Dec
04
2023
Target Funds vs Index Funds: Key Differences

Target Funds vs Index Funds: Key Differences

By | Growing Wealth, invest, Investing | Comments Off on Target Funds vs Index Funds: Key Differences

Target-date funds and index funds are two common investment vehicles for individuals investing for retirement. Investors may see one or both of these types of investment as options in their 401(k) or other workplace retirement fund. Target-date funds offer a sort of set-it-and-forget-it approach to investing typically tied to an investor’s timeline, while index funds include a basket of investments corresponding to an underlying index.

Understanding the key differences between target date funds and index funds to help investors understand which is right for their portfolio.

Target-Date Funds vs Index Funds: A Comparison

Target-date funds and index funds are both common ways for investors to save for future goals, especially retirement. Target-date funds offer what can feel like a hands-off approach to saving for retirement. In a way, they’re like a retirement plan inside a single investment vehicle. Investors do not have to choose the funds held by target date funds or reallocate the fund as it nears its target date.

Target-date funds may include index funds. Index funds track specific indices and typically perform in line with the broader market.

Here’s a quick look at the main differences between these two types of funds.

Target Date Funds

 Index Funds

•   Reallocated automatically. Portfolios typically become more conservative as a target date approaches.

•   A fund of funds that provides investors with diversification and a single set-it-and-forget-it solution to retirement savings.

•   Passive management translates into lower fees.

•   Designed to track an index, such as the S&P 500, and provide returns similar to the movements of the index.

•   Allows investors more flexibility in choosing the funds in their portfolios.

Target-Date Funds

A target date fund is a type of investment that holds a mix of different mutual funds, usually including stock and bond funds. When choosing a target date fund, investors must decide on a target date, often offered in five-year intervals and included in the name of the fund and corresponding with the year in which they want to retire. For example, someone in their early 30s might choose a target date of 2055 with a goal of retiring around age 65.

You could, in theory, use target date funds to save for any point in the future. However, they’re a popular type of financial security for saving for retirement and often appear on the menu of investments available to employees through their 401(k)s.

As an individual nears their target date, the fund automatically rebalances from high-risk, high-reward investments into low-risk, low-reward investments. For example, the rebalancing might include shifting a greater proportion of its holdings into bonds to help preserve accrued increases in a portfolio’s value.

Pros of Target-Date Funds

There are several reasons investors might choose a target date fund.

First, they essentially provide a ready-made portfolio of diversified stock and bond funds, making it easy to save for retirement. This may appeal to beginner investors or those who don’t want to design their own portfolios or those who find a hand-on approach to researching and choosing investments difficult.

Additionally, target-date funds provide automatic rebalancing. As the market shifts up and down, different investments may move off track from their initial allocations. When that happens, the fund will rebalance itself so that the allocation remains in line with its original allocation plan. The target date fund also automatically shifts its allocation to more conservative investments as the target date approaches.

Recommended: When Can I Retire? This Formula Will Help You Know

Cons of Target-Date Funds

Investors who want more control over their portfolios may not like target-date funds, which don’t allow investors any control over their mix of investments or when and how rebalancing takes place.

Target-date funds build portfolios using a variety of investments. Some may use index mutual funds that come with relatively low fees. Others might use managed mutual funds, which may come with higher fees. It’s important to look closely at target-date fund holdings to understand what types of fees they might charge.

Here are the pros and cons of target date funds at a glance.

Pros

 Cons

•   Ready-made portfolio.

•   Diversification through a basket of mutual funds.

•   Automatic rebalancing, including a shift to more conservative assets over time.

•   Lack of control over investments and when portfolio is rebalanced.

•   Potentially higher fees for funds that hold managed mutual funds.



💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

Index Funds

An index fund is a type of mutual fund or exchange-traded fund (ETF). It’s built to follow the returns of a market index, of which there are many.

These indexes track a basket of securities meant to represent the market as a whole or certain sectors. For example, the S&P 500 is a market capitalization weighted index that tracks the top 500 U.S. stocks.

An index fund may follow a market index using several strategies. Some index funds may hold all of the securities included in the index. Others may include only a portion of the securities held by an index, and they may have the leeway to include some investments not tracked by the index.

Because index funds are attempting to follow an index rather than beat it, they don’t require as much active management as fully managed funds. As a result, they may charge lower fees, making them a low-cost option for investors.

Index funds are popular choices for retirement savings accounts. They offer diversification through exposure to a wide range of securities, they’re easy to manage, and they offer the potential for steady long-term growth.

Pros of Index Funds

Low fees and full transparency are among the benefits of holding index funds. Investors can review all of the securities held by the fund, which can help them identify and weigh risk. Also, because they track an index, which updates its numbers constantly, it is unlikely fund managers will be blindsided by something they were unable to anticipate.

Index funds also potentially offer better returns than their actively managed counterparts, especially after factoring in fees.

Recommended: Index Funds vs Managed Funds: Key Differences

Cons of Index Funds

Some of the drawbacks to index funds include the fact that they are often fairly inflexible. If they follow an index that requires them to hold a certain mix of stocks, fund managers will hang on to them even if they are performing poorly. In actively managed funds, fund managers can swap out slumping securities in favor of those that are outperforming. In fact, by design, index funds rarely beat the market.

Here’s a look at the pros and cons of index funds at a glance.

Pros

 Cons

•   Diversification through a basket of securities that tracks an index.

•   Transparency.

•   Lower fees. Passive management makes it cheaper to operate funds, which results in lower management fees passed on to investors.

•   Steady gains and potentially better returns than actively managed funds.

•   Lack of flexibility. Index fund managers follow stricture mandates about what can and can’t be included in the fund.

•   Index funds do not typically outperform the market.

Index Funds for Retirement

You can use index funds to build a retirement portfolio as well as to save for other goals. If you’re using them for retirement, you may want a mix of index funds covering a range of asset classes that can provide some diversity within your overall portfolio. Unlike a target-date fund, if that allocation strays from your goals, you’ll need to handle the rebalancing on your own.

Recommended: Are Mutual Funds Good for Retirement?

The Takeaway

Index funds and target-date funds are funds used by retail investors for different purposes. Investors choosing between the two will need to consider their personal financial circumstance and needs. Index funds may be an option for investors looking for passive, long-term investments that they can choose based on their own goals, risk tolerance, and time horizon. They may also be right for beginners who are looking for simple, low-cost investment options.

Target date funds, on the other hand, may be another option for long-term investors who do not want to have to rethink their portfolio allocations on a regular basis. These investors may not want to or know how to pick funds themselves.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).


For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/Ridofranz

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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.

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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04
2023
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Investing vs. Speculation: Understanding the Core Differences

By | Growing Wealth, invest, Investing | Comments Off on Investing vs. Speculation: Understanding the Core Differences

All investments carry some risk, but the difference between speculating and investing is the amount of risk involved. Speculative investments are typically short-term, and far riskier than traditional investing products and strategies, and may involve the risk of total loss.

Investing typically indicates a more long-term approach to making a profit, with an eye toward managing risk.

Defining Investing and Speculation

Speculating often describes scenarios when there’s a high chance the investment will deliver losses, but also when the investment could result in a high profit. High-risk, high-reward investments include commodities, crypto, derivatives, futures, and more.

In contrast, investing generally refers to transactions where an individual has researched an asset, and puts money into it with the hope that prices will rise over time. There are no guarantees, of course, and all types of investing include some form of risk.

Examples of Investments and Speculative Investments

Assets that are thought of as more traditional types of investments include publicly traded stocks, mutual funds, exchange-traded funds (ETFs), bonds (e.g. U.S. Treasury bonds, municipal bonds, high-grade corporate bonds), and real estate.

Even some so-called alternative investments would be considered more long-term and less speculative: e.g., jewelry, art, collectibles.

Assets that are almost always considered speculative are junk bonds, options, futures, cryptocurrency, forex and foreign currencies, and investments in startup companies.

Sometimes it isn’t as simple as saying that all investments in the stock market or in exchange-traded funds or in mutual funds hold the same amount of risk, or are “definitely” classified as investments. Even within certain asset classes, there can be large variations across the speculation spectrum.


💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

The Traditional Approach to Investing

When it comes to the more traditional approach to investing, individuals typically buy and hold assets in their investment portfolios or retirement accounts, with the aim of seeing reasonable, long-term gains.

Traditional forms of investing focus on the performance of the underlying business or organization, not on the day-to-day or hour-by-hour price movements of an asset.

For this reason, more traditional investors tend to rely on various forms of analysis (e.g. fundamental analysis of stocks) and analytical tools and metrics to gauge the health of a company, asset, or market sector.

Speculation: A High-Risk, High-Reward Game

The difference between speculating and investing can be nuanced and a matter of opinion. (After all, some investors view the stock market as a form of gambling.) But when traders are speculating, they are typically seeking super-high gains in a relatively short period of time: e.g., hours, days, or weeks.

In the case of commodities or futures trading, the time horizon might be longer, but the aim of making a big profit fairly quickly is at the heart of most speculation.

Speculators may also use leverage, a.k.a. margin trading, to boost their buying power and amplify gains where possible (although using leverage can also lead to steep losses).

The Psychology of Investing vs. Speculating

The psychology of a typical investor is quite different from that of a speculative investor, and again revolves around the higher tolerance for risk in pursuit of a potentially bigger reward in a very short time frame.

Long-Term Investing

 Speculating
Taking calculated or minimal risks Willing to take on high-risk endeavors
Pursuit of reasonable gains Pursuit of abnormally high returns
Willing to invest for the long term Willing to invest only for the short term
Uses a mix of traditional investments and strategies (e.g. stocks, bonds, funds) Uses single strategies and alternative investments
Infrequent use of leverage/margin Frequent use of leverage/margin

Historical Perspectives on Investing and Speculation

The history of investing and speculating has long been entwined. In the earliest days of trading thousands of years ago, most markets were focused on the exchange of tangible commodities like livestock, grain, etc. Wealthy investors might put their money into global voyages or even wars. Thus many early investors could be described as speculators.

But investing in forms of debt as a way to make money was also common, eventually leading to the bond market as we know it today.

The concept of investing in companies and focusing on longer-term gains took hold gradually. As markets became more sophisticated over the centuries, and a wider range of technologies, strategies, and financial products came into use, the division between investing and speculating became more distinct.

Recommended: What Causes a Stock Market Bubble?

Speculation History: Notable Market Bubbles and Crashes

The history of investing is rife with market bubbles, manias, and crashes. While the speculative market around tulip bulbs in 17th-century Holland is well known, as is the Great Financial Crisis here in the U.S. in 2008-09, there have been many similar financial events throughout the world — most of them driven by speculation.

What marks a bubble is a well-established series of stages driven by investor emotions like exuberance (i.e., greed) followed by panic and loss. That’s because many investors tend to be irrational, especially when in pursuit of a quick profit that seems like “a sure thing.”

Some classic examples of financial bubbles that changed the course of history:

•   The South Sea Bubble (U.K., 1711 to 1720) — The South Sea company was created in 1711 to help reduce national war debt. The company stock peaked in 1720 and then crashed, taking with it the fortunes of many.

•   The Roaring Twenties (U.S., 1924 to 1929) — The 1920s saw a rapid expansion of the U.S. economy, thanks to both corporations’ and consumers’ growing use of credit. Stock market speculation reached a peak in 1929, followed by the infamous crash, and the Great Depression.

•   Japanese Bubble Economy (1984 to 1989) — The Japanese economy experienced a historic two-decade period of growth beginning in the 1960s, that was further fueled by financial deregulation and widespread speculation that artificially inflated the worth of many corporations and land values. By late 1989, as the government raised interest rates, the economy fell into a prolonged slowdown that took years to recover from.

•   Dot-Com Bubble (1995 to 2002) — Sparked by rapid internet adoption, the dot-com boom saw the rapid growth of tech companies in the late 1990s, when the Nasdaq rose 800%. But by October 2002 it had fallen 78% from that high mark.

Key Differences Between Investing and Speculating

What can be confusing for some investors is that there is an overlap between investing in the traditional sense, and speculative investing in higher risk instruments.

And some types of investing fall into the gray area between the two. For example, options trading, commodities trading, or buying IPO stock are considered high-risk endeavors that should be reserved for more experienced investors. What makes these types of investments more speculative, again, is the shorter time frame and the overall risk level.

Time Horizon: Long-term Goals vs. Quick Gains

As noted above, investors typically take a longer view and invest for a longer time frame; speculators seek quick-turn profits within a shorter period.

That’s because more traditional investors are inclined to seek profits over time, based on the quality of their investments. This strategy at its core is a way of managing risk in order to maximize potential gains.

Speculators are more aggressive: They’re geared toward quick profits, using a single strategy or asset to deliver an outsized gain — with a willingness to accept a much higher risk factor, and the potential for steep losses.

Fundamental Analysis vs. Market Timing

As a result of these two different mindsets, investors and speculators utilize different means of achieving their ends.

Investors focused on more traditional strategies might use tools like fundamental analysis to gauge the worthiness of an investment.

Speculators don’t necessarily base their choices on the quality of a certain asset. They’re more interested in the technical analysis of securities that will help them predict and, ideally, profit from short-term price movements.
While buy-and-hold investors focus on time in the market, speculators are looking to time the market.


💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Real-World Implications of Investment vs. Speculation

To better understand the respective value and impact of investing vs. speculating, it helps to consider the real-world implications of each strategy.

The Impact of Speculation on Markets

It’s important to remember that speculation occurs in many if not all market sectors. So speculation isn’t bad, nor does it always add to volatility — although in certain circumstances it can.

For example, some point to IPO shares as an example of how speculative investors, who are looking for quick profits, may help fuel the volatility of IPO stock.

Speculation does add liquidity to the markets, though, which facilitates trading. And speculative investors often inject cash into companies that need it, which provides a vital function in the economy.

Strategic Approaches to Investment

Whether an investor chooses a more traditional route or a more speculative one, or a combination of these strategies, comes down to that person’s skill, goals, and ability to tolerate risk.

Diversification and Asset Allocation

For more traditional, longer-term investors, there are two main tools in their toolkit that help manage risk over time.

•   Diversification is the practice of investing in more than one asset class, and also diversifying within that asset class. Studies have shown that by diversifying the assets in your portfolio, you may offset a certain amount of investment risk and thereby improve returns.

•   Asset allocation is the practice of balancing a portfolio between more aggressive and more conservative holdings, also with the aim of growth while managing risk.

When Does Speculation Make Sense?

Speculation makes sense for a certain type of investor, with a certain level of experience and risk profile. It’s not so much that speculative investing always makes sense in Cases A, B, or C. It’s more about an investor mastering certain speculative strategies to the degree that they feel comfortable with the level of risk they’re taking on.

The Takeaway

One way to differentiate between investment and speculation is through the lens of probability. If an asset is purchased that carries a reasonable probability of profit over time, it’s an investment. If an asset carries a higher likelihood of significant fluctuation and volatility, it is speculation.

A long-term commitment to a broad stock market investment, like an equity-based index fund, is generally considered an investment. Historical data shows us that the likelihood of seeing gains over long periods, like 20 years or more, is high.

Compare that with a trader who purchases a single stock with the expectation that the price will surge that very day (or even that year!) — which is far more difficult to predict and has a much lower probability of success.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).


Invest with as little as $5 with a SoFi Active Investing account.


SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.


Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

*Borrow at 11%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure 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.

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Strategies for Lowering Your Student Loan Interest Rate

By | Budgeting & Goals, Financial Independence, Fresh Out of School, Student Loans, student_loan | No Comments

When you’re in college, you don’t have a lot of control over the interest rates on your student loans. With federal loans, the U.S. Department of Education sets the rate each year for all borrowers. And if you get private student loans, a limited credit history can make it hard for young people to score favorable terms.

But once you graduate, there are a few things you can try to save money on interest. Here are a few tips that may lower your interest rate on student loans.

Refinancing Your Student Loans

Scoring discounts with your current servicer can help you get a lower student loan interest rate, but there is another option to consider. Depending on your financial profile, you may qualify for a lower student loan interest rate than what you’re currently paying with student loan refinancing.

There are multiple advantages to refinancing student loans. You can potentially lower your interest rate by bundling several loans (federal and private) into one new loan. And if you shorten your loan term, you may be able to pay off your student loans much faster and pay less in interest over the life of your loan.

Student Loan RefinancingStudent Loan Refinancing

Student loan refinancing is ideal for borrowers with high-interest student loans who have good credit scores and know they won’t use any of the federal loan benefits, like student loan forgiveness. (All federal loan benefits, including income-based repayment, will be lost if you refinance.)

Here are a few things that can help you improve your chances of getting a lower student loan interest rate with refinancing:

•   A high credit score: Lenders typically have a minimum credit score requirement, so the higher your score, the better your chances of getting a low rate usually are.

•   A low debt-to-income (DTI) ratio: Your income is also an important factor that lenders consider, especially as it relates to your overall debt burden. If a smaller portion of your monthly income goes toward debt payments, it shows you may have more income to dedicate to your new loan’s payments.

•   A co-signer: Even if your credit and income situation is in good shape, having a co-signer with great credit and a solid income might help your case.

•   A variable rate: Some student loan refinance lenders offer both variable and fixed interest rates. Variable interest rates may start out lower but increase over time with market fluctuations. Fixed rates, stay the same over the life of the loan. If you’re planning on paying off your student loans quickly, a variable rate might save you money.

•   The right lender: Each lender has its own criteria for setting interest rates, so it’s important to shop around to find the best lender for your needs. Some lenders, including SoFi, even allow you to view rate offers before you officially apply.


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

Take control of your student loans.
Ditch student loan debt for good.

Consolidate Your Student Loans

Have multiple student loans floating around that you’d love to combine into one? Consider loan consolidation, where you’ll merge all your student loans into one easy monthly payment with a single interest rate. Here’s the rub, though: Consolidation alone does not necessarily get you a lower student loan interest rate. It just offers you one payment instead of multiple.

When consolidating federal student loans, you can use a Direct Consolidation Loan. Your new interest rate is simply the weighted average of all your current student loan interest rates. The weighted average might be a smidge higher than the interest rates you were paying previously. Often folks utilize consolidation to stretch out the life of their student loan, which lowers your payments but may increase the amount you owe over time.

Even though consolidation itself is not a direct way to get a better rate on your student loans, it can be helpful if you’re having trouble keeping track of your monthly payments. Consolidation may also be useful if you want to merge non-direct federal loans (like Perkins loans) with direct loans, in order to qualify for income-driven repayment and/or loan forgiveness programs.

By the way, the term “consolidating” is often used interchangeably with “refinancing,” but they technically mean different things. When refinancing student loans, you also happen to be consolidating, but it is done with the goal of achieving a more favorable interest rate on your student loans.

Recommended: The Basics of the Student Loans

Set Up Automatic Payments

Many student loan servicers — both federal and private — offer an interest rate discount if you set up autopay on your account. Depending on the servicer, you can lower your student loan interest rate. SoFi, for example, offers a 0.25% autopay discount.

The reason servicers offer this discount is that by setting up automatic payments, you’re less likely to miss payments and default on the loan.

In addition to getting a lower student loan interest rate, you’ll also (hopefully!) have peace of mind knowing that you won’t accidentally miss a payment. If you feel you’re putting a little too much money toward student loans, check with your loan servicer to see whether they offer an autopay discount.

To get an idea of how a change in interest rate would impact your loan, take advantage of a student loan refinance calculator to see what your new payments could be.


💡 Quick Tip: Refinancing could be a great choice for working graduates who have higher-interest graduate PLUS loans, Direct Unsubsidized Loans, and/or private student loans.

Choose the Right Repayment Plan

If you don’t choose a specific repayment path, you’re typically opted into the Standard Repayment Plan. In this plan, your payments are generally based on a 10-year timeline. But this one-size-fits-all plan is not the best option for everyone.

The federal government also offers four income-driven repayment (IDR) plans — Pay As You Earn (PAYE), Saving on a Valuable Education (SAVE), Income-Based Repayment (IBR), and Income-Contingent Repayment (ICR) — where the monthly payments are based on your income and family size. While choosing one of these plans may lower your monthly payments, it will likely not alleviate how much interest you pay over time. In fact, you might even pay significantly more.

After 20 or 25 years, depending on the IDR plan, any remaining balance is forgiven. However, the amount forgiven may be considered taxable income by the IRS. So even though your student loan debt goes away, prepare yourself for a big tax bill that year.

Another money-saving repayment option for federal student loans is the Public Service Loan Forgiveness (PSLF) program. If you work in a qualifying public service job — for the government or a nonprofit organization — you might be eligible to have your student loans forgiven after 10 years of service.

You can confirm whether your work qualifies here. You’ll want to submit an Employment Certification as soon as possible to be sure that you’re on track to qualify.

Recommended: 4 Student Loan Repayment Options, and How to Choose

Lower Your Student Loan Interest Rate

There are several ways to get a lower student loan interest rate. It can be as easy as calling your servicer to find out what discounts are available. You can also choose a new repayment plan, consolidate your federal loans, or refinance federal and private loans. With refinancing, you may secure a lower interest rate if you have a high credit score, low debt-to-income ratio, a cosigner, or a variable interest rate. Just know that when refinancing federal student loans, borrowers lose federal protections and forgiveness.

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.

With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.

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.


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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.

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

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.

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.

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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Solo 401(k): The Retirement Plan Built for the Self-Employed

Navigating Solo 401(k) Plans: A Complete Guide for the Self-Employed

By | invest, Investing, Preparing for Retirement | Comments Off on Navigating Solo 401(k) Plans: A Complete Guide for the Self-Employed

Being self-employed offers many perks, including freedom and flexibility. What it doesn’t offer is an employer-sponsored retirement plan. But when you don’t have access to a 401(k) at work, opening a solo 401(k) can make it easier to stay on track with retirement planning.

Before you establish a solo 401(k) for yourself, it’s important to understand how these plans work and the pros and cons involved.

What Is a Solo 401(k)?

A solo 401(k) is a type of 401(k) that’s designed specifically with self-employed individuals in mind. This retirement savings option follows many of the same rules as workplace 401(k) plans in terms of annual contribution limits, tax treatment, and withdrawals. But it’s tailored to individuals who run a business solo or only employ their spouses.

It’s one of several self-employed retirement options you might consider when planning a long-term financial strategy.

Definition and Overview

A solo 401(k) is a tax-advantaged retirement account that’s for self-employed individuals and business owners who have zero employees, or no employees other than their spouse. This type of 401(k) plan is also known by a few other names:

•   Solo-k

•   Uni-k

•   One-participant plan

Traditional solo 401(k) contributions are made using pre-tax dollars. However, it’s possible to open a Roth solo 401(k) instead. In the case of a Roth solo 401(k), you’d make contributions using after-tax dollars and be able to withdraw the money tax-free in retirement.

A self-employed 401(k) plan works much the same as a regular 401(k). For instance, you may be able to take loans from your savings if needed. Catch-up contributions are also allowed. The biggest difference is that there is no matching contribution from an outside employer.

You can start investing in a solo 401(k) for yourself through an online brokerage. There’s some paperwork you’ll need to fill out to get the process started, but once your account is open you can make contributions year-round.

At the end of the year, the IRS requires solo 401(k) plan owners to file a Form 5500-EZ if the account has $250,000 or more in assets.


💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Contribution Limits in Solo 401(k) Plans

Much like workplace 401(k)s, there are annual contribution limits that apply to solo 401(k) plans.

The IRS caps total contributions to a solo 401(k) account at $66,000 for 2023 and $69,000 for 2024. That doesn’t include catch-up contributions for those age 50 and over, which are an additional $7,500 for each year.

As both the employee and employer of your own business, you can contribute both elective salary deferrals and employer nonelective contributions (you are both the employer and the employee in this scenario). Each has different contribution caps.

Annual Contribution Limits

As an employee, you can contribute up to 100% of your earned income up to the annual contribution limit: $22,500 in 2023 and $23,000 in 2024, plus an additional $7,500 for those age 50+ in elective salary deferrals.
In addition, you can make employer nonelective contributions. These come directly from the “employer” (aka you) and are not deducted from the employee’s (your) salary. As an employer, you can contribute up to 25% of your self-employment income (business income – ½ self-employment tax and elective salary deferrals), in pre-tax dollars.

Setting Up a Solo 401(k) Plan

If you’re interested in setting up a solo 401(k) for yourself, you can do so through an online brokerage. Here’s a step-by-step guide for how to open a solo 401(k).

Steps to Establish Your Plan

1. Choose a Plan Administrator

A plan administrator is the person responsible for managing your solo 401(k). It’s their job to make sure the plan is meeting reporting and other requirements established by the IRS. If you’re self-employed, you can act as your own plan administrator or you could choose your accountant instead.

2. Choose a Brokerage

Once you know who’s going to manage the plan, the next step is deciding where to open it. A number of brokerages offer solo 401(k) plans so you may want to spend some time comparing things like:

•   Account setup process

•   Investment options

•   Fees

You may be able to start the solo 401(k) account setup process online, though some brokerages require you to call and speak to a representative first. And you may need to finalize your account opening by mailing or faxing in any supporting documents the brokerage needs to complete the application.

3. Fill Out a Solo 401(k) Application

Before you can start a 401(k) account for yourself, you’ll need to give your brokerage some information about your business. A typical solo 401(k) application may ask for your:

•   First and last name

•   Employer Identification Number (EIN)

•   Plan administrator’s name and contact information

•   Social Security number

•   Mailing address

•   Citizenship status

•   Income information

You’ll also need to disclose any professional associations or affiliations that might result in a conflict of interest with the brokerage. In completing the application, you’ll be asked to name one or more beneficiaries. You may also be asked to provide bank account information that will be used to make your initial contribution to the plan.

4. Choose Your Investments

Once you’ve returned your solo 401(k) account application and it’s been approved, you can choose your investments. The type of investments offered can depend on the brokerage and the plan. But typically, you may be able to choose from:

•   Target-date funds

•   Index funds

•   Actively managed funds

•   Exchange-traded funds (ETFs)

Whether you have access to individual stocks, bonds, CDs, or alternative investments such as commodities can depend on the platform that’s offering the plan.

5. Decide How Much to Contribute

You may choose to schedule automatic investments or make them manually according to a schedule that works for you.

Choosing Between Traditional and Roth Solo 401(k)s

You can opt for a traditional solo 401(k), which is made with pre-tax dollars, or a Roth solo 401(k), which is made with after-tax dollars. Which plan is better for you may depend on what you expect your income to be in retirement.

If you believe your income will be higher in retirement than it is now, in general, a Roth could be a better choice since you can take the distributions tax-free at that time. But if you think your income may be less in retirement than it is now, you might be better off with a traditional solo 401(k), which allows you to take the tax deduction now and have your distributions taxed in retirement.

Advantages and Disadvantages of Solo 401(k) Plans

When considering retirement account options, it can be helpful to look at the pros and cons to determine what works best for your personal situation.

Benefits of Having a Solo 401(k)

There are different reasons why opening a 401(k) for self employed individuals could make sense.

•   Bigger contributions. Compared to other types of self-employed retirement plans, such as a SEP IRA or SIMPLE IRA, solo 401(k) contribution limits tend to be more generous. Neither a SEP IRA or SIMPLE IRA, for instance, allows for catch-up contributions.

•   Roth contributions. You also have the option to open a Roth solo 401(k). If you anticipate being in a higher tax bracket when you retire, you may prefer being able to withdraw contributions tax-free with a Roth.

•   Flexible withdrawal rules. A solo 401(k) can also offer more flexibility with regard to early withdrawals than a SEP IRA, SIMPLE IRA, traditional IRA, or Roth IRA. If your solo 401(k) plan allows it, you could take out a loan in place of an early withdrawal. This could help you to avoid early withdrawal penalties and taxes. An IRA-based plan wouldn’t allow for loans.

Considerations and Potential Drawbacks

There are also a few potential downsides of investing in a solo 401(k).

•   Eligibility restrictions. If you run a small business and you have at least one employee other than a spouse, you won’t be able to open a solo 401(k) at all.

•   Complicated reporting. Calculating contributions and filing can be more complicated with a solo 401(k) vs. a SEP IRA or SIMPLE IRA. If your plan has more than $250,000 in assets you’ll need to file Form 5500-EZ with the IRS each year.

•   Administrative costs. Depending on where you open a solo 401(k) plan, the cost of maintaining it year to year may be higher compared to other self employed retirement plans. And an early 401(k) withdrawal can trigger taxes and penalties.

It’s important to consider the range of investment options offered through a solo 401(k). What you can invest in at one brokerage may be very different from another. The individual cost of those investments can also vary if some mutual funds or exchange-traded funds offered come with higher expense ratios than others.


💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.

Withdrawals and Loan Provisions

There are certain requirements for withdrawals and/or loans from a solo 401(k).

Rules for Withdrawing Funds

You can make withdrawals from a solo 401(k) without penalty at age 59 ½ or older. Distributions may be allowed before that time in the case of certain “triggering events,” such as a disability, but you may owe a 10% penalty as well as income taxes on the withdrawal.

Loan Options and Conditions

Some solo 401(k) plans may be set up to allow loans. If yours does, you could take out a loan in place of an early withdrawal. This could help you to avoid early withdrawal penalties and taxes. Just be sure to find out the loan terms and conditions, which can vary by plan.

Testing and Compliance for Solo 401(k)s

Unlike workplace 401(k)s, solo 401(k)s have no testing compliance requirements involved.

Alternatives to Solo 401(k) Plans

Instead of a solo 401(k), self employed individuals can consider another type of retirement account. Here’s how different options stack up.

Comparing a Solo 401(k) to a SEP IRA and Other Retirement Options

A SEP IRA is designed for small businesses. However, unlike a solo 401(k), a SEP IRA allows no catch-up contributions and there is no Roth version of the plan.

A SIMPLE IRA is for businesses with no more than 100 employees. It has much lower contribution limits than a solo 401(k) and once again, there is no Roth option.

Pros and Cons of a Solo 401(k)

A solo 401(k) has advantages and disadvantages. Here’s a side-by-side comparison of the benefits and drawbacks.

Solo 401(k) Pros

 Solo 401(k) Cons
Catch-up contributions may allow older investors to save more for retirement versus a SEP IRA or SIMPLE IRA. Only self-employed individuals who have no employees or just employee their spouses can contribute.
It’s possible to choose between a traditional solo 401(k) or Roth solo 401(k), based on your investing goals and tax situation. Annual reporting requirements may be more complicated for a solo 401(k) compared to other self employed retirement plans.
Solo 401(k) plans may allow for loans, similar to workplace plans. Early withdrawals from a solo 401(k) are subject to taxes and penalties.

The Takeaway

A solo 401(k) can be a worthwhile investment vehicle for self-employed people who want to save for retirement. It has more generous contribution limits than some other retirement options. In addition, there is a Roth version of the plan, and a solo 401(k) plan may also offer flexibility in terms of early withdrawals. For individuals who are self-employed, opening a solo 401(k) is one potential way to start saving for their golden years.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Easily manage your retirement savings with a SoFi IRA.

FAQ

Can I contribute 100% of my salary to a solo 401(k)?

As an employee, you can contribute up to 100% of your earned income to a solo 401(k) up to the annual contribution limit, which is $22,500 in 2023, and $23,000 in 2024, plus an additional $7,500 for those age 50 and up in elective salary deferrals.

Is a solo 401(k) taxable income?

You will pay taxes with a solo 401(k), but the type of plan you open determines when you’ll pay those taxes. If you have a traditional 401(k), your contributions are tax-deferred, and they reduce your taxable income for the year in which you make them. However, you will pay taxes on distributions when you take them in retirement. If you have a Roth 401(k), you pay taxes on your contributions when you make them, but your distributions in retirement are tax-free.

What is the average return on a solo 401(k)?

The return on a solo 401(k) depends on the investments in your portfolio. However, in general, a solo 401(k) invested in a mix of bonds, stocks, and cash assets can have an average rate of return ranging between 3% and 8%. But again, it depends on what your investments are, and how much you allocate to those different assets. You may want to compare your plan’s performance to plans with similar funds to get a general sense of what the average return might be.

Who qualifies for a solo 401(k)?

To be eligible for a solo 401(k), you must be self-employed or a small business owner with no employees other than a spouse. To open a solo 401(k) you will need an Employee Identification Number (EIN), which is available from the IRS.

Photo credit: iStock/visualspace

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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.

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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What Is the Minimum Down Payment for an FHA Loan?

By | Family Finances, Home Ownership, mortgage | Comments Off on What Is the Minimum Down Payment for an FHA Loan?

Saving up for a down payment is a common challenge for many prospective homebuyers. FHA loans allow qualifying borrowers to put as little as 3.5% down on a property, helping lower the barriers to homeownership for many.

With an FHA loan, borrowers may also be eligible for down payment assistance. But there are other out-of-pocket expenses to keep in mind when considering an FHA loan. Let’s take a closer look at FHA loan down payment requirements and how much money you’ll need to get to the closing table.

What Is an FHA Loan?

An FHA loan is a type of mortgage that’s issued by a lender, such as a bank or credit union, but insured by the Federal Housing Administration (FHA). The purpose of the FHA mortgage program is to make homeownership more affordable for low- to moderate-income buyers.

Since FHA loans are government-insured, they offer more flexible eligibility requirements for borrowers who might not qualify for a conventional home loan. FHA loans have lower minimum down payment and credit score requirements, making them popular with first-time homebuyers and applicants with limited savings or poor credit. Compared to conventional mortgages, FHA loan interest rates are typically lower, but will vary depending on the lender and on the borrower’s credit score and finances.


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First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.

FHA Loan Income Requirements

There aren’t any minimum or maximum income requirements to qualify for an FHA loan. However, there may be income limits for borrowers receiving down payment assistance through a state or local program.

In any case, lenders will look at an applicant’s ability to manage monthly mortgage payments and ultimately repay the FHA loan. Besides savings and assets, lenders assess an applicant’s debt-to-income (DTI) ratio, which measures the percentage of monthly income that goes toward debt payments. A lower DTI ratio is typically viewed as favorable. Depending on the lender, borrowers can get an FHA loan with a DTI ratio of up to 50%. In comparison, conventional loans typically require a DTI ratio of 43% or less.

Recommended: How Much is a Down Payment?

What Is the Down Payment Required for an FHA Loan?

Down payments are calculated as a percentage of the home purchase price. Historically, lenders looked for buyers to put down one-fifth of a home’s purchase price upfront. But you no longer always need to put down 20% on a house. The minimum down payment percentage for FHA loans depends on a borrower’s credit score.

The average down payment on a house in the U.S. was 13% in 2022. But with an FHA loan, borrowers with a credit score of 580 or more may qualify for a down payment of 3.5% of the home purchase price. Those with credit scores between 500 and 579 will need to put 10% of the home price towards a down payment. For a $400,000 house, this translates to $14,000 for a 3.5% down payment and $40,000 for a 10% down payment.


💡 Quick Tip: Generally, the lower your debt-to-income ratio, the better loan terms you’ll be offered. One way to improve your ratio is to increase your income (hello, side hustle!). Another way is to consolidate your debt and lower your monthly debt payments.

What Other Cash Will I Need to Close?

Besides the down payment, the remaining amount you need to close on a house will depend mainly on the home’s purchase price. Taking out an FHA loan requires paying an upfront mortgage insurance premium (MIP) of 1.75% of the loan total. It may be possible to roll this cost into the loan, which would increase the loan principal and monthly payment amount.

Buyers will also be on the hook for FHA loan closing costs, which typically range from 2% to 5% of the home’s purchase price. Borrowers can potentially avoid the upfront expense by rolling closing costs into an FHA loan. By financing closing costs, borrowers will pay a portion of the costs each month, plus interest. Note that financing closing costs can increase a borrower’s DTI ratio and potentially impact their ability to qualify for an FHA loan.

An alternative option to cover closing costs would be to ask for seller concessions. FHA loans allow the seller to contribute up to 6% of the home value for closing costs as a seller concession.

Recommended: What Do You Need to Buy a House?

How to Save for an FHA Loan Down Payment

Understanding how much house you can afford is a useful place to start to determine your housing budget and savings goal. Using an FHA loan mortgage calculator can help crunch the numbers to determine your down payment and monthly payment based on different loan terms. Not sure you will choose an FHA loan? Use a home affordability calculator to determine how much house you can afford.

With a savings goal in mind, calculate how much you can set aside each month after paying for debts and expenses. Consider cutting discretionary spending, such as dining out and travel, to increase monthly savings.

Buyers can also get the money they need for an FHA down payment in the form of a gift from family, friends, employer, charitable organization, or government program. Gifted funds need to be accompanied by a gift letter to show the lender that the money is going toward the down payment and doesn’t need to be repaid.

Is Down Payment Assistance Available for FHA Loans?

Borrowers who can’t afford a down payment on an FHA loan may be eligible for financial assistance. Down payment assistance can come in several forms, including grants and forgivable loans. These programs are available through local, state, and federal government programs, as well as nonprofit organizations.

Most down payment assistance programs are geared towards first-time buyers. They may include additional eligibility requirements, such as income limits and participation in homebuyer education courses. Consult a list of first-time homebuyer programs and loans to see what you might be eligible for. If it has been more than three years since you have owned a home, you may qualify for first-time homebuyer status.

Additional Cost Considerations for FHA Loans

In addition to the upfront costs of a down payment, closing costs, and MIP, there are other expenses to plan for.

The MIP includes an additional annual fee besides the 1.75% that’s required for closing. Annual payments range from 0.15% to 0.75% depending on the loan terms and loan-to-value ratio. The total annual cost is divided by 12 and spread out across the monthly payments in a given year. Note that MIP usually spans the life of the FHA loan unless a borrower refinances.

Depending on the property location, borrowers may also need to pay for flood insurance to get an FHA loan.

Pros and Cons of an FHA Loan

FHA loans are popular for their lower down payment mortgage requirements, but they’re not for everyone. Here are some advantages and drawbacks to consider when comparing home mortgage loan options.

Pros:

•   Smaller down payments

•   More lenient credit score requirements

•   No income limits

•   Can finance closing costs

Cons:

•   Required to pass an inspection and appraisal

•   Must be used for a primary residence.

•   Loan limits of $472,030 to $1,089,300 for a single-family home, depending on the cost of living by state.

•   Can require an inspection and stricter standards for the condition of the property.

The Takeaway

What is the minimum down payment for an FHA loan? Borrowers with credit scores of 580 or more can put just 3.5% down, while those with scores between 500 to 579 need to put 10% toward a down payment. The combination of lower minimum credit score and low down payment make FHA loans one attractive option for first-time homebuyers.

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.

SoFi Mortgages: simple, smart, and so affordable.

FAQ

What is the lowest down payment for an FHA loan?

The lowest down payment for an FHA loan is 3.5% of the loan amount. Borrowers can explore down payment assistance programs to help cover the cost.

What is the down payment for an FHA loan 2023?

The down payment for an FHA loan in 2023 ranges from 3.5% to 10% depending on the borrower’s credit score.

What will disqualify you from an FHA loan?

Borrowers could be disqualified from an FHA loan based on a high debt-to-income ratio, poor credit, or insufficient funds to pay for the down payment, closing costs, and monthly mortgage payment.

Photo credit: iStock/Edwin Tan

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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.

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Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility-criteria 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.
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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