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Subprime mortgages allow borrowers with lower credit scores to obtain homeownership, but the homebuyers pay a steep price for the privilege, thanks to the higher risk to lenders. Fortunately, there is hope for subprime borrowers who raise their credit profiles through consistent, on-time payments: They can look into refinancing. Here’s a closer look at the subprime mortgage world.

What Is a Subprime Mortgage?

A subprime mortgage is a housing loan made to a borrower with a subprime credit score, typically one in the 580 to 669 range, although what constitutes a prime and subprime credit score can vary among lenders and organizations. A credit score above 670 is considered prime, according to Experian, which tracks data on the credit industry. (And generally speaking, to qualify for the best interest rates, a borrower needs a “super prime” score of 740 or better.)

Borrowers with lower credit scores represent a greater risk to the lender; they are statistically more likely to have trouble paying on time. So subprime mortgages often come with higher interest rates and larger down payments to help protect the lender from the increased risk of default.

Subprime borrowers accept these terms because they cannot qualify for a conventional mortgage — one from a private lender like a bank, credit union, or mortgage company — with lower costs. Subprime mortgages are different from government-backed loans for borrowers with low credit scores (such as FHA loans backed by the Federal Housing Administration).


💡 Quick Tip: Buying a home shouldn’t be aggravating. SoFi’s online mortgage application is quick and simple, with dedicated Mortgage Loan Officers to guide you through the process.

How Subprime Mortgages Work

The main difference between a mortgage loan offered to a prime borrower vs. a subprime borrower is cost. Borrowers go through the same rigorous underwriting process with a lender and must submit documentation to verify income, employment, and assets.

But in the end, a prime borrower is offered the best rates, while a subprime borrower with so-called bad credit has to put more money down, pay more in fees, and pay a much higher interest rate over the life of the loan. Subprime mortgages also are often adjustable-rate mortgages, which means the payment can go up based on market indices after a predetermined period of time.

Subprime Mortgages and the 2008 Housing Market Crash

Subprime mortgages became popular in the 2000s as more high-risk mortgages were made available to subprime borrowers. In 2005, subprime mortgages accounted for 20% of all new mortgage loans.

It became possible for a lender to originate more of these high-risk mortgages because of a new financial product called private-label mortgage-backed securities, sold to investors to fund the mortgages. The investments masked the risk of the subprime mortgages within.

Home prices soared as more borrowers sought out the various subprime mortgages being offered. Rising home prices also protected the investors of mortgage-backed securities from losses.

When the housing market had passed its peak and borrowers had no viable option for selling or refinancing their homes, properties began to fall into default. In an attempt to reduce their risk exposure, lenders originated fewer loans and increased requirements for all borrowers. This depressed the market further.

Financial institutions that had taken strong positions in mortgage-backed securities were also in trouble. Many of the largest banking institutions in the world filed for bankruptcy, and the world learned once again what stock market crashes are.

In response to the financial crisis, the Federal Reserve implemented low mortgage rates in an attempt to jumpstart the economy.

Subprime Mortgage Regulations

In the wake of the financial crisis, Congress passed the Dodd-Frank Act to reduce excessive risk-taking in the mortgage industry. It established rules for what qualified mortgages are, which gave lenders a set of rules to follow to ensure that borrowers had the ability to repay the loans they were applying for.

It also provided regulation of qualified mortgages, including:

•   Limiting mortgages to 30-year terms

•   Limiting the amount of debt a borrower can take on to 43%

•   Barring interest-only payments

•   Barring negative amortization

•   Barring balloon payments

•   Putting a cap on fees and points a borrower can be charged for a loan

Subprime mortgages are not qualified mortgages. Borrowers who seek non-qualified mortgage loans may include self-employed people who want a more flexible financial verification process, people who have high debt, and people who want an interest-only loan.

Types of Subprime Mortgages

The most common types of subprime mortgages are adjustable-rate mortgages (ARMs), extended-term mortgages, and interest-only mortgages.

•   ARMs. Adjustable-rate mortgages have an interest rate that will change over the life of the loan. They often come with a low introductory rate, which after a predetermined time period changes to a rate tied to market indices.

•   Extended-term mortgages. A subprime mortgage may have a term of 40 years instead of the typical 30-year term. Add to this the higher interest rate, and borrowers pay much more for the mortgage over the life of the loan.

•   Interest-only mortgages. Interest-only loans offer borrowers the ability to only repay the interest part of the loan for the first part of the repayment period. Borrowers have the option of not repaying any principal for five to 10 years. The annual percentage rate is typically higher than for conventional loans. Origination fees may be higher as well.

The “dignity mortgage,” a new kind of subprime loan, could help borrowers who expect to redeem their creditworthiness. The borrower makes a down payment of about 10% and agrees to pay a higher rate of interest for a number of years, typically five. After that period of on-time payments, the amount paid toward interest goes toward reducing the mortgage balance, and the rate is lowered to the prime rate.

Subprime vs Prime Mortgages

Subprime mortgages have many of the same features as prime mortgages, but there are some key differences.

Applying for Subprime Mortgages

Most lenders require a minimum credit score of 620 for a conventional mortgage, but there are lenders out there that specialize in subprime mortgages.

Generally, applying for a subprime mortgage is much the same as applying for a traditional mortgage. Lenders will check your credit and analyze your finances. They will ask for proof of income, verification of employment, and documentation of assets (such as bank statements). They may also ask for documentation regarding your debts or negative items in your credit reports.

Mortgage rates for subprime loans will vary depending on the prime rate, lending institution, the home’s location, the loan amount, the down payment, credit score, the interest rate type, the loan term, and loan type. The rate is typically much higher than a prime mortgage’s.

A mortgage calculator can help you find out what your monthly payments will be with a subprime mortgage. Simply adjust your mortgage rate to the one quoted by a lender for your credit situation.

Alternatives to Subprime Mortgages

Subprime loans are not the only option for borrowers with fair credit scores. Borrowers with credit issues can also look at mortgages backed by the FHA and the Department of Veterans Affairs (VA).

FHA loans have more flexible standards for borrowers than conventional loans. Though borrowers can obtain a mortgage with a credit score as low as 500 (assuming they have a 10% down payment), FHA loans are not considered subprime mortgages. Instead, FHA loans are government-backed loans that provide mortgage insurance to FHA-approved lenders to use if the borrower defaults on the loan.

For many borrowers with good credit and a moderate down payment, FHA loans are more expensive and don’t make sense. However, for borrowers with lower credit scores and smaller down payments, an FHA loan could be the best option.

VA loans have no minimum credit requirement, but instead, lenders review the entire loan profile. The VA advises lenders to consider credit satisfactory if 12 months of payments have been made after the last derogatory credit item (in cases not involving bankruptcy).


💡 Quick Tip: Keep in mind that FHA loans are available for your primary residence only. Investment properties and vacation homes are not eligible.1

The Takeaway

Subprime mortgages allow borrowers with impaired credit to unlock the door to a home, but to mitigate risk, the lender may charge more for the loan. Borrowers considering this type of mortgage would be smart to look closely at terms and costs, and to also consider other options such as FHA loans.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

Photo credit: iStock/shapecharge

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

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.

^¹FHA loans are subject to unique terms and conditions established by FHA and SoFi. Ask your SoFi loan officer for details about eligibility, documentation, and other requirements. FHA loans require an Upfront Mortgage Insurance Premium (UFMIP), which may be financed or paid at closing, in addition to monthly Mortgage Insurance Premiums (MIP). Maximum loan amounts vary by county. The minimum FHA mortgage down payment is 3.5% for those who qualify financially for a primary purchase. SoFi is not affiliated with any government agency.
^†Veterans, Service members, and members of the National Guard or Reserve may be eligible for a loan guaranteed by the U.S. Department of Veterans Affairs. VA loans are subject to unique terms and conditions established by VA and SoFi. Ask your SoFi loan officer for details about eligibility, documentation, and other requirements. VA loans typically require a one-time funding fee except as may be exempted by VA guidelines. The fee may be financed or paid at closing. The amount of the fee depends on the type of loan, the total amount of the loan, and, depending on loan type, prior use of VA eligibility and down payment amount. The VA funding fee is typically non-refundable. SoFi is not affiliated with any government agency.
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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Heard of a no-closing-cost mortgage or refinance? Sounds divine, but mortgage closing costs are as certain as death and taxes. They must be accounted for, one way or the other.

You may be spared the pain of paying closing costs upfront, depending on the type of loan and the lender’s criteria, but they won’t just magically disappear. Instead, you’ll either be given a higher interest rate on the mortgage to cover those costs or see the costs added to your principal balance.

If you’re thinking about what’s needed to buy a house, keep closing costs in mind and understand the pros and cons of rolling these costs into your loan.

What Are Closing Costs?

A flock of fees known as closing costs on a new home are part and parcel of a sale. They typically range from 2% to 5% of the home’s purchase price. Closing costs include origination fees, recording fees, title insurance, the appraisal fee, property taxes, homeowners insurance, and possibly mortgage points. Some of the costs are unavoidable; lender fees are negotiable.

Closing costs come into play when acquiring a mortgage and when refinancing an existing home loan.

You may cover closing costs with a cash payment at closing, with your down payment, or by tacking them on to your monthly loan payments. You may also be able to negotiate with the sellers to have them cover some or all of the closing costs.


💡 Quick Tip: When house hunting, don’t forget to lock in your home mortgage loan rate so there are no surprises if your offer is accepted.

Can Closing Costs Be Rolled Into a Loan?

If you’re buying a home and taking out a new mortgage, your lender may allow you to roll your closing costs into the loan, depending on:

•   the type of home loan

•   the loan-to-value ratio

•   your debt-to-income (DTI) ratio

Rolling closing costs into your new mortgage can raise the DTI and loan-to-value ratios above a lender’s acceptable level. If this is the case, you may not be able to roll your closing costs into your loan. It’s also possible that if you roll in your closing costs, your loan-to-value ratio will become high enough that you will be forced to pay for private mortgage insurance. In that case, it may be worth it to pay your closing costs upfront if you can.

If you hear of someone who’s taken out a mortgage and says they rolled their closing costs into their loan, they may have actually acquired a lender credit — the lender agreed to pay the closing costs in exchange for a higher interest rate in a “no-closing-cost mortgage.” A no-closing-cost refinance works similarly.

Not all closing costs can be financed. For example, you can’t roll in the cost of homeowners insurance or prepaid property tax. Some of the costs that may be included are the origination fees, title fees and title insurance, appraisal fees, discount points, and the credit report fee.

What about government-backed mortgages? Most FHA loan closing costs can be financed. And VA loans usually require a one-time VA “funding fee,” which can be rolled into the mortgage.

USDA loans will allow borrowers to roll closing costs into their loan if the home they are buying appraises for more than the sales price. Buyers can then use the extra loan amount to pay the closing costs.

Finally, for FHA and USDA loans, the seller may contribute up to 6% of the home value as a seller concession for closing costs.

How to Roll Closing Costs Into an Existing Home Loan

When you’re refinancing an existing mortgage and you roll in closing costs, you add the cost to the balance of your new mortgage. This is also known as financing your closing costs. Instead of paying for them up front, you’ll be paying a small portion of the costs each month, plus interest.

Pros of Rolling Closing Costs Into Home Loans

If you don’t have the cash on hand to pay your closing costs, rolling them into your mortgage could be advantageous, especially if you’re a first-time homebuyer or short-term homeowner.

Even if you do have the cash, rolling closing costs into your loan allows you to keep that cash on hand to use for other purposes that may be more important to you at the time.

Cons of Rolling Closing Costs Into Home Loans

Rolling closing costs into a home loan can be expensive. By tacking on money to your loan principal, you’ll be increasing how much you spend each month on interest payments.

You’ll also increase your DTI ratio, which may make it more difficult for you to secure other loans if you need them.

By adding closing costs to your loan, you are also increasing your loan to value ratio, which means less equity and, often, private mortgage insurance.

Here are pros and cons of rolling closing costs into your loan at a glance:

Is It Smart to Roll Closing Costs Into Home Loans?

Whether or not rolling closing costs into a home loan is the right choice for you will depend largely on your personal circumstances. If you don’t have the money to cover closing costs now, rolling them in may be a worthwhile option.

However, if you have the cash on hand, it may be better to pay the closing costs upfront. In most cases, paying closing costs upfront will result in paying less for the loan overall.

No matter which option you choose, you may want to do what you can to reduce closing costs, such as negotiating fees with lenders and trying to negotiate a concession with the sellers in which they pay some or all of your costs. That said, a seller concession will be difficult to obtain if your local housing market is competitive.


💡 Quick Tip: If you refinance your mortgage and shorten your loan term, you could save a substantial amount in interest over the lifetime of the loan.

The Takeaway

Closing costs are an inevitable part of taking out a home loan or refinancing one. Rolling closing costs into the loan may be an option, but it pays to carefully consider the long-term costs of avoiding paying closing costs up front before you commit to your mortgage.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

FAQ

What is a no-closing-cost mortgage?

The name of this kind of mortgage is a bit misleading. Closing costs are in play, but the lender agrees to cover them in exchange for a higher interest rate or adds them to the loan balance.

How much are home closing costs?

Closing costs are usually 2% to 5% of the purchase price of a home.

Can you waive closing costs on a home?

Some closing costs must be paid, no matter what. But you can try to negotiate origination and application fees with your lender. You may even be able to get your lender to waive certain fees entirely.

Photo credit: iStock/kate_sept2004

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

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.

SOHL0124029

A mortgage contingency allows homebuyers to exit the purchase contract without legal repercussions should they be unable to secure financing by the agreed-upon deadline.

Consider this scenario: You found a gem of a home that many others are eyeballing. You make an offer and cough up earnest money to show that you mean business. You’ve been preapproved for a mortgage, so financing seems a shoo-in — until you hit a snag. That’s when a mortgage contingency becomes important.

If you’re unable to obtain financing by the deadline, you can walk away from the purchase agreement and have your earnest money returned.

Some non-cash buyers consider waiving the mortgage contingency to make their offer more competitive in a hot market, but of course, that involves risk. Here’s the scoop on the financing contingency.

What Is a Mortgage Contingency?

Should something unexpected happen, like a job loss or the inability to sell an existing home, a mortgage contingency clause in the purchase agreement allows buyers to back out of the contract and have their earnest money returned. An earnest money deposit isn’t small potatoes for anyone, but that’s especially true for those who are competing against multiple offers: Buyers might lay down as much as 10% of the home’s sale price as a good-faith deposit.

A mortgage contingency also protects both buyers and sellers from uncertainty in the real estate transaction. It’s one of several contingencies that buyers might include in the contract when the property listing status changes to contingent but not yet pending.


💡 Quick Tip: You deserve a more zen mortgage. Look for a mortgage lender who’s dedicated to closing your loan on time.

The Mortgage Contingency Clause

The mortgage contingency clause gives the buyers a time frame to go shopping for a mortgage or move beyond preapproval. Though the clause may vary from contract to contract, most will allow buyers to back out of the contract if they do not directly cause the financing to fail. The earnest money held in escrow is returned to the buyer.

Even when buyers have mortgage preapproval, financing can fall through at the last minute. This is the legal “out” if that happens.

Recommended: What Is the Difference Between Pending and Contingent Offers?

How Mortgage Contingency Works

Buyers find a home and make an offer and the seller’s real estate agent or attorney draws up a contract for the purchase of the property. Many buyers include in their offer a mortgage contingency, which has a deadline. If the sellers agree to this contingency (and other conditions of the offer), they sign the contract. The mortgage contingency becomes legally binding at this point.

Next, buyers complete a full application with the lender of their choice. The lender will review the buyer’s finances in-depth, and mortgage underwriting will make a final decision on whether or not to approve the loan.

If the mortgage is denied, the buyers are able to exit the contract and have their earnest money returned when a mortgage contingency is included.

In the absence of a mortgage contingency, the sellers would be able to keep the buyers’ earnest money and put the property back on the market to find another buyer.

How Long Does a Contingency Contract Last?

When buyers submit an offer, they will suggest a deadline for mortgage financing alongside the mortgage contingency. Typically, the time frame to secure a loan is 30 to 60 days.

Mortgage Contingency Clause Elements

Some mortgage contingency clauses are simple and give the buyers absolute discretion in obtaining financing acceptable to them. In others, financing is more specifically described. This variance depends on your contract and state law. Elements can include a mortgage contingency deadline, type of mortgage, amount needed, closing fees, and interest rate.

Mortgage Contingency Deadline

The mortgage contingency deadline is how long the buyer has to find approval for a mortgage. The deadline is often suggested by the buyer in the contract when an offer is made on the property.

When the seller signs the offer, the contingencies become legally binding and must be followed in good faith. Should a buyer need an extension of the deadline, an addendum must be submitted to and agreed upon by the seller.

Type of Mortgage

There are many different types of mortgages a buyer can use to purchase property, so while one loan may not work for a buyer’s situation, another may. Buyers may have the option of selecting a conventional or government-insured loan, a jumbo loan, a mortgage with a term of 30, 15, or other years, or an interest-only mortgage. A lender can help walk buyers through their options.

Amount Needed

A mortgage contingency clause can also designate the amount needed to secure the loan. A mortgage calculator tool can help buyers estimate how much a mortgage payment is going to be and the total amount a borrower can qualify for.

Closing Fees

The mortgage contingency can stipulate what closing fees and mortgage points are acceptable.

Maximum Interest Rate

An interest rate can be specified that the lender must provide before the mortgage contingency is satisfied. This makes it so the buyer can back out of the contract if the costs are too high.

Can You Waive a Mortgage Contingency?

Yes. Mortgage preapproval can help make your offer more competitive, but you may still waive the mortgage contingency. In that case, your earnest money is at risk, and you’re not able to renegotiate the contract if the appraisal comes in low. Keep in mind that FHA and VA loans do not allow buyers to waive the appraisal (which is an important part of the financing contingency).

Reasons to Waive a Mortgage Contingency

There are some scenarios where it doesn’t make sense to include a mortgage contingency in the contract:

•   When the buyer is able to pay cash for the property. Cash buyers do not have to include a mortgage contingency.

•   When owner financing is involved. If the current owner of the home is financing the sale, buyers do not need to include a mortgage contingency.

•   When competition is extremely high. It might be a good idea to look at this option as a last resort, but in a market where sellers only accept offers without contingencies, this could be a buyer’s only way to win the contract.

💡 Quick Tip: One answer to rising house prices is a jumbo loan. Apply for a jumbo loan online with SoFi, and you could finance up to $2.5 million with as little as 10% down. Get preapproved and you’ll be prepared to compete in a hot market.

Other Common Types of Contingency Clauses

The financing contingency isn’t the only common one in a contract. Some others are:

•   Inspection contingency. This is a contingency that allows the buyer to exit the contract should the property fail a home inspection.

•   Appraisal contingency. This contingency is connected to the financing contingency. Should the property fail to appraise for the amount needed to finance the loan, the buyer would have the option of renegotiating or dropping the contract.

•   Title contingency. A property needs to be free of title defects for the sale of the property to go through.

•   Sale of home contingency. This contingency allows buyers to sell their current home before completing the purchase of a new home.

Recommended: How to Read a Preliminary Title Report

The Takeaway

A mortgage contingency protects homebuyers’ ability to get their earnest money back if financing falls through. Waiving the mortgage contingency in a hot market could put some house hunters at the front of the line, but it’s a risk only those feeling confident in their financial situation should take.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

FAQ

Can you waive a mortgage contingency?

Yes. Even if you need to obtain financing, waiving the mortgage contingency is an option.

What does no mortgage contingency mean?

No mortgage contingency means that buyers are willing to take on the risk of losing their earnest money if they are unable to secure financing by the closing deadline.

Should you waive mortgage contingency?

Homebuyers willing to take the risk of losing their earnest money to the seller to better compete are best poised to waive the mortgage contingency. Buyers who are not willing to risk their earnest money should not waive the mortgage contingency.

How long does a mortgage contingency usually take?

A mortgage contingency is usually set between 30 and 60 days.

Photo credit: iStock/kate_sept2004

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

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.

This article is not intended to be legal advice. Please consult an attorney for advice.

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When it comes to a personal loan vs. a personal line of credit, the two main differences are how the loan funds are disbursed to the borrower and how the credit is repaid.

There are also similarities between these two financial products. Funds from each can be used for a variety of expenses, with few exceptions. Also, to approve a personal loan or line of credit, lenders will run a hard credit check during the application process.

Deciding whether a personal loan or a personal line of credit might be right for you can require looking at a few different factors. Here, you’ll learn more about this important topic so you can make the best choice for your specific situation.

What Is a Personal Line of Credit and How Does It Work?

A personal line of credit (LOC) is a type of revolving credit similar to a credit card. But funds are typically accessed by writing checks provided by the lender or requesting a funds transfer to your checking account instead of by using a card.

An LOC typically allows the borrower to withdraw funds repeatedly, up to the credit limit. Any funds that are withdrawn are subject to repayment with interest. When they are repaid, they can be accessed again up to your particular credit limit. There may be a limit on the number of years the line of credit is available.

Additional points to know:

•   Some lenders may assess fees associated with an LOC. There may be a maintenance charge for inactive accounts. There may also be ongoing fees, monthly or annual, even if the LOC is being used. Some other expenses may include application fees, check processing fees, and late fees, among others. It’s important to be aware of any potential fees before you sign an LOC agreement.

•   Personal lines of credit are usually unsecured, although you may be able to put up collateral to get a lower interest rate. A home equity line of credit, or HELOC, is an example of a secured line of credit.

•   Typically, a personal LOC will be offered by a bank or credit union, and you might have to have another account with the lending institution to be considered for an LOC.

•   If your LOC is unsecured, the interest rate will probably be variable, which means it could go up or down during the loan’s term, and your payments could vary. But you’ll only be charged interest on the amount you withdraw. If you’re not using any LOC funds, you won’t be charged interest.

If you expect to have ongoing expenses or if you have a big expense (like a wedding or home renovation) but don’t know what your final budget will be, this type of borrowing might be a useful financial tool.

A personal LOC also may be the right fit if you need some flexibility with your borrowing. For example, self-employed workers who know they’ll be paid by a client but aren’t sure exactly when, can tap into their line of credit to pay expenses while they wait. They can pay that money back when they receive payment from the client, and they won’t have to use high-interest credit cards or borrow from other savings to make ends meet.

Of course, there are downsides to that easy-to-access money. Here’s a closer look:

•   Since unsecured lines of credit are considered by lenders to be riskier than their secured counterparts, it can be more difficult to qualify at a favorable interest rate.

•   Once you have access, it may be tempting to use the funds for purposes other than originally planned. Keeping in mind the intended purpose for the funds may help you stick to it and not use the funds for other purchases.

💡 Quick Tip: A low-interest personal loan from SoFi can help you consolidate your debts, lower your monthly payments, and get you out of debt sooner.

Pros and Cons of Personal Lines of Credit

Having funds that can be accessed as needed can be helpful. But there are also some drawbacks to consider. Take a look at how the pros and cons stack up for personal lines of credit.

Pros of Personal Lines of Credit

•   Easy access to funds.

•   Open-ended vs. set distribution of money.

•   Minimal limits on use of funds.

•   Can be useful for ongoing expenses.

Cons of Personal Lines of Credit

•   May have a higher interest rate than other forms of credit.

•   Typically are unsecured, so may be more difficult to qualify for than other forms of credit.

•   Interest rate may be variable, presenting a budgeting challenge.

•   Ease of access can be tempting to use for impulse shopping.

What Is a Personal Loan and How Does It Work?

A personal loan, on the other hand, is a fixed amount of money disbursed to the borrower in a lump sum. If the loan has a fixed interest rate, as is typical for personal loans, the payments are in fixed installments for the term of the loan. If the loan has a variable interest rate, the monthly payments may fluctuate as the interest rate changes in accordance with market rates.

Because personal loans typically have lower interest rates than credit cards, they’re often used to pay off other debts such as home and car repairs or medical bills, or to consolidate other higher-interest debts such as credit card balances into one manageable — and potentially lower — monthly payment.

Here are some more ways these loans are often used:

•   A personal loan can be a helpful tool for debt consolidation. If you can qualify for a personal loan that has a lower interest rate than your other outstanding debts, you may be able to save money in the long run by consolidating those debts. In order for this financial strategy to work, it’s important to stop using the old sources of credit to avoid going deeper into debt.

•   A personal loan also could be a suitable choice for paying for a wedding or home renovation. But it’s important that you feel confident about being able to repay the loan on time and in full. If you don’t responsibly manage a personal loan — or any kind of debt, for that matter — your credit can be adversely affected.

•   You can apply for a secured or unsecured personal loan. A secured loan, which is backed by collateral, is typically considered less of a risk by lenders than an unsecured loan is. Collateral is an asset the borrower owns — a vehicle, real estate, savings account, or other item of value. If the borrower fails to repay a secured loan, the lender has the right to take possession of the asset that was put up as collateral.

Here are a few more points about how the process of getting a personal loan can work:

•   An applicant’s overall creditworthiness will be considered during the approval process. Generally, an applicant with a higher credit score will qualify for a lower interest rate, and vice versa.

•   Some lenders charge personal loan fees such as origination fees or prepayment penalty fees. Before signing a loan agreement, it’s important to be aware of any fees you may be charged.

💡 Quick Tip: In a climate where interest rates are rising, you’re likely better off with a fixed interest rate than a variable rate, even though the variable rate is initially lower. On the flip side, if rates are falling, you may be better off with a variable interest rate.

Pros and Cons of Personal Loans

When you need a set amount of money for an expense, a personal loan can be a good choice. Along with the benefits of using this financial tool also come a few drawbacks to consider.

Pros of Personal Loans

•   May be a good choice for large, upfront expenses.

•   Typically have fixed interest rates.

•   Steady payments may be easier to budget for.

•   May have a lower interest rate than credit cards.

Cons of Personal Loans

•   Unsecured personal loans may have higher interest rates than other forms of secured credit.

•   May need a higher credit score to qualify for lower interest rates.

•   If not used responsibly, it can add to a person’s debt load instead of alleviating it.

•   May have fees.

Major Differences Between Personal Lines of Credit and Personal Loans

When you’re looking for the right source of funding for your financial needs, it can help to compare different types. Here are some specifics to consider when looking at personal LOCs and personal loans.

Considering the Type of Debt

When you’re thinking about applying for a personal LOC or a personal loan, it’s important to consider the effect borrowing money can have on your credit score. If you borrow money without a repayment plan in place, you could run into trouble no matter which borrowing option you go for. But each is looked at differently by the credit bureaus.

A personal LOC is revolving debt, which means it will factor into your credit utilization ratio — how much you owe compared to the amount of credit that’s available to you. This can count as the second most weighty factor (at 30%) toward your score.

For a FICO® Score, keeping your total credit utilization rate below 30% is recommended. That means if your credit limit on is $15,000, you would use no more than $4,500.

•   Using a large percentage of your available credit can have a negative effect on your credit score. And lenders may see you as a high-risk applicant because they may assume you’re close to maxing out your credit cards.

•   Using a small percentage of your available credit can work in your favor. If your credit utilization ratio is low (under 10%), it signifies to potential lenders that other lenders have determined you to be a good risk, but you don’t need to use the credit that’s been extended to you.

•   Having a low credit utilization rate by using just a little of your available credit could actually have a more positive effect on your credit score than not using any of it at all. Lenders generally look for signifiers of a healthy relationship with credit.

A personal loan is installment debt and isn’t considered in your credit utilization ratio. In fact, if you pay off your revolving debt with a personal loan, it potentially can lower your credit utilization ratio and have a positive effect on your credit score. A personal loan also can add some positive variety to your credit mix — something else that’s calculated into your credit score.

Personal LOC or Personal Loan: Which Is Right for You?

Before you decide to take out a line of credit or a personal loan, it’s wise to compare lenders. Look at the annual percentage rate and whether it’s fixed or variable. You can also take into account any fees you might have to pay, including origination fees, annual fees, access fees, prepayment penalties, and late payment fees.

Estimating the total cost of the loan until it’s paid in full, including the principal loan amount, interest owed, and any fees or penalties you could potentially be charged, will help you figure out how much the loan will actually cost you.

You might use an online personal loan calculator to help you assess these total costs.

The Takeaway

Deciding when and how to borrow money can be a tough decision. Personal loans and personal lines of credit each have their pros and cons. Personal lines of credit allow you to borrow up to a credit limit, while personal loans disburse a lump sum. Interest rates, fees, and other features may vary. It’s wise to consider your needs and options carefully, reading the fine print on possible offers.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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.

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The average student loan borrower with federal loans graduates with $37,338 in debt. If you were to pay that amount on the Standard Repayment Plan at a rate of 5.50%, you’d have to shell out $405 per month for the next 10 years.

But depending on where life takes you after graduation, you may not be able to afford it. There are plenty of circumstances that may make repayment difficult, including going back to school, going into active military duty, and losing a job.

As such, it’s important to know how to pause student loan payments when you can’t afford them. Depending on who your lender is, though, the options can vary.

Repayment of federal student loans was effectively paused from spring 2020 until fall of 2023, but the Debt Ceiling bill required payments to restart in October 2023. However, there are still options available to borrowers who need to pause payment on their student loans.

Two Ways You Can Pause Student Loan Payments

Depending on your situation, you may be able to pause student loan payments through student loan deferment or forbearance. Each of these options has different requirements and outcomes, so it’s essential to understand how they work.

1. Student Loan Deferment

Student loan deferment allows you to reduce or pause your payments for a set period of time. In the meantime, however, the deferred loan will continue to accrue interest, in most cases. For example, if you have an unsubsidized loan or a PLUS loan, you’ll need to make interest-only payments during the deferment, otherwise the interest will capitalize (be added to the loan balance) at the end of the deferment period.

This means that you’ll have a new, higher balance that includes the principal amount at the beginning of the deferment period plus the unpaid interest that accrued during deferment.

The exception is if you have subsidized federal loans or Perkins Loans, in which case you won’t be responsible for paying accrued interest.

2. Student Loan Forbearance

Another option is putting loans in forbearance. Like deferment, forbearance allows qualified applicants to delay payments for a set period of time.

The primary difference is that you’re responsible for paying any interest that accrues during the forbearance period, regardless of which type of loan you have.

Again, it is possible to make interest-only payments during the forbearance period. Under new rules introduced in 2023, though, unpaid interest that accrues during forbearance will not capitalize at the end of the forbearance period.

While these general definitions apply to both federal and private student loans, some details differ between the two.


💡 Quick Tip: Enjoy no hidden fees and special member benefits when you refinance student loans with SoFi.

Federal Student Loans

The U.S. Department of Education offers both deferment and forbearance on all of its student loans. With the exception of the pandemic-era federal forbearance period that came to an end in fall 2023, neither comes automatically. Both deferment and forbearance need to be applied for through your student loan servicer. Here’s what you need to know about both options.

Qualifying for Federal Loan Deferment

If you have federal loans, you may be able to defer your student loan payments for up to three years. Here’s how to know if you may be eligible:

•   You have any federal student loan, subsidized or unsubsidized.

•   You’re enrolled at least half-time at an eligible school, and you received a Direct PLUS Loan or FFEL PLUS Loan as a graduate or professional student. In this case, your loans will be deferred while you’re in school at least half-time plus six months after you leave.

•   You’re a parent who took out a Direct PLUS Loan or FFEL PLUS Loan on behalf of your child student, and they’re enrolled at least half-time at an eligible school. In this case, your loans will be deferred while your child remains in school plus six months after they leave.

•   You’re enrolled in an approved graduate fellowship program.

•   You’re enrolled in an approved rehabilitation training program for the disabled.

•   You’re unemployed and unable to find employment.

•   You’re experiencing economic hardship.

•   You’re serving in the Peace Corps.

•   You’re on active duty military service in connection with a war, military operation or national emergency. In this case, your loans will be deferred while you’re on active duty plus 13 months afterward.

You can read more about deferment eligibility here .

Qualifying for Federal Loan Forbearance

The federal government has two types of forbearance: general and mandatory. Both can last for up to 12 months at a time. But if you still qualify once that period is up, you can request a renewal.

General forbearance is also sometimes called discretionary forbearance because your loan servicer gets to choose whether or not to approve your request.

You can request general forbearance if you’re unable to make your monthly payments due to:

•   Financial difficulties

•   Medical expenses

•   Change in employment

•   Other reasons your loan servicer will accept

Mandatory forbearance is not at the discretion of your loan servicer, and can be granted if you meet any of the following requirements:

•   You’re serving in a medical or dental internship or residency program and meet specific requirements.

•   The total amount you owe on all of your loans is 20% or more of your gross monthly income.

•   You’re serving in an AmeriCorps position for which you’ve received a national service award.

•   You’re a teacher and qualify for teacher loan forgiveness.

•   You qualify for partial payments on your loans through the U.S. Department of Defense Student Loan Repayment Program.

•   You’re a member of the National Guard and have been activated by a governor, but don’t qualify for the military deferment.

You can read more details about eligibility requirements for forbearance here .

A Note on the Temporary On-Ramp Period

If you’re currently struggling to manage federal student loan payments, you may be able to take advantage of a temporary repayment on-ramp period without having to rely on deferment or forbearance. This period, which takes place from Oct. 1, 2023 to Sept. 30, 2024, protects financially vulnerable borrowers from the consequences of missing payments. Those who miss payments will not have them reported to the credit bureaus or collections agencies, and loans will not be considered delinquent or in default. However, once this on-ramp period is over, any missed payments will be due.

Private Student Loans

While the options and requirements for these programs are clear on federal student loans, they can be a little trickier with private loans.

That’s because there are so many different private student lenders, and each has its own policy and criteria for determining eligibility.

Unfortunately, there’s no mandatory forbearance option like there is with federal loans. Instead, it’s typically at the lender’s discretion to determine whether you qualify.

Also, the deferment and forbearance periods can vary by lender. For example, you may need to apply every few months, and you may be limited on how often you can apply.

Since there’s no real consistency among private student lenders, if you borrowed a private loan it’s important to check with your lender directly to find out what their policy is.

How Deferment and Forbearance Can Affect You

When you request a deferment or forbearance on your federal loans, it will be noted on your credit report. However, neither option will have a negative impact on your credit score.

That said, if you miss a payment while you’re waiting for your deferment or forbearance request to get approved, it may hurt your credit. At 90 days overdue, your lender can report the missed payment(s) to the credit bureaus.

Because of this, it may be wise to continue making payments as usual until you receive the official approval for your deferment or forbearance with an effective date.

Also, since interest accrued during a deferment can capitalize at the end of the period, you could end up with a higher balance and monthly payment than when you started.

If you originally wanted to pause student loan payments because you couldn’t afford them, a higher payment could make things more difficult. Take interest into account while considering these options.

What If You Don’t Qualify to Pause Student Loan Payments?

Depending on your lender and situation, you may not be eligible for deferment or forbearance. If this happens, there are a couple of options to consider.

Income-Driven Repayment Plans

If you have federal student loans, it may be possible to reduce your monthly payment by enrolling an income-driven repayment plan, such as the newest SAVE plan.

If you qualify, you can decrease your monthly payment to a percentage of your discretionary income. It won’t stop your loan payments altogether, but it can help make them more affordable.

Refinancing Your Student Loans

Whether you have federal or private loans, you can opt to refinance your student loans. Refinancing could help you save money by reducing your monthly payment, either by securing a lower interest rate or lengthening the repayment term. Note that you may pay more interest over the life of the loan if you refinance with an extended term.

You may also be able to switch to a different lender that offers hardship programs or other support if you’re having trouble making payments.

Keep in mind that refinancing federal loans with a private lender will cause you to lose certain benefits, including income-driven repayment options and access to federal loan forgiveness programs.

Determine If Pausing Student Loan Payments Is Right for You

As you’re considering your options and seeing whether you qualify, take a step back and think about whether deferment or forbearance are right for you in the long run.

And if you find that your current lender’s options aren’t enough, consider refinancing your student loans with a lender that provides what you need.

Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.

SoFi Student Loan Refinance
SoFi Student Loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891. (www.nmlsconsumeraccess.org). SoFi Student Loan Refinance Loans are private loans and do not have the same repayment options that the federal loan program offers, or may become available, such as Public Service Loan Forgiveness, Income-Based Repayment, Income-Contingent Repayment, PAYE or SAVE. Additional terms and conditions apply. Lowest rates reserved for the most creditworthy borrowers. For additional product-specific legal and licensing information, see SoFi.com/legal.