough balance that it’s making a large difference, there are likely better places to keep your money than a typical savings account at a local bank. Your best approach is to simply find a bank with a good interest rate and good customer service and stick with them rather than chasing a better compounding frequency.
We withdrew a bunch of rolls of pennies from the bank and put a bowl of pennies out on the table, starting with 30 or so. We told them that each day, the number of pennies in the bowl would grow by 10 percent — in other words, for every 10 pennies in the bowl, we would add one penny.
We had them guess how many pennies would be in the bowl in one month. Each night, we’d count the pennies, then we would add one penny for every 10 we counted.
Their guesses were all super low, so they were blown away by the growth of it — the bowl was literally overflowing by the end of the month, with incredibly fast growth over the last week.
Later, we offered them a very high weekly compound interest rate on their allowance money if they deposited it at the “Bank of Mom and Dad.” In other words, if they held their allowance in their hand and decided to deposit it with us, we would give them 5 percent interest each week on their savings. At first, our children were hesitant to take advantage of it, but when one of them started to save for a big goal and they saw how the savings were accelerating thanks to the power of compound interest, they all jumped on board. We actually had to put a cap on weekly interest!
The message is simple. If you want your kids to learn about compound interest, make it tangible and visual. Make it important to them. Make the rate of growth rapid, so that their patience is not overly tested. Once they see the idea, it will stick with them for life.
Are there any investments that offer a high rate of steady interest? Bank accounts are so low these days and everything else is so variable.
Unfortunately, investments that offer a very steady rate of return offer a very low rate of return these days. It’s not like it was in the late 1970s and early 1980s, when you could buy U.S. Treasurys that paid 10 percent or more. Even as recently as 2007, online bank accounts could be found that paid as much as 6 percent per year.
Before we dig too much into this, consider why banks offer interest on bank accounts in the first place. In really simple terms, they do it because they need to have a certain amount in their vaults in order to lend out money to other customers. In essence, the money in your checking or savings account ends up being the money that banks lend out to people getting mortgages and business loans.
The reason that you won’t find steady, solid interest rates much above 1 percent right now is because of the Federal Reserve. The Federal Reserve sets a number of interest rates that dictate how much banks can charge each other for temporary loans and how much the Federal Reserve charges them for emergency loans. If banks have access to money at the low interest rates that the Federal Reserve offers, they don’t have a whole lot of incentive to offer high interest rates to customers.
Think about it this way. If a bank can borrow money from another bank for 0.25 percent, why would they give you much more than that in interest on your deposits? All a bank wants is money in their vaults as inexpensively as possible so they can lend it out in the form of business loans and car loans and mortgages. If they charge a lot more than 0.25 percent, they’re probably going to lose money by doing so.
So, as long as the Federal Reserve keeps interest rates low, your bank will give you low interest rates on your savings and checking accounts. It will only go up when the Federal Reserve raises rates.
Too long, didn’t read?
As long as interest rates remain low, the rate of compounding in your savings account doesn’t make much difference.
If you want your children to understand compound interest, make it visual and tangible, and make the rate of compounding very rapid.
There aren’t any stable and secure investments that offer a steady high interest rate of compounding right now. If you want a high rate of return, you have to take on some risk and volatility.
Banking Black isn’t a new concept, but it’s gaining momentum amid the rise of the Black Lives Matter movement. But what does it mean to bank Black? According to the Urban Institute, a Black financial institution provides services to minority communities and is 51% or more Black-owned.
Black financial institutions have been around for centuries, with initial meetings among African Americans interested in establishing their own banks held as far back as 1851 — before the Civil War. However, the first Black-owned bank in the U.S. didn’t materialize until after the war, in 1888.
The first Black-owned banks enabled African Americans to accumulate enough capital to start other service-oriented businesses like nursing homes, catering businesses and insurance companies. And they provided an opportunity for African Americans to learn accounting skills and other techniques required for handling large volumes of cash.
Today, there are roughly 19 Black-owned banks in the U.S. offering the same services as other financial institutions, such as certificates of deposits, loans, online and mobile banking assistance and more. This number used to be much higher — in 2001, there were 48 Black-owned banks — but, as with other community banks, the numbers have dwindled over the years partially due to regulatory restrictions that often favor larger financial institutions.
As we celebrate Black History Month, we celebrate the Black-owned financial institutions that have served as pillars in the community for years now.
In this article
Why you should consider banking Black
It’s no secret there’s a wealth gap between minority and non-minority households. As of 2016, the median wealth for a White family was $171,000 compared to $17,600 for a Black family.
This is partly attributed to a lack of financial services in minority communities. Without financial inclusion, minorities can’t affordably save, invest and insure themselves, which is required to grow and sustain wealth. This lack of experience also places them at a disadvantage.
“I believe it is vital that African Americans make financial literacy a priority in 2020 and beyond, especially because of the effects of the coronavirus. Over 67% of Americans cannot pass a basic financial literacy test. African Americans, on average, can only answer less than 40% of financial literacy questions correctly. According to research, African Americans have the lowest levels of financial literacy,” states Dr. JeFreda R. Brown, personal finance consultant, educator and CEO of Provision Financial Education.
Because of financial exclusion, minorities often resort to expensive financial services, such as check cashing stores and pay-day lenders, because there are fewer banks in their neighborhoods. There are roughly 41 financial institutions per 100,000 people in a White community compared to only 27 in non-White majority communities. And the financial institutions present in minority neighborhoods often make it difficult to open and maintain an account. For example, a bank may require higher account balances to eliminate service charges or a larger minimum account balance. According to one study, the average minimum account balance at banks in Black neighborhoods is $871, compared to $626 in White communities.
Because of this, nearly half of Black households are either underbanked or lacking access to such institutions.
“Earning money is not a problem for African Americans,” says Dr. JeFreda R. Brown. “However, there is a large gap for African Americans when it comes to personal finance education, understanding how money works, understanding economics and economic indicators, understanding time value of money and understanding wealth building.”
Many Black-owned banks aim to combat the wealth disparity gap through:
community development lending
supporting minority businesses and nonprofits
offering financial literacy workshops for community members
providing financial aid to underserved Black communities
“I think banking with Black-owned banks is good because many of them give people a second chance who can’t get bank accounts with other banks,” says Dr. JeFreda R. Brown. “Also, Black-owned banks offer the same services as other banks and credit unions.”
In 2016, there was a rise in support for Black-owned businesses following the Black Lives Matter movement. One initiative was the Black Money Matters movement, headed by rapper Michael “Killer Mike” Render. He made a call for action in July 2016 during a town hall meeting televised by BET, asking Blacks to “bank Black.” It was an effective yet short-lived effort that led to 8,000 new accounts at Atlanta’s Black-owned Citizens Trust Bank. In addition, One United Bank reported receiving $3 million in deposits at branches across the country, and Carver Bank witnessed $2.4 million in deposits thanks to the movement.
There is also the Bank Black Challenge, which was launched by One United Bank, that is challenging one million people to open a $100 savings account at a Black-owned bank to generate $100 million of economic power. This challenge started in 2016 and is still ongoing today.
Initiatives like these are significant, but it requires ongoing support to make their effects long-lasting. In 2020, the current Black Lives Matter (BLM) movement is motivating people to support the Black community in new ways. And by banking with Black financial institutions, you can now play your part in reinvesting in the Black community in the U.S.
“Black-owned banks should be given a chance to grow and be a strong financial staple in the communities they serve. Also, Black-owned banks are a great option for anyone because they promote economic revitalization. Banking with Black-owned banks helps increase community development and economic development. This is why they need support from everyone,” states Dr. JeFreda R Brown.
Black-owned banks and credit unions
If you’re considering banking with a Black financial institution, check out this list of Black-owned banks and credit unions in the U.S. If you don’t see a bank listed in your area, keep in mind you may still be able to use the bank’s digital banking services.
Black-owned financial institutions are struggling. In 2013, 60% of Black banks lost money, and they were especially hit hard by the 2008 recession. As we enter yet another economic downturn, now is a great time to invest in Black banks. In doing so, you can help keep these entities afloat so that minority communities can continue working to close the disparity gap.
Together, Black banks control $5 billion in assets, which is a fraction of what the banking giants have (for example, Wells Fargo has $1.7 trillion in assets alone). It’s up to the people to help grow Black financial institutions in the U.S. If you’d like to make a difference, then follow these simple steps to switch to a Black-owned bank.
Step 1: Identify your banking needs
Are you currently banking with another bank? What do you like and dislike about it? Keep this in mind as you’re shopping for a new, Black-owned bank.
Maybe you like the mobile banking options your current bank offers but hate the high monthly fees. Or perhaps you want to do your banking with an institution that has more involvement in minority communities.
Make a list of your must-haves to help you decide on the best Black banking solution for your needs.
Step 2: Choose a new banking institution
After you’ve identified your list of banking needs, it’s time to search for a Black-owned financial institution that meets those requirements. Use the list of Black-owned banks and credit unions above to start your search. Create a list of options and mark off the ones that don’t make the cut.
Step 3: Take note of your automatic payments and deposits
Do you use automatic withdrawals for your billing? How about direct deposits from your employers (or clients)? If so, you’ll need to make a list of these automatic transactions so you can set them up with your new bank.
Step 4: Open up your new account
Once you’ve found a bank that meets your needs, it’s time to create your new account. Go through the application process and schedule to make a deposit (if required). Also, check with your new bank to determine what process they have to make transferring funds from your old bank easier. Once your account is up and running, don’t forget to schedule your automatic payments and deposits.
Deciding to bank Black isn’t just about choosing where you keep your money. It’s a way to take a stand against inequality in minority communities that lack financial inclusion. And it helps push the Black Lives Matter movement forward.
In 2012, Wells Fargo was sued for pushing Blacks toward more expensive mortgages with higher fees and rates (compared to white borrowers with similar credit). Then in March 2018, Bank of America was fined for racial discrimination in its hiring and lending practices.
Unfortunately, this is an ongoing issue for people of color who receive less than 1% of mortgages from white-owned banks.
Banking Black isn’t a choice only available to African Americans, either. It’s a viable option for anyone who wants to make a difference in their financial prosperity, as well as the prosperity of those in underserved communities.
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Rising inflation can shrink purchasing power as prices of goods and services increase. This, in turn, can affect interest rates and the cost of borrowing. While the inflation rate doesn’t have a direct impact on mortgage rates, the two do tend to move in tandem.
What does that mean for homebuyers looking for a home loan and for homeowners who want to refinance a mortgage? Simply that as inflation rises, mortgage rates may follow suit.
Understanding the difference between the inflation rate and interest rates, and what affects mortgage rates for different types of home loans, matters in terms of timing.
Inflation Rate vs. Interest Rates
Inflation is defined as a general increase in the overall price of goods and services over time.
The Federal Reserve, the central bank of the United States, tracks inflation rates and inflation trends using several key metrics, including the Consumer Price Index, to determine how to direct monetary policy.
What to Learn from Historical Mortgage Rate Fluctuations
Inflation Trends for 2021 and Beyond
As of May 2021, the U.S. inflation rate had hit 5% as measured by the Consumer Price Index, representing the largest 12-month increase since 2008 and moving well beyond the 2% target inflation rate the Federal Reserve aims for.
While prices for consumer goods and services were up across the board, the biggest increase overall was in the energy category.
Rising inflation rates in 2021 are thought to be driven by a combination of things, including:
• A reopening economy
• Increased demand for goods and services
• Shortages in supply of goods and services
The coronavirus pandemic saw many people cut back on spending in 2020, leading to a surplus of savings. State reopenings have spurred a wave of “revenge spending” among consumers.
Although the demand for goods and services is up, supply chain disruptions and worker shortages are making it difficult for companies to meet consumer needs. This has resulted in steadily rising inflation.
Fed Chair Jerome Powell said in June 2021 that he anticipates a continued rise in the U.S. inflation rate in 2021. This is projected to be followed by an eventual dropoff and return to lower inflation rates in 2022.
In the meantime, the Fed has discussed the possibility of an interest rate increase, though there are no firm plans to do so yet. Some Fed bank presidents, though, have forecast an initial rate increase in 2022.
Recommended: 7 Factors that Cause Inflation – Historic Examples Included
Is Now a Good Time for a Mortgage or Refi?
It’s clear that there’s a link between inflation rates and mortgage rates. But what does all of this mean for homebuyers or homeowners?
It simply means that if you’re interested in buying a home it could make sense to do so sooner rather than later. Despite the economic upheaval in 2020 and the rise in inflation that’s happening now, mortgage rates have still held near historic lows. If the Fed decides to pursue an interest rate hike, that could have a trickle-down effect and lead to higher mortgage rates.
good mortgage rate, especially as home values increase.
The higher home values go, the more important a low-interest rate becomes, as the rate can directly affect how much home you’re able to afford.
The same is true if you already own a home and you’re considering refinancing an existing mortgage. With refinancing, the math gets a bit trickier.
You might want to determine your break-even point when the money you save on interest charges catches up to what you spend on closing costs for a refi loan.
To find the break-even point on a refi, divide the total loan costs by the monthly savings. If refinancing fees total $3,000 and you’ll save $250 a month, that’s 3,000 divided by 250, or 12. That means it’ll take 12 months to recoup the cost of refinancing.
If you refinance to a shorter-term, your savings can multiply beyond the break-even point.
If your current mortgage rate is above refinancing rates, it could make sense to shop around for refinancing options.
Keep in mind, of course, that the actual rate you pay for a purchase loan or refinance loan can also depend on things like your credit score, income, and debt-to-income ratio.
Recommended: How to Refinance Your Mortgage – Step-By-Step Guide
Inflation appears to be here to stay, at least for the near term. Understanding what affects mortgage rates and the relationship between the inflation rate vs. interest rates matters from a savings perspective.
Buying a home or refinancing when mortgage rates are lower could add up to a substantial cost difference over the life of your loan.
SoFi offers fixed-rate home loans and mortgage refinancing. Now might be a good time to find the best loan for your needs and budget.
It’s easy to check your rate with SoFi.
Photo credit: iStock/Max Zolotukhin
SoFi Loan Products SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636 . For additional product-specific legal and licensing information, see SoFi.com/legal. SoFi Home Loans Terms, conditions, and state restrictions apply. SoFi Home Loans are not available in all states. See SoFi.com/eligibility for more information. Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances. SOHL0521026
Hypothecation may be a word you’ve never heard, but it describes a transaction you’ve probably participated in. Hypothecation is what happens when a piece of collateral, like a house, is offered in order to secure a loan.
Auto loans and mortgages involve hypothecation since the lender can repossess the car or house if the borrower is unable to pay.
There are, though, some more subtle details to understand about hypothecation—and rehypothecation—particularly if you’re in the market for a home loan. Read on to learn about hypothecation loans.
What Is Hypothecation?
Hypothecation is essentially the fancy word for pledging collateral. If you’re taking out a secured loan—one in which a physical asset can be taken by the lender if you, as the borrower, default—you’re participating in hypothecation. (Hypothecation is also possible in certain investing scenarios, which we’ll talk briefly about later.)
Some of the most common hypothecation loans are auto loans and mortgages. If you’ve ever purchased a car, it’s likely you have (or had) a hypothecation loan, unless you were able to pay the full purchase price in cash.
Importantly, just because the asset is offered as collateral doesn’t mean that the owner loses legal possession or ownership rights of that asset. For instance, with an auto loan, the car is still yours, even though the lender might hold the title until the loan is paid off.
You also maintain your right to the positive parts of ownership, such as income generation and appreciation. This is perhaps most obvious in the case of homeownership. Even if you’re paying a mortgage on your property, you still have the right to lease the place out—and you can still collect the rental income.
However, the lender has the right to seize the property if you fail to make your mortgage payments. (Which would be a bad day for both you and the renters alike.)
Why Is Hypothecation Important?
Hypothecation makes it easier to qualify for a loan—particularly a loan for a lot of money—because the collateral means the transaction is less of a risk for the lender.
For instance, hypothecation is the only way that most people are able to qualify for mortgages. If those loans weren’t secured with collateral, lenders might have very steep eligibility requirements to lend hundreds of thousands of dollars!
There are loans where hypothecation is not present, however. They are also known as unsecured loans. A personal loan is a good example.
Because unsecured loans are riskier for the lending institution, they tend to be harder to qualify for and carry higher interest rates than secured loans.
It’s a trade-off: With an unsecured loan, you’re not at risk of having anything repossessed from you, and you can use the money for just about anything you want.
On the other hand, if comparing, say, a car loan and personal loan of equal length, you’re likely to pay more interest over the life of the unsecured loan and be subject to a stricter eligibility screening to get the loan in the first place.
Recommended: Smarter Ways to Get a Car Loan
Hypothecation in Investing
Along with hypothecation in the context of a secured loan on a physical asset, like a house or a car, hypothecation can also occur in investing—though usually not unless you’re taking on more advanced investment techniques.
Hypothecation occurs when investors participate in margin lending, which involves borrowing money from a broker in order to purchase a stock market security (like a share of a company).
This technique can help active, short-term investors buy into securities they might not otherwise be able to afford, which can lead to gains if they hedge their bets right.
But here’s the catch: The other securities in the investor’s portfolio are used as collateral and can be sold by the broker if the margin purchase ends up being a loss.
TL;DR: Unless you’re a well-studied day trader, buying on margin probably isn’t for you and you probably don’t have to worry about hypothecation in your investment portfolio. But you should know it can happen in investing, too!
Recommended: What Is Margin Trading?
Hypothecation in a Mortgage
As mentioned above, a mortgage is a classic example of a hypothecation loan: The lending institution foots the six-digit (or seven-digit) cost of the home upfront but retains the right to seize the property if you’re unable to make your mortgage payments.
Given the staggering size of most home loans and the risk of losing the home, you may wonder if taking out a mortgage is worth it at all.
Even though any kind of loan involves going into debt and taking on some level of risk, homeownership is still often seen as a positive financial move. That’s because much of the money you’re paying into your mortgage each month usually ends up back in your own pocket in some capacity … as opposed to your landlord’s pocket.
When you pay a mortgage, you’re slowly building equity in the home. And since most homes have historically tended to increase in value, or appreciate, you can often end up making a profit even after factoring in whatever interest you pay on the mortgage—most or all of which is likely tax-deductible.
A Note on Rehypothecation
There is such a thing as rehypothecation, which is what happens when the collateral you offer is then, in turn, offered by the lender in its own negotiations.
It’s like hypothecation inception. We have to go deeper.
But this, as anyone who lived through the 2008 housing crisis knows, can have dire consequences. Remember The Big Short? Rehypothecation is part of the reason the housing market became so fragile and eventually fell apart entirely, and thus is practiced much less frequently these days.
Hypothecation is the process in which a piece of collateral, like a house or car, is offered as part of the negotiation of a loan. Mortgages are a classic example of hypothecation—and hypothecation is the reason most of us are able to qualify for such a large loan.
If you’re looking to finance or refinance a home, SoFi offers a range of fixed-rate mortgages with terms ranging from 10 to 30 years.
Prequalifying takes just two minutes, and mortgage loan officers are standing by to help guide you through every step of the process.
It’s quick and easy to find your rate.
SoFi Loan Products SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636 . For additional product-specific legal and licensing information, see SoFi.com/legal. SoFi Home Loans Terms, conditions, and state restrictions apply. SoFi Home Loans are not available in all states. See SoFi.com/eligibility for more information. Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Traditionally considered a last-ditch source of cash for eligible homeowners, reverse mortgages are becoming more popular.
Older Americans, particularly retiring baby boomers, have increasingly drawn on this financial tool to fund home renovations, consolidate debt, pay off medical expenses, or simply improve their lifestyles.
So what is a reverse mortgage? It’s a loan that allows homeowners to turn part of their home equity into cash. Available to people 62 and older, a reverse mortgage can be set up and paid out as a lump sum, a monthly payment, or a line of credit.
The reverse mortgage loan and interest do not have to be repaid until the last surviving borrower dies, sells the house, or moves out permanently. In some cases, a non-borrowing spouse may be able to remain in the home.
Reverse mortgages aren’t for everyone. They eat up home equity and incur fees and interest. Depending on your age, home equity, and goals, alternatives like personal loans, a cash-out refinance, or a home equity loan may be a better fit.
Most Common Kind of Reverse Mortgage
Usually when people refer to a reverse mortgage, they mean a federally insured home equity conversion mortgage (HECM), which can also be used later in life to help fund long-term care. The current loan limit is $822,375.
HECM reverse mortgages are made by private lenders but are governed by rules set by the Department of Housing and Urban Development (HUD).
If the borrower moves to another home for a majority of the year or to a long-term care facility for more than 12 consecutive months, the reverse mortgage loan needs to be paid back if no other borrower is listed on the loan. That was the status quo at least.
A new HUD policy offers protections to a non-borrowing spouse when a partner moves into long-term care. The non-borrowing spouse may remain in the home as long as he or she continues to occupy the home as a principal residence, is still married, and was married at the time the reverse mortgage was issued to the spouse listed on the reverse mortgage.
In 2021 HUD also removed the major remaining impediment to a non-borrowing spouse who wanted to stay in the home after the borrower’s death. They will no longer have to provide proof of “good and marketable title or a legal right to remain in the home,” which often meant a probate filing and had forced many spouses into foreclosure.
To qualify for this kind of reverse mortgage loan, you must meet with an HECM counselor. To find one, you can search for a counselor on the HUD site.
The counselor may cover eligibility requirements, the financial ramifications if you decide to go forward, and when the loan would need to be paid back, including circumstances under which the outstanding amount would become immediately due and payable.
The counselor may also share alternatives. The goal is that you will be able to make an informed decision about whether a reverse mortgage is right for your situation.
Nearly 42,000 HECMs were awarded in 2020.
How Does a Reverse Mortgage Work?
To qualify for an HECM, all owners of the home must be 62 or older, and have paid off their home loan or have a considerable amount of equity.
Borrowers must use the home as their primary residence or live in one of the units if the property is a two- to four-unit home. Certain condominium units and manufactured homes are also allowed.
The borrower cannot have any delinquent federal debt. Plus, the following will be verified before approval:
• Income, assets, monthly living expenses, and credit history
• On-time payment of real estate taxes, plus hazard and flood insurance premiums, as applicable
The reverse mortgage amount you qualify for is determined based on the lesser of the appraised value or the HECM mortgage loan limit (the sales price for HECM to purchase), the age of the youngest borrower or age of an eligible non-borrowing spouse, and current interest rates.
Generally, the older you are and the more your home is worth, the higher your reverse mortgage amount could be, depending on other eligibility criteria. Borrowers or their
An HECM loan includes several charges and fees. They include:
• Mortgage insurance premiums
Upfront fee: 2% of the home’s appraised value or the Federal Housing Administration (FHA) lending limit (whichever is less)
Annual fee: 0.5% of the outstanding loan balance
• Origination fee (the greater of $2,500 or 2% of the first $200,000 of the home value, plus 1% of the amount over $200,000. The origination fee cap is $6,000)
• Third-party charges
• Service fees
Your lender can let you know which of these are mandatory.
Many of the costs can be paid out of the loan proceeds, meaning you wouldn’t have to pay them out of pocket. However, financing the loan costs reduces how much money will be available for your needs.
A lender or agent services the loan and verifies that real estate taxes and hazard insurance premiums are kept current, sends you account statements, and disburses loan proceeds to you.
In return, they could charge you a monthly service fee of up to $30 if the loan interest rate is fixed or adjusts annually. If the interest rate can adjust monthly, the maximum monthly service fee is $35.
Third-party fees could include an appraisal fee, surveys, inspections, title search, title insurance, recording fees, and credit checks.
Two Other Types of Reverse Mortgages
The information provided so far answers the questions “What is a reverse mortgage?” and “How do reverse mortgages work?” for HECMs, but there are also two other kinds: the single-purpose reverse mortgage and the proprietary reverse mortgage.
Here’s more info about each of them.
Single-Purpose Reverse Mortgage
This loan is offered by state and local governments and nonprofit agencies. It’s the least expensive option, but the lender determines how the funds can be used. For example, the loan might be approved to catch up on property taxes or to make necessary home repairs.
Check with the organization giving the loan for specifics about costs, as they can vary.
Proprietary Reverse Mortgage
If a home is appraised at a value that exceeds the maximum for an HECM ($822,375), a homeowner could pursue a proprietary reverse mortgage.
Counseling may be required before obtaining one of these loans, and a counselor can help a homeowner decide between an HECM and a proprietary loan.
Typically, proprietary reverse mortgages can only be cashed out in a lump sum. The costs can be substantial and interest rates higher. This type of reverse mortgage, unlike an HECM, is not federally insured, so lenders tend to approve a lower percentage of the home’s value than they would with an HECM.
One cost a borrower wouldn’t have to pay with a proprietary mortgage: upfront mortgage insurance or the monthly premiums.
In some cases, the costs associated with this type of mortgage may cause a homeowner to decide to sell the home and buy a new one.
Pros and Cons of Reverse Mortgages
If you’re nearing retirement, it’s easy to see why reverse mortgages are appealing.
Unlike most loans, you don’t have to make any monthly payments. The HECM loan can be used for anything, whether that’s debt, health care, daily expenses, or buying a vacation home (although this is not true for the single-purpose variety).
How you get the money from an HECM is flexible. You can choose whether to get a lump sum, monthly disbursement, line of credit, or some combination of the three.
You can pay back the loan whenever you want, even if that means waiting until you’re ready to sell the house. If the home is sold for less than the amount owed on the mortgage, borrowers may not have to pay back more than 95% of the home’s appraised value because the mortgage insurance paid on the loan covers the remainder.
The money from a reverse mortgage counts as a loan, not as income. As a result, Social Security and Medicare are not affected, and payments are not subject to income tax.
An HECM can be used to buy a new primary residence. You’d make a down payment and then finance the rest of the purchase with the reverse mortgage.
Reverse mortgage interest rates can be higher than traditional mortgage rates. The added cost of mortgage insurance also applies, and, like most mortgage loans, there are origination and third-party fees you will be responsible for paying, as described above.
Taking out a reverse mortgage generally means reducing the equity in your home. That can mean leaving less for those who might inherit your house.
You’ll need to keep up property taxes and insurance, repairs, and any association dues. If you don’t pay insurance or taxes, or if you let your home go into disrepair, you risk defaulting on the reverse mortgage, which means the outstanding balance could be called as immediately “due and payable.”
Interest accrued on a reverse mortgage isn’t deductible until it’s actually paid (usually when the loan is paid off). And a deduction of mortgage interest may be limited.
Alternatives to Reverse Mortgages
A reverse mortgage payout depends on the borrower’s age, the value of their home, the mortgage interest rate, and loan fees, and whether they choose a lump sum, line of credit, monthly payment, or combination.
If the payout will not provide financial stability that allows an individual to age in place, there are other ways to tap into cash. Here are suggestions:
Cash-out refi. If you meet credit and income requirements, you may be able to borrow up to 80% of your home’s value with a cash-out refinance of an existing mortgage. Closing costs are involved, but this product lets you turn home equity into cash and possibly lock in a lower interest rate.
Personal loan. A personal loan could provide a lump sum without diminishing the equity in your home. This kind of loan does not use your home as collateral. It’s generally a loan for shorter-term purposes.
Home equity line of credit (HELOC). A HELOC, based in part on your home equity, provides access to cash in case you need it but requires interest payments only on the money you actually borrow. Some lenders will waive or reduce closing costs if you keep the line open for at least three years. HELOCs usually have a variable interest rate.
Home equity loan. A fixed-rate home equity loan allows you to borrow a lump sum based on your home’s market value, minus any existing mortgages. You make a monthly principal and interest payment each month. Again, lenders may reduce or waive closing costs if you keep the loan for, usually, at least three years.
A reverse mortgage makes sense for some older people who need to supplement their cash flow. But many factors must be considered: the youngest homeowner’s age, home value, equity, loan rate and costs, heirs, and payout type. Retirees have options.
SoFi offers a cash-out refinance, which involves taking out a home loan with new terms for more than you owe and pocketing the difference in cash.
SoFi also provides fixed-rate unsecured personal loans of $5,000- $100,000.
Need a financial boost? Consider a personal loan or a refinance with SoFi.
SoFi Loan Products SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636 . For additional product-specific legal and licensing information, see SoFi.com/legal. SoFi Home Loans Terms, conditions, and state restrictions apply. SoFi Home Loans are not available in all states. See SoFi.com/eligibility for more information. Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances. PL18133
Maybe you’ve recently become an empty nester and are looking to downsize, or perhaps you accepted a job offer in a new city. Whatever your motivation, you’re thinking about selling your home and moving on to greener pastures.
But before you dive in, it helps to know which home selling mistakes to avoid to help ensure you get a great offer, sell your property quickly, and facilitate a positive experience for yourself and prospective buyers.
Getting a home ready for the market is often stressful. And it’s even more so if you make these home selling mistakes. From neglecting curb appeal to using low-quality listing photos, avoid these pitfalls to have a more positive and profitable selling experience.
1. Not Pricing Realistically
Pricing your home can be tricky. While you certainly want to make a profit from the sale, you also have to be realistic about the value of your property. Price it too high and you’ll scare away potential buyers. Price it too low and you’ll be taking money out of your own pocket.
A good way to gauge how much to list your property for is to look at comparable homes in your neighborhood that have recently sold. Pay special attention to how they differ from yours to determine whether you should aim for a higher or lower sale price.
Have either of the homes been renovated?
Is one property bigger than the other?
Does one home have upgrades the other doesn’t, like a pool or fenced yard?
Reviewing sold homes in your community will give you a feel for your house’s market value. If your home is in better condition than a comparable property or if it has desirable features another doesn’t, you may be able to price slightly higher. However, if your home is in worse shape you might need to settle for a lower asking price.
2. Not Staging Your Home
Staging your home doesn’t necessarily have to mean hiring a professional home stager. But it does mean that you should clean, declutter, and organize your home so that it’s visually appealing to potential buyers.
To prep your home to sell, consider:
Applying a fresh coat of paint to your walls
Keeping surfaces like counters, tables, and desks free of clutter
Deep cleaning carpets and rugs
Renting nice furniture or decorative pieces
Landscaping or maintaining your yard, deck, or balcony
Replacing outdated wallpaper
Fixing damages to walls, flooring, and counters
If you have a lot of items to remove from your home, such as furniture or personal items, rent a storage locker as you declutter and organize. Store any items you want to keep for your new home so you can depersonalize and stage the one you’re selling.
Or, if you’re not interested in staging your home yourself, hire a professional to do it for you. Professional real estate stagers are well-versed in interior design and will be able to help you show off your home’s best assets.
If you choose not to opt for home staging at all, you risk giving prospective buyers a poor first impression. Disorganized clutter and too many personal items like family photos make it hard for others to picture themselves living in your home. Do your best to provide a neutral setting, where prospective buyers who come for showings can envision making the space their own.
3. Not Considering Closing Costs
Whether you sell your home using a realtor or you opt to go the for sale by owner (FSBO) route, there are closing costs you can’t avoid. For example, homeowners may have to pay for:
One common home selling mistake is forgetting to incorporate these costs into your listing price or profit. Although some costs associated with closing a home sale are typically covered by homebuyers, most sellers still have to pay at least some closing costs.
Before choosing to put your home on the market, consider how much your closing costs will be. They can vary greatly based on where you live, the type and age of your property, and how you choose to sell your home.
Understanding how much you need to plan to spend before listing your house gives you a better idea of the price range you can afford and how much profit you’ll come away with.
4. Selling on Your Own
Selling a home on your own may seem like a great way to save money on realtor fees, but if you don’t know what you’re doing, it will cause unnecessary stress and may even lead to you losing money. If you choose to list your house as for sale by owner, be prepared to:
Set up showings and open houses
Negotiate offers and conditions
Stage your own home
Take high-quality photos of your home
Write an appealing description of your property
Advertise and market your listing
Close the sale of the home on your own
Realtors have access to a variety of listing tools that homeowners don’t, such as the Multiple Listing Service (MLS), a major real estate platform that offers property searches, history, and more. They also network with each other to find the right buyers as well as cover communications and paperwork between you and potential buyers during the home selling process.
While selling your home without a listing agent can save you money, it’s not a decision you should make lightly. Make sure you understand what FSBO means and the responsibilities you’ll be taking on. If you don’t have the know-how to sell yourself, consider looking for a good real estate agent instead.
5. Choosing the Wrong Real Estate Agent
Real estate agents aren’t all alike. The one you choose to sell your home can make or break how successful your home sale is. A good realtor can accelerate the sale of your home, get you better offers, and make the home selling process a breeze.
A bad real estate agent can cost you time, money, and showings.
To find a good realtor, look for someone who:
Has experience in your neighborhood
Has sold similar properties before
Has a real estate license
You feel comfortable working with
Is a good communicator
Understands your goals and priorities
Has a proven track record of selling homes
Bonus points if they’re a member of a professional real estate organization like the National Association of Realtors.
Get referrals from your contacts and meet with a few realtors before choosing one to work with. It’s completely acceptable to shop around and take your time. After all, a lot is riding on your real estate agent when it comes to selling your property.
6. Taking Feedback Personally
Your home likely has sentimental value to you, even if you’re selling it. This makes it easy to take lowball offers or criticisms about the paint choices or yard size personally during open houses and showings.
But it’s important to remember that your home only has sentimental value to you, not to potential buyers. Try not to get offended during the selling process. It will only cloud your judgment and cause you to base any decisions you make off your emotions, not reason.
Emotionally driven decisions can force you to miss out on negotiations and offers, causing your home to stay on the market longer.
Detach yourself from your home by depersonalizing it, avoiding attending showings and open houses, and looking at offers or other negotiations from a logical standpoint. Treat selling your home like a business transaction.
Just because someone makes a lowball offer doesn’t mean the negotiation process is over. Counter with a higher number and take it from there.
7. Selling in the Wrong Season
The housing market typically starts to quiet down during the winter months. After all, who wants to move in the cold?
If you put your house on the market during the winter, chances are you’ll wind up with fewer viewings and lower offers.
Instead, list your home during peak real estate season, which starts in the spring and runs until early fall. At this time of year, the market is flooded with buyers looking to find a home and make it their own before the end of the year.
This ups your chances of getting an offer that reflects the true value of your home without having to factor in the weather and a sparse market.
8. Selling in a Buyer’s Market
In real estate, there are two distinct types of market: a buyer’s market and a seller’s market. A buyer’s market is when there are more homes listed than there are buyers. This enables buyers to negotiate lower offers and shop around to find the best deal.
In a seller’s market, there are more buyers looking to purchase a property than there are houses up for sale. This means buyers need to compete against one another to land a deal — often resulting in offers over your asking price.
If you have the luxury of waiting to list your home until you’re in a seller’s market, you’re certain to make top dollar for your property. At the very least, try not to sell in a buyer’s market unless you have to.
9. Using Poor Listing Photos
The listing photos you use for your home heavily influence a potential buyer’s first impression. And they use them to determine whether they want to bother booking a viewing or not.
If your listing photos are poor quality, you’re almost guaranteed to miss out on showings because they won’t appeal to buyers.
Bad listing photos:
Are taken with a low-quality camera
Have poor lighting (too bright or too dark)
Don’t showcase a home’s best features
Are taken before a home is cleaned and staged
Only provide a few shots
Good listing photos:
Are taken with a professional camera
Take advantage of natural light
Showcase a home’s best features, including renovations, upgrades, or landscaping
Are taken after a home is clean and staged
Provide a variety of shots
Many real estate agents will have a professional photographer come in to take photos of your home, which will be covered in their realtor fees. If you sell your home by owner, you can hire someone to do it for you.
Great pictures make a big difference in how many buyers are interested in viewing your home, so it’s an investment worth making.
10. Not Being Flexible
When it comes to selling your home, it’s easy to forget that it involves two different families making a major life change. Coordinating selling your property and moving into your next home is challenging enough, but you also need to consider your buyers.
For example, in an offer, a buyer may request a closing date either sooner or later than you had anticipated. While your initial instinct may be to refuse their request, it was probably made for a reason. Perhaps the buyer is aiming to move in when their current lease ends or a week before their new job starts.
The same may be true for offers below your asking price. Maybe the buyer loves the property but offered slightly less than the asking price because it was all they were approved to borrow for their mortgage loan.
When negotiating the sale of your home, remember to be flexible — within reason. Buyers are experiencing just as much stress and upheaval as you are, and often their requests come with a reasonable explanation.
Refusing to budge on small issues like a closing date or accept a fair offer just because you are being stubborn won’t do you any good. In fact, they could be what causes a buyer to back out, leaving you back at square one.
11. Not Making Repairs in Advance
Neglecting to make small home repairs before listing your property is a big mistake. Buyers and home inspectors will notice these issues and use them to justify a lower asking price. And they’ll typically cost you more this way than if you’d just handled them in the first place.
For example, a leaky faucet, a torn window screen, or a damaged fence panel are relatively easy fixes. If a buyer notices them, they may make you an offer that requires them to be fixed by a professional at your cost. That’s likely to be more out of your pocket than if you’d fixed them yourself or had time to shop around for a handyman.
You don’t have to go for an entire home renovation, but making obvious fixes can go a long way. If you don’t take care of small repairs before listing your home, they’ll impact everything from your curb appeal and showing atmosphere to the offers you get and the conditions they come with.
12. Being Dishonest
Being dishonest when selling your home won’t get you anywhere. Buyers are encouraged — and, in some cases, required — by their banks, brokers, realtors, insurance agents, and friends to be diligent and careful when buying a home.
As an example, mortgages are often subject to approval based on an applicant’s ability to obtain property insurance. In turn, whether a buyer is approved for property insurance depends on a review by an insurance agent, which may require a home inspection completed by a professional that cites any issues with the home.
This is meant to not only protect buyers but the lenders and insurance agencies who fund and insure them.
If you try to hide something about your home or fail to disclose important information, you’re likely to be caught and could face legal repercussions as a result. Some common required disclosures include:
Deaths in the home
Risk of natural disaster
Nuisances like airports, farms, or landfills near the property
Known electrical or plumbing issues
Depending on which state you live in, failing to disclose any of the above before the sale of your home closes could get you involved in a lawsuit.
Instead of trying to hide anything about your home, be upfront about it. It will save you a lot of time (and possibly money) in the end.
13. Neglecting Curb Appeal
Many home sellers only focus on staging the interior of their home, but curb appeal matters just as much. Details like landscaping, fresh paint, and small repairs to fences and decks make your property look more inviting to potential buyers.
Make the outside of your property look inviting and welcoming by:
Tidying up your yard and raking leaves, mowing, and trimming
Pressure washing aged wood steps, decks, and patios
Applying a fresh coat of paint or stain to exterior doors, window frames, and sheds
Adding a pop of color with planters and hanging baskets
Weeding and replanting any garden beds
Cleaning up clutter like yard tools, pet supplies, and children’s toys
Since the exterior of your home is what potential buyers will see first, it’s important to consider it when staging, photographing, and listing your property. Curb appeal can go a long way in enticing buyers to book a showing and make an offer.
14. Not Being Ready to Sell
If you’re not truly ready to sell your home, the whole process is likely to feel negative and stressful.
For example, if you’re pushing yourself to sell within an unrealistic timeline or you’re listing your home just because you want to take advantage of a seller’s market, you’re likely to feel overwhelmed and unprepared.
Think about why you’re making the decision to sell, and whether it makes sense for you to do right now — emotionally, financially, and professionally. Do you have strong sentimental ties to the property? How will it affect your finances? What about your job?
Selling your home is a big decision, so don’t make it lightly. If you aren’t ready, you may rush into making a decision you come to regret after it’s too late.
Selling a home is an exciting and life-changing experience, as long as it’s done right. Embark on the process thoughtfully and with consideration to avoid common mistakes like overpricing your home or selling during the winter months.
By preparing yourself to be a home seller and thinking ahead, you’ll enjoy a more satisfying and successful selling experience.
What does it mean to be prequalified or preapproved for a mortgage? The two words are often used interchangeably, but they aren’t the same thing and don’t carry the same weight when a hopeful homeowner is ready to buy.
Here’s a look at how these two steps vary, how each can play a significant part in any home buying strategy, and how one in particular can increase the chances of having a purchase offer accepted when there are multiple offers on a house.
Getting Prequalified for a Mortgage
Getting prequalified is a relatively quick and easy process.
You, the mortgage applicant, provide a few financial details to a lender. The lender uses this unverified information, usually along with a soft credit pull, to let you know approximately how much you may be able to borrow and at what terms.
Because prequalification is an estimate of what the lender thinks you can probably afford based on the data input, the lender may ask some clarifying questions around income, assets, employment, and debt. You likely won’t be asked to provide any documentation at this point, so it’s pretty painless.
Getting prequalified can give an applicant a general idea of loan programs and the amount they may be eligible for.
But because the information provided has not been verified, there’s no guarantee that the loan or amount will be approved.
That doesn’t make this step irrelevant, though. Prequalification can help you in a few ways.
• It can give you an idea of how much house you can afford.
• It can alert you to loan programs you may be eligible for.
• It can tell you what your monthly payment might look like when you do get approved for a mortgage.
It might be tempting to blow through this step by providing incomplete or embellished financial information to lenders—or to skip the prequalification process entirely. But who wants to fall in love with a house they can’t potentially afford? And who wouldn’t want to weed out any mortgage programs or lenders that don’t suit their needs?
Getting Preapproved for a Mortgage
Once you decide on a mortgage lender or lenders, you can begin the preapproval process.
Preapproval typically takes longer than prequalification and requires a thorough investigation of your income sources, employment history, assets, credit history, and other financial commitments and debts.
Verification of this information, along with a hard credit pull from all three credit bureaus, allows the lender to complete a preapproval of the loan before you shop for an eligible property.
When seeking preapproval, besides filling out an application, you may be asked to submit the following to a lender for verification:
• Social Security number or some other form of identification
• Two most recent pay stubs
• W-2 statements for the past two years
• Tax returns from the past two years
• Sixty days’ worth of documentation (or a quarterly statement) of the activity in checking, savings, and investment accounts
• Residential addresses from the past two years, including contact information for rental companies or landlords, if applicable
The lender may require backup documentation for certain types of income in order to qualify for a mortgage. For example, rental property owners may be asked to show lease agreements. Freelancers may be asked to provide 1099 forms, bank statements, a profit and loss statement, a client list, or work contracts.
Buyers also can expect to have to explain negative information that might show up during a credit check. (To avoid any surprises, proactive buyers can get annual free credit reports from freeannualcreditreport.com. A credit report shows all balances, payments, and derogatory information but does not give credit scores. It may help potential borrowers identify and amend errors before applying for a loan.)
Those who have filed for bankruptcy in the past may have to show documentation that it has been discharged. Applicants face a waiting period, which varies with the lender and whether they are seeking a conventional vs. government home loan, after a bankruptcy dismissal or discharge and before being eligible for new loan approval.
The lender will need to verify the amount and source of the down payment you plan to provide. If your parents are kicking in some cash, for example, the lender will ask for a gift letter that confirms that the money is a gift and not a loan. Some loan programs may require you to contribute a certain amount of your own money (sometimes 5%) to the loan before a gift can be applied. Generally, investment properties are not eligible for gift funds.
Those taking a loan or withdrawal from a 401(k) also typically will have to show the paperwork. And any sudden changes in finances may have to be explained—so it’s important to have a paper trail.
Three Reasons to Get Preapproved
Sounds like a lot of work, right? But preapproval has at least three selling points:
1. Preapproval lets you know the specific amount you are qualified to borrow from the lender, instead of just an estimate. You can always purchase a house for less than the preapproved amount.
2. Going through preapproval before house hunting could take some stress out of the loan process by breaking up the borrower and property underwriting portions of the loan. Underwriting, the final say on mortgage approval or disapproval, comes after you’ve been preapproved, found a house you love and agreed on a price, and applied for the home loan.
3. Being preapproved for a loan helps to show sellers that you’re a vetted buyer. The lender can provide a preapproval letter that indicates the willingness to lend you a particular amount, and the interest rate and fees you can expect to pay on that loan (though it’s not a guarantee that you’ll get the loan).
Depending on the real estate market, sellers might receive offers from multiple buyers. Having a preapproval letter could improve the chances that your offer will be selected, especially if other offers lack a preapproval letter.
The letter tells the seller that your credit, income, and assets have been reviewed and approved by a lender to move forward and that if the property is eligible, the loan should close with no issues to derail the purchase.
Time Is of the Essence
A preapproval letter usually expires in 90 days because pay stubs, bank statements, and so on are considered dated after 90 days.
If the information needs to be updated and reverified after that point, the preapproval letter can be reissued with a new expiration date.
If you’re seeking loan preapproval, you may benefit from mortgage rate shopping within a focused period—generally 14 to 45 days, varying by the credit score model each lender uses—to avoid dragging down your credit score.
If you apply for mortgages with several lenders within the condensed time frame, and each makes a hard pull of your credit, it will count as just one hard inquiry.
Finalizing the Mortgage Application
After you find the house you want to purchase and the seller has accepted the offer, the next step is to finalize your mortgage application and move toward final loan approval.
You don’t have to choose a mortgage from the same place a preapproval letter came from.
Once the lender receives the property appraisal and title report, a loan underwriter reviews the data and issues a loan commitment letter or final approval. This means that the loan has been fully approved and a closing date can be scheduled.
The lender may perform another credit check right before a loan closes. Applying for any new credit cards or auto loans, or making large credit purchases during the home buying process could affect final mortgage approval.
Some borrowers choose to lock in the interest rate offered by the lender once they find a home they want to buy. This freezes the mortgage rate for a predetermined period.
It’s a good idea to verify the time period to make sure the rate is in effect through the escrow closing date, and to review the fully executed purchase contract with the lender for closing and loan contingency timelines to be sure contract dates can be met.
Finally, even if you pass the loan approval process with flying colors, the home being purchased might not. The lender will likely order an appraisal to be sure the selling price is accurate and that the property type (single-family home, farm, etc.) and condition are eligible for home loan financing.
If the sales price is higher than the appraised value, you may have to go back to the negotiating table, walk away from the deal, or come up with cash to make up the difference.
What If My Preapproval Didn’t Pan Out?
Being turned down for a mortgage—or not being able to borrow as much as expected—can be disappointing. But it doesn’t have to put a stop to home buying hopes.
If you are in that boat, you might want to try to understand why you were not eligible. You could:
• Consider another loan product or lender where you might meet the lending criteria.
• Work on improving whatever put a damper on your home loan qualification.
• Find a home that’s better suited to your budget if you were preapproved for a lower loan amount than expected.
Preapproval vs. prequalification: If you’re serious about buying a house, do you know the difference? Getting prequalified and then preapproved may increase the odds that your house hunt will lead to homeownership.
SoFi offers a range of fixed-rate mortgage loans with competitive rates and low down payment options.
Looking at investment properties? SoFi has loans for those, too.
It’s a snap to get prequalified and view your rate.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement. Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice. Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners. Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. A hard credit pull, which may impact your credit score, is required if you apply for a SoFi product after being pre-qualified. SoFi Loan Products SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636 . For additional product-specific legal and licensing information, see SoFi.com/legal. SoFi Home Loans Terms, conditions, and state restrictions apply. SoFi Home Loans are not available in all states. See SoFi.com/eligibility for more information.
Mortgage shoppers have multiple options, including the adjustable-rate mortgage (ARM). Is a 5/1 ARM a good choice? A lot depends on how long borrowers plan to keep the property and whether they can cover higher mortgage payments if interest rates go up.
While most borrowers will opt for a conventional 30-year fixed-rate mortgage, some may decide that an adjustable-rate loan is a better fit.
Recommended: Understanding the Different Types of Mortgage Loans
Here’s a closer look at ARMs and the 5/1 ARM in particular.
Anatomy of an ARM
An adjustable-rate mortgage often has a lower initial interest rate—for as little as six months to as long as 10 years—than a comparable fixed-rate mortgage.
Then the rate “resets” up (or, sometimes, down) based on current market rates, with caps dictating how much the rate can change in any adjustment.
With most ARMs, a rate adjustment happens once a year. And ARMs are usually 30-year loans.
Recommended: Adjustable Rate Mortgage (ARM) vs. Fixed Rate Mortgage
What Is a 5/1 ARM?
You’ll see adjustable-rate mortgage loans typically come in the form of a 3/1, 7/1, and 10/1, but the most common is the 5/1 ARM.
With a 5/1 ARM, the interest rate is fixed for the first five years of the loan, and then the rate will adjust once a year—hence the “1.”
Adjustments are based on current market rates for the remainder of the loan.
5/1 ARM Rates
An ARM interest rate is made up of the index and the margin. The index is a measure of interest rates in general. The margin is an extra amount the lender adds, and is usually constant over the life of the loan.
Caps, or limits, on how high (or low) your rate can go will affect your payments.
Let’s say you’re shopping for a 5/1 ARM and you see one with 3/2/5 caps. Here’s how the 3/2/5 breaks down:
• Initial cap. Limits the amount the interest rate can adjust upward the first time the payment adjusts. In this case, the first adjustment, after five years, can’t be higher than 3%. • Cap on subsequent adjustments. In the example, the rate can’t go up more than 2% with each adjustment after the first one. • Lifetime cap. The rate can’t go up more than 5% for the life of the loan.
A mortgage payment spike after a rate adjustment can lead to payment shock.
Then again, a 5/1 ARM borrower may be able to save significant cash over the first five years of the loan.
Let’s say a borrower has a choice between a 30-year fixed-rate mortgage loan and a 5/1 ARM. Here’s the difference between the two loans after five years, using hypothetical interest rates, based on a loan amount of $300,000.
The 30-year fixed-rate loan has a rate of 3.8%, a monthly payment of $1,398 (not including taxes, insurance, or closing costs), and a total loan payout of $83,820. The remaining loan balance after five years is $270,456.
A 5/1 ARM has an initial interest rate of 3.0%, a monthly payment of $1,265, and a total loan payout of $75,840. The borrower owes $266,719 after five years.
Over the initial five-year period, the 5/1 ARM borrower would save the following:
Monthly savings = $133.00
Five-year savings = nearly $8,000
Of course, that represents only five years of a typical 30-year mortgage loan.
5/1 ARM Loan Pros and Cons
Borrowers should be aware of all the upsides and downsides of adjustable-rate mortgages.
5/1 ARM Pros
A lower interest rate upfront. The initial five-year mortgage period usually comes with a lower interest rate than a fixed-rate mortgage. This can be an advantage for new homeowners who lack the cash needed to furnish the home and pay for landscaping and maintenance. And first-time homebuyers may gravitate toward an ARM because lower rates increase their buying power.
Potential for long-term benefit. If interest rates dip or remain steady, an ARM could be less expensive over a long period than a fixed-rate mortgage.
Could be good for short-term homeowners. Some buyers may only need a home for five years or less (for example, business professionals who think they’ll move or be transferred). These borrowers may get the best of both worlds with a 5/1 ARM: lower interest rates and no risk of much higher rates later on, as they’ll likely sell the home and move before the interest rate adjustment period kicks in.
5/1 ARM Cons
Risk of higher long-term interest rates. The good fortune with a 5/1 ARM runs out after five years, when the likelihood of higher interest rates increases. The loan could eventually reset to a rate leading to loan payments the borrower finds uncomfortable or unaffordable.
Higher overall home loan costs. As interest rates rise with a 5/1 ARM, homeowners will likely pay more over the entire loan than they would have with a fixed-rate home loan.
Refinancing fees. You can refinance an ARM to a fixed-rate loan, but you can also expect to pay some significant fees. Typically, mortgage loan refinancing costs 3% to 6% of the total cost of the loan.
Possible prepayment penalty. Some ARMs require special fees or penalties if you refinance or pay off the ARM early (usually within the first three to five years of the loan). And some loans have prepayment penalties even if you make only a partial prepayment.
Possible negative amortization. Some loans have payment caps. Payment caps limit the amount of payment increases, so payments may not cover all the interest due on your loan. The unpaid interest is added to your debt, and interest may be charged on that amount. You might owe the lender more later in the loan term than you did at the start. Be sure you know whether the ARM you are considering can have negative amortization, the Federal Reserve advises.
Recommended: How To Avoid Paying a Prepayment Penalty
Is a 5/1 ARM Right for You?
Is a 5/1 ARM loan a good idea? It depends on your finances and goals.
In general, adjustable-rate mortgages make more sense when there’s a sizable interest rate gap between ARMs and fixed-rate mortgages. If you can get a great deal on a fixed-rate mortgage, an adjustable-rate mortgage may not be as attractive.
If you plan on being in the home for a long time, then one fixed, reliable interest rate for the life of the loan may be the smarter move.
As the Fed says, an ARM presents a trade-off: You get a lower initial rate in exchange for assuming more risk over the long run. The advantages must be weighed along with the risk that an increase in interest rates will lead to higher monthly payments in the future.
Your best bet on ARMs? More tips from the Fed:
• Talk to a trusted financial advisor or housing counselor. • Get information in writing about each ARM program of interest before you have paid a nonrefundable fee. • Ask the lender or broker about anything you don’t understand, such as index rates, margins, caps, and negative amortization. • If you apply for a loan, you will get more information, including the annual percentage rate (APR) and a payment schedule, and whether the loan has a prepayment penalty. The APR takes into account interest, points paid on the loan, any fees paid to the lender, and any mortgage insurance premium. You can compare APRs on similar ARMs and compare terms. • Shop around and negotiate for the best deal if you’ve chosen to take out an adjustable-rate mortgage.
A 5/1 ARM offers borrowers a temporary perk, but they assume risk over the long run. Tempted by a sweet introductory rate? It’s a good idea to go in with eyes wide open about rate adjustments, prepayment penalties, and your homeownership goals.
If one sweet fixed rate from here to eternity—well, up to 30 years—sounds good, SoFi offers fixed-rate home loans as well as mortgages for second homes and investment properties.
There’s never a prepayment penalty. If you’re curious, find your rate in a flash.
Learn more about SoFi home loans today.
SoFi Loan Products SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636 . For additional product-specific legal and licensing information, see SoFi.com/legal. SoFi Home Loans Terms, conditions, and state restrictions apply. SoFi Home Loans are not available in all states. See SoFi.com/eligibility for more information. Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.