Dec
13
2024
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Understanding a Taxable Brokerage Account vs an IRA

By | Growing Wealth, invest, Investing | No Comments

Tax-sheltered accounts like the IRA and 401(k) have long been the go-to investment accounts for retirement planning. These types of accounts offer ways to build up tax-advantaged savings for the future. However, investing in taxable brokerage accounts is another common way to build wealth for the short or long term.

The most notable difference between an IRA and a taxable brokerage account can be seen around tax season. With taxable brokerage accounts, you typically pay taxes on your capital gains and dividends each year. In contrast, tax-advantaged accounts generally only involve paying taxes when you make your contribution or withdraw your money, depending on the type of account.

Investors should know the similarities and differences between IRAs and taxable brokerage accounts. Learning the ins and outs of these accounts can help you decide which is right for you to build wealth and meet your financial goals.

Key Points

•   Taxable brokerage accounts and IRAs serve different purposes, with brokerage accounts focusing on general investment and IRAs designed specifically for retirement savings.

•   Taxable brokerage accounts require annual taxes on capital gains and dividends, while IRAs allow for tax-deferred growth until funds are withdrawn.

•   Different types of IRAs, such as Traditional and Roth, offer unique tax advantages and rules regarding contributions and withdrawals tailored to individual financial situations.

•   A combination of both account types can provide flexibility and diversification, allowing investors to meet both short-term and long-term financial goals.

•   Each account type has its pros and cons, making it essential to evaluate personal financial objectives before deciding on the appropriate investment strategy.

What Are Taxable Brokerage Accounts?

Think of taxable brokerage accounts as “traditional” investment accounts — brokerage-offered investment accounts with stocks, bonds, exchange-traded funds (ETFs), and mutual funds. Investors who utilize these accounts, including online brokerage accounts, invest and trade to build short- or long-term wealth, but not necessarily for retirement.

The investments within a taxable brokerage account are subject to tax on any capital gains, dividends, or interest earned. Brokerage account holders pay taxes each year based on investment income.

It’s also important to note that tax liability can vary based on variables like the types of investments held within the brokerage account, the length of time they are held, and an individual’s tax bracket. For example, short-term capital gains, which are gains on investments held for less than a year, are taxed at the same rate as ordinary income. In contrast, long-term capital gains, which are gains on investments held for more than a year, are typically taxed at a lower rate.

Recommended: Capital Gains Tax Guide

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What Is an IRA?

An IRA, or individual retirement account, is an investment account designed specifically to save for retirement. Contributions to an IRA may be tax-deductible or tax-deferred, and the accounts’ investments can grow tax-free until they are withdrawn at retirement age.

There are several different types of IRAs, including Traditional IRAs, Roth IRAs, and SEP IRAs, which have different rules for contributions, taxes, and withdrawals. An IRA can be a helpful tool for saving for retirement and taking advantage of potential tax benefits.

Taxable Brokerage Accounts vs IRA Accounts

Tax-sheltered, or tax-deferred, investment accounts like IRAs differ from taxable brokerage accounts because they generally offer tax advantages and have restrictions on contributions and withdrawals. The tax advantages make them designed for long-term retirement saving and investing. Besides having money invested for retirement, the most notable benefits of IRAs are no yearly tax burden and, in some cases, tax-deductible contributions.

Here’s a breakdown of what each tax-deferred account may offer compared to a brokerage account.

Traditional IRAs vs Taxable Brokerage Accounts

The traditional IRA has no income limits; as long as someone has a taxable income, they can contribute to a traditional IRA. The gains, dividends, and interest earned in IRAs grow tax-deferred during contributing years. Contributions to a traditional IRA may be tax-deductible, though the benefits phase out if you have a high enough income.

With a few exceptions, IRA withdrawal rules say account holders will have to pay a 10% early withdrawal penalty if they take a distribution before reaching age 59 ½. Additionally, account holders are required to start making withdrawals the year they turn age 73 (if they reach age 72 after December 31, 2022) that are taxed as income.

These limitations make a traditional IRA different from a taxable brokerage account, as taxable brokerage accounts do not have withdrawal restrictions and penalties.

With a traditional IRA, as with taxable brokerage accounts, account holders will need to manage it independently or with a financial planner’s help.

A traditional IRA might be a good option for investors who think they will be in a lower tax bracket when they retire. In theory, these investors would save money on taxes by paying them in retirement compared to paying taxes now.

For 2024, account holders can contribute up to $7,000 per year (or up to $8,000 if they are age 50 or older). For 2025, the total contributions investors can make to a traditional IRA remains the same — up to $7,000 (or up to $8,000 if they are 50 and up).

Roth IRAs vs Taxable Brokerage Accounts

Like taxable brokerage accounts, Roth IRA contributions aren’t tax-deductible. Investors contribute with post-tax dollars, but that also means they won’t be subject to taxes when they withdraw funds in retirement.

However, income limits exist for those who can contribute to a Roth IRA account. If you make more than the income limits, then the amount of money you can contribute to a Roth IRA may be reduced, and high earners may not be able to contribute to a Roth IRA at all. For 2024, income limits start at $146,000 per year for single tax filers and $230,000 for married couples filing jointly. For 2025, income limits start at $150,000 per year for single tax filers and $236,000 for married couples filing jointly. You can use a Roth IRA calculator to help determine your contribution limit.

As with brokerage accounts, Roth IRA account holders can contribute to their accounts at any age. Investors who want to make retirement contributions can do so even after they’ve retired.

Rules around Roth IRA withdrawals are less stringent than those for a traditional IRA. Roth account holders can also begin to take the account’s growth starting at age 59 ½ with no penalty as long as the account has been open for five years.

For those eligible to contribute to a Roth IRA, these accounts make the most sense if the account holder thinks they will be in a higher tax bracket in retirement. Since account holders pay taxes on the contributions in the year they were made, it makes the most sense to pay income taxes when in a lower tax bracket.

Recommended: Traditional vs Roth IRA: How to Choose the Right Plan

401(k)s vs Taxable Brokerage Accounts

Similar to an IRA, 401(k) accounts are one of the most common tax-sheltered accounts. The big difference between an IRA and a 401(k) account is that the 401(k) is employer-sponsored, and employees and employers can contribute to the account.

Employees can contribute to their 401(k) up to $23,000 per year in 2024 and up to $23,500 in 2025. Employees over 50 can make additional catch-up contributions of $7,500 annually in both 2024 and 2025, and in 2025, those 60 to 63 can make a higher catch-up contribution of up to $11,250 under the SECURE 2.0 Act. Many employers offer employees 401(k) plans, some even matching contributions up to a certain percentage.

The 401(k) is one of the most common ways to build a retirement nest egg because the contributions are automatic and come out of the employee’s paycheck, so employees may not even notice the money is gone.

Tax Advantages of an IRA vs Taxable Brokerage Account

As noted above, IRAs offer several tax advantages compared to taxable brokerage accounts. Investors generally use IRAs for tax efficient investing.

Here are some of the main differences:

•   Contributions to traditional IRAs may be tax-deductible: Contributions to a traditional IRA may be tax-deductible, depending on your income and whether a retirement plan at work covers you or your spouse. This means that the money you contribute to a traditional IRA can be deducted from your taxable income, potentially reducing the amount of tax you owe.

•   Earnings in an IRA grow tax-free or tax-deferred: The money you earn in an IRA, including interest, dividends, and capital gains, grows tax-deferred or tax-free until you withdraw it in retirement. In a taxable brokerage account, you would have to pay taxes on any capital gains and dividends you earn each year.

•   Withdrawals from traditional IRAs may be taxed at a lower rate: When you withdraw money from a traditional IRA in retirement, it is taxed as ordinary income at your marginal tax rate. However, if you are in a lower tax bracket in retirement than when you made the contributions, your withdrawals may be taxed at a lower rate.

•   Contributions to a Roth IRA are not tax-deductible: Contributions to a Roth IRA are not tax-deductible, but the money you withdraw in retirement is tax-free, provided you meet specific requirements. This can be a good option if you expect to be in a higher tax bracket in retirement than you are now.

Which Type of Account Is Best for Me?

Brian Walsh, Certified Financial Planner™ at SoFi, says ultimately, you’ll have a mixture of accounts. However, what’s right for you depends on your situation. “It depends if you have access to a 401(k) and an employer match … it depends on what you’re eligible for.” Here are a few considerations that can help you assess your situation.

Think About Investing in a Traditional IRA If…

•   You want to take advantage of tax-deferred contributions.

•   You expect to be in a lower tax bracket in retirement.

•   You’ve maxed out your 401(k) contributions and make too much to contribute to a Roth account.

Think About Investing in a Roth IRA If…

•   You expect to be in a higher tax bracket in retirement.

•   You want the option to pass on the account easily to your heirs.

•   You’ve maxed out your traditional 401(k) and want to offset some of your future tax burden with a Roth IRA.

Think About Investing in a 401(k) If…

•   Your employer offers a plan with a match program.

•   You’re uncertain about your future tax liability, and your employer allows you to split contributions between a traditional 401(k) and a Roth 401(k).

•   You prefer a hands-off approach to investing.

Think About Investing in a Taxable Brokerage Account If…

•   You’ve maxed out all contribution limits to your 401(k) and IRAs.

•   You want to invest in investments not offered in your 401(k) or IRA, like options or cryptocurrency.

•   You want more control over your investments with the opportunity to withdraw funds at your leisure.

Pros and Cons of Taxable Brokerage Accounts

Here are some of advantages and disadvantages of taxable brokerage accounts:

Pros of Taxable Accounts

•   Flexibility: Taxable brokerage accounts allow you to invest in a wide range of assets, such as stocks and bonds, as well as derivatives. This allows you to create a diversified portfolio that may help you meet your investment goals.

•   Growth potential: Taxable brokerage accounts offer the potential for significant growth, as you can earn capital gains on your investments if they increase in value.

•   No contribution limits: Unlike tax-advantaged accounts, taxable brokerage accounts have no contribution limits. This means you can contribute as much as you want to your account, subject to income limits or restrictions.

Cons of Taxable Accounts

•   Taxes: One of the main disadvantages of taxable brokerage accounts is that you will be required to pay taxes on your investment income and capital gains. This can significantly reduce your overall returns.

•   Lack of tax benefits: Taxable brokerage accounts do not offer the same tax benefits as tax-advantaged accounts. For example, 401(k)s and IRA contributions may be tax-deductible, while investments in taxable brokerage accounts are not.

•   Potential for loss: As with any investment, there is a risk of loss in a taxable brokerage account. If your investments decline in value, you could lose some or all of your initial investment.

Is it Smart to Have Both an IRA and a Taxable Brokerage Account?

It may be a consideration to have both an IRA and a taxable brokerage account, as each type has its specific benefits and drawbacks.

An IRA can be a good option if you are looking to open a retirement account and save for retirement and want the potential tax benefits of an IRA. On the other hand, a taxable brokerage account can be a good choice if you are looking to invest for goals other than retirement or if you are not eligible for a tax deduction on your contributions to an IRA.

Having both an IRA and a taxable brokerage account can give you more flexibility and diversification in your investments, which can help you manage risk and improve your overall financial situation.

The Takeaway

Every account — from taxable brokerage accounts to IRAs — has advantages and disadvantages, which is why some investors choose to invest in a few. The old cliche, “don’t put all your eggs in one basket,” is a solid philosophy for financial planning. Investing in several different “baskets” is one way to ensure that your money is working hard for you.

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FAQ

What is the difference between an IRA and a taxable brokerage account?

An IRA is designed specifically to save for retirement. Unlike a taxable brokerage account, which is used for general investing, contributions to a traditional IRA may be tax-deductible, and the investments within the account grow tax-deferred until they are withdrawn at retirement age. There are several other types of IRAs, including Roth IRAs, which have different rules for contributions, taxes, and withdrawals.

Is it better to contribute to an IRA or a taxable brokerage account?

Whether to contribute to an IRA or a taxable brokerage account depends on your circumstances and financial goals. In general, an IRA can be a good option if you are looking to save for retirement and want the potential tax benefits of an IRA. However, if you are not eligible for a tax deduction on your contributions or looking to invest for goals other than retirement, a taxable brokerage account may be a better choice.

How is a taxable brokerage account taxed?

The investments held within a taxable brokerage account may be subject to tax on any capital gains, dividends, or interest earned. Short-term capital gains, which are gains on investments held for less than a year, are taxed at the same rate as ordinary income. Long-term capital gains, which are gains on investments held for more than a year, are typically taxed at a lower rate. Dividends and interest income earned are also subject to tax.

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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.


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Dec
13
2024
Guide to Idle Funds: Where to Put Them

Guide to Idle Funds: Where to Put Them

By | Budgeting & Goals, Growing Wealth, money | Comments Off on Guide to Idle Funds: Where to Put Them

Idle funds are funds that aren’t serving any specific purpose or working for you in any way. This is a term that’s often used when discussing business and government finance. It’s common for government entities and corporations to have idle money sitting in cash reserves until it’s ready to be used for specific expenditures.

It’s also possible for individuals to have idle cash. For example, you might keep a few hundred dollars stashed in your dresser or checking account. That money is technically idle, since it isn’t earning you any interest. The good news is that it’s easy to put idle funds to work so your money has a chance to grow.

Key Points

•   Idle funds is the term used to describe money that is sitting and not growing or building your wealth.

•   Idle funds can be deposited into high-yield savings accounts to earn competitive interest rates while maintaining liquidity.

•   Other options include investing in certificates of deposit (CDs) for fixed interest rates over a set period.

•   Brokerage accounts, which invest in stocks, bonds, or mutual funds based on risk tolerance and investment goals, can be used to grow idle funds.

•   Consider cash management accounts at brokerages to earn interest while planning longer-term investments, or I Bonds can be another use for idle funds.

What Are Idle Funds?

In personal finance, idle funds or idle savings refers to money that isn’t being invested or otherwise earning interest. Idle funds may be held in cash or sit in a deposit account, like a checking account, at a bank, credit union, or other financial institution. It can be called idle savings, idle cash, or idle money, but it all means the same thing. It’s money that’s doing absolutely nothing. It’s not appreciating in any way or earning you interest.

Here’s another way to think of idle funds. Imagine you’re in a car that’s idling at a stoplight. You’re not moving forward toward any specific destination and you’re not gaining anything; in fact, you’re just burning gas. When you allow your money to sit idle, you’re not getting closer to your financial goals either.

As mentioned, businesses and governments may keep idle savings on hand that don’t earn any interest. They can do so if they plan to spend that money later for a specific purpose, such as an expansion project or funding government contracts. But it’s possible that you might have idle funds without realizing it, which can be a missed opportunity to build wealth.

How Do Idle Funds Work?

Idle funds work by, somewhat ironically, not working for you. Normally, when you deposit money into a savings account, money market account, or investment account, those funds can grow over time.

The bank typically pays you interest on deposits, and you can end up with more money than you started with thanks to compounding interest.

Compounding means earning interest on your interest. The more often interest compounds and the higher the interest rate earned, the more your money can grow. For example, if you deposit $1,000 into an interest-bearing account and earn a 7% annual rate of return, that initial amount would grow to $7,612 after 30 years, even if you never add another dime.

With idle savings, that doesn’t happen. Your money doesn’t earn interest or any kind of return. If you deposit $1,000 into an idle funds account (or have it sitting in a piggy bank) on Day 1, you’d still have that same $1,000 on day 10,000, assuming you don’t make any withdrawals. Since you’re not putting money into a savings account or another account where it can earn interest, idle funds don’t benefit from the power of compounding.

What Is the Value of Idle Funds?

You might assume that the value of idle funds is the same as the money’s face value. So $100 in idle cash would be worth $100. But it’s important to keep the impact of inflation in mind. Inflation refers to a continuous rise in consumer prices for goods and services for an extended time period. In the U.S., the Consumer Price Index (CPI) is one of the most commonly-used measures for tracking inflation.

When inflation is high (as it was in recent memory), your money doesn’t go as far. If gas goes from $3 a gallon to $5 a gallon, for example, it costs more to fill up your tank. When you have idle funds that aren’t earning interest, your money can’t keep up with the pace of inflation. That’s why personal finance experts recommend keeping some of your money in a savings account or investment account as a hedge against the toll inflation takes.

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Real Life Examples of Idle Funds

Idle money can take different forms but again, it’s all money that isn’t working for your benefit or advantage in some way. Here are some examples of idle funds you might have right now:

•   You get a rebate check in the mail that you forget to deposit. Since this money isn’t being used to grow savings, it’s idle.

•   Every day, you dump out your coins and dollar bills into a jar that you keep in your closet. Even though you’re saving, this is idle savings because you earn a 0% interest rate.

•   Instead of separating some of your money into a savings account, you keep all of your funds in a checking account that doesn’t earn interest. While you might use some of this to pay bills and technically put it to work that way, the rest of your money in the account is idle because it doesn’t grow.

You can also have idle funds if you have money in any type of savings or investment vehicle that doesn’t earn interest. A zero-coupon bond, for instance, doesn’t pay interest to you but instead, allows you to purchase the bond at a deep discount. In that way, when it matures, you enjoy an increase vs. the amount you paid.

Recommended: APY Calculator

Pros of Idle Funds

For governments and businesses, it can make sense to have some idle cash on hand. For example, if there’s a budget shortfall, then a corporation could dip into their idle funds to cover operating expenses.

In terms of why having some idle funds might be a good thing when discussing your personal finances, here are the main pros:

•   Idle funds can be liquid assets, meaning you can access your money when you need it.

•   Keeping idle money in cash at home means you’re not paying bank fees.

•   Waiting to invest idle savings gives you time to research the best investment options for you.

•   There’s generally very little risk of losing money in idle funds.

•   Putting idle funds to work can be as simple as opening an interest-bearing savings account at a traditional or online bank or starting an investment account.

Cons of Idle Funds

While there are some positives associated with idle funds, there are also some drawbacks to keep in mind. Here are some of the biggest cons of idle money:

•   When cash sits idle, it’s not earning interest, and you’re not growing wealth.

•   If you’re keeping idle savings in cash at home, you run the risk of it being lost or stolen.

•   Keeping all of your money in idle funds means you’re not working toward any financial goals.

•   Delaying investment of idle funds can mean missing out on the power of compounding interest.

•   Cash sitting in idle funds can lose purchasing power as inflation rises.

Parking Places for Your Idle Money

If you’d like to put your idle funds to good use, there are several places you can keep that money in order to earn interest. When deciding where to keep idle cash, consider what kind of access you’d like to have to those funds, the interest rates you could earn, and the fees you might pay.

Here are some of the different savings accounts to have for idle funds if you’d like to grow your money.

Certificates of Deposit

A certificate of deposit account is a time deposit account. When you deposit money into a CD, you’re agreeing to leave it there for a set time period, until what is known as its maturity date. The bank pays you interest on your deposit, and, once the CD matures, you can withdraw your initial deposit and the interest earned. Or you could roll it over into a new CD.

CD accounts can be a good place to keep idle funds that you know you won’t need any time soon. Online banks can offer competitive rates on CDs with no monthly fees. Just keep in mind that you might pay an early withdrawal penalty fee if you take money from your CD account before maturity.

Brokerage Account

Brokerage accounts are designed to hold money that you invest. For example, you can open a taxable investment account or a tax-deferred individual retirement account (IRA) at a brokerage. The rate of return you earn on your money can depend on how you choose to invest it.

Some brokerages can also offer cash management accounts to hold money that you plan to invest later. These accounts can function like checking accounts, but they can also earn interest. Depositing some of your idle funds into a cash management account at your brokerage can help you earn some interest until you’re ready to invest it.

Recommended: How to Set up a Health Savings Account

High-Yield Savings Account

A high-yield savings account is a savings account that pays an above-average interest rate and annual percentage yield (APY). Traditional banks can offer high-yield savings accounts but you’re more likely to get competitive rates from an online bank. Online banks can also make high-yield accounts more attractive with low initial deposit requirements and no monthly fees.

Opening a high-yield savings account for idle funds could be a good move if you’d like to keep some of your money liquid and accessible. You can link a high-yield savings account to a checking account for easy transfers. Depending on the bank, you may also be able to get an ATM card with your savings account for added convenience.

I Bonds

An I Bond is a type of savings bond that’s issued by the U.S. Treasury. I Bonds can earn a competitive interest rate that’s based on inflation. Putting money into I Bonds could be a good use of idle cash if you’re worried about inflation eating into your spending power. Just keep in mind that I Bonds, like CDs, are designed to be longer-term investments and cashing them out early could cost you some of the interest earned.

The Takeaway

Having idle funds (money that’s just sitting and not appreciating in value) isn’t necessarily a bad thing. However, it’s important to understand what you could be missing out on if your savings or cash isn’t earning any interest. If you’re unsure what to do with idle money, some options include a high-yield savings account, a CD, or other financial products that can help you grow your wealth.

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FAQ

What is the best option for me to activate idle funds?

If you have idle funds, depositing them into a high-yield savings account can be the fastest way to put them to use. Online banks typically offer these kinds of savings accounts with competitive interest rates and no or low monthly fees. You can link your online savings account to your checking account for convenient access to your money.

Are idle funds always a bad thing?

Idle funds aren’t always a bad thing if you’re planning to invest or save them at some point in the near future. For example, you may have $1,000 sitting in a cash management account at your brokerage that you plan to invest in stocks. Since that money does have an end goal, the fact that it’s idle in the meantime isn’t so bad.

Can idle funds ever improve your money?

Having some idle funds could offer reassurance if you’d like to have a go-to stash of cash on hand for emergencies. Whether idle funds can improve your money depends on where you’re keeping them, how you plan to use them, and whether you have other funds that are actively working for you and earning interest.

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As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

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 content is provided for informational and educational purposes only and should not be construed as financial advice.

Third Party Trademarks: Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

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.

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Dec
13
2024
woman looking out window

Managing Loans After Losing a Job

By | Debt Payoff, personal_loan | Comments Off on Managing Loans After Losing a Job

There’s no such thing as a good time to lose your job. Unfortunately, a layoff typically does not stop the influx of bills.

Luckily, individuals who find themselves in such a tough position have options. Before resorting to pulling out the big guns, like forbearance or other alternatives that can potentially hurt your credit, it’s worth taking a look at all of the choices on the table. That way, you’ll fully understand your options and their implications before making a move when you’ve lost your job and can’t pay your bills.

Key Points

•   Explore financial assistance options like unemployment benefits, hardship loans, and forbearance programs to manage loans after job loss.

•   Communicate with lenders to discuss potential relief measures such as reduced payments or interest rates.

•   Seek professional guidance from financial planners or credit counselors to manage finances and explore debt consolidation.

•   Assess your financial situation by creating a budget, prioritizing essential expenses, and cutting unnecessary costs.

•   Consider loan modification or refinancing to make payments more affordable without resorting to high-interest debt traps.

Assess Your Financial Situation

Whether you’ve lost your job or are in a precarious employment situation, getting your financial house in order is an important first step. Start by evaluating your current income and recurring expenses and looking for areas where you can cut back.

A good way to keep monthly spending in check is to create a budget, either on your own or with the help of a budget planner. If you’ve lost your job and your income has dropped, you’ll want to prioritize the essentials: food, utilities, housing, and transportation.

Explore Financial Assistance Options

Even with modified spending habits and a new budget, a loan due is a loan due — or at least a situation that won’t go away without dealing with it. Here are some options to consider.

Reaching for Lifelines

Even with modified spending habits and a new budget, a loan due is a loan due — or at least a situation that won’t go away without dealing with it. The reason you lost your job will form a fork in the road of sorts about how to proceed.

Unemployment Benefits

If you voluntarily quit without good cause, then unemployment benefits probably will not be available. But usually the first part of a survival plan for unemployment is to get into the system for unemployment, if possible. To get started, an unemployment benefits finder can help, as can exploring unemployment resources by state.

Hardship Loans

These types of personal loans are designed to help borrowers overcome a job loss or other financial difficulty. Whether they’re unsecured or secured, hardship loans for unemployed borrowers can provide much-needed funds during a difficult time. You may be approved within a couple of days and could receive the money in about a week or less.

Forbearance and Deferment Programs

Many lenders have forbearance and deferment programs in place for their customers, but it’s generally up to the customer to reach out and ask for help.

Forbearance — a pause in monthly payments toward a loan — is an option offered in many lending agreements. The terms vary, but it can open the door to a revised agreement that may allow for decreased or delayed payments for a specific period of time. Some lenders may even offer to reduce the interest rate charged on the debt.

On the surface, this sounds positive, but note that these options can significantly affect your credit scores. The impact depends on the type of loan and the lender. What’s more, interest will usually accrue and be added to your principal balance at the end of a forbearance period.

Communicate With Lenders

As we mentioned, it’s a good idea to contact your lenders as soon as possible if you’ve lost your job and are struggling to make your monthly payments. Discuss your situation with them, and explain how your job loss is impacting your ability to repay your debt.
Then explore options that may be available to you. Two strategies to consider:

•   Negotiate a reduced balance on the account. Most creditors would rather receive a partial payment than none at all. If you’re having a difficult time making ends meet, you may want to propose paying a lump sum for less than what you owe. If the lender agrees, be sure to get the arrangement in writing.

•   Ask about hardship programs. Depending on the lender, you may be offered relief measures like a lower interest rate, waived late fees and penalties, a temporary pause in payments, or lower minimum payments.

Explore Loan Modification or Refinancing

Instead of falling into potential debt traps like payday loans or credit cards with high interest rates, look for solutions that make monthly payments more affordable — without saddling you with hefty interest rates and fees. A loan modification or refinancing are two such options.

With a modification, a lender agrees to change your loan’s rate, repayment term, or both to an amount you can afford. For example, they may extend the number of years you have to pay back the loan, lower your interest rate, or reduce your principal balance. Keep in mind that lenders are under no obligation to offer loan modifications, and they’ll likely first require you to provide proof of financial hardship.

Another option is to explore refinancing opportunities. While it can be harder to qualify for refinancing when you don’t have a job, it is possible. Lenders like to see borrowers with a strong credit history and a good debt-to-income ratio. Asking a trusted friend or family member to be a cosigner may also help bolster your application.

As you weigh your choices, consider enlisting the help of a financial advisor or mortgage specialist who can help you find the solution that’s right for you.

Build an Emergency Fund

Losing a job can be stressful, but there are ways to prepare financially while you’re still employed. One effective strategy is to build an emergency fund.

There are several approaches you can use to help you establish a safety net, including:

•   Creating a budget — and sticking to it

•   Building a savings plan so you’re able to cover at least three to six months’ worth of unexpected expenses

•   Exploring high-yield savings accounts

•   Automating your savings contributions

•   Paying down debt

Seek Professional Guidance

If you’re struggling to pay off your loans after losing a job, you may think you have to figure out all the answers on your own. You don’t. Help is available.

•   Consult with a financial planner or credit counselor. These professionals can help you manage your finances after a job loss and get back on firmer financial ground once you land a new job.

•   Seek assistance from nonprofit organizations. Services vary by organization but may include resume building programs, education and training opportunities, and job placement programs.

•   Consider debt counseling or debt consolidation. With debt counseling, a professional will offer advice on your finances and debt, help you create a budget and debt management plan, and provide financial education. Debt consolidation is when you combine multiple debts into a single loan, ideally with a lower interest rate. However, it may lead to longer payment terms or involve fees.

The Takeaway

The main thing to remember for anyone who is out of work and still responsible for loans is: You are not alone. It might seem difficult, even impossible, but it is doable — and even the longest journeys begin with taking the first steps.
After you’ve started tracking your expenses, cutting back on costs, and reaching for lifelines through unemployment benefits and your lender, the next step in dealing with loan payments after a job loss is to explore your options. Rather than turning to potential debt traps like payday loans and credit cards, you might consider jobless loans.

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’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.

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.

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

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 .

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.

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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Dec
13
2024
Payday Loan vs. Installment Loan: What Are the Main Differences?

Payday Loan vs. Installment Loan: Which Is Right for You?

By | Financial Independence, personal_loan, Terminology | Comments Off on Payday Loan vs. Installment Loan: Which Is Right for You?

If you need cash to cover an emergency expense, like a car repair or medical bill, a payday loan or an installment loan are two options you may consider. However, these two loans are different in key ways that are important to understand before making a choice between them. Namely, a payday loan tends to have a short turnaround before you need to pay it off, and typically offers extremely high interest rates.

We’ll explain more about the features of each loan type, and why people choose payday loans vs installment loans.

Key Points

•   Installment loans provide a lump sum upfront, repaid in fixed payments over time, and can be secured or unsecured.

•   Payday loans are short-term, high-fee loans due on the next payday, often leading to debt cycles.

•   Personal loans, a type of installment loan, offer lower rates than payday loans and can be used for various purposes.

•   Eligibility for installment loans depends on credit score, income, and other factors, while payday loans require minimal qualifications.

•   Payday loans are considered predatory due to high fees, whereas installment loans offer more favorable terms if eligibility requirements are met.

Understanding Payday Loans

There is no set definition of a payday loan. Generally speaking, they are short-term loans that are due to be paid back on your next payday. Payday loans don’t charge interest per se, but they do charge high fees.

Payday loans are typically for relatively small amounts. In fact, many states limit the amount of a payday loan to $500. Borrowers usually repay the loan in a lump sum on their next payday. The specific due date is often between two and four weeks from when the loan was made.

To repay the loan, borrowers must make out a post-dated check to the lender for the full balance of the loan plus any fees. As an alternative, borrowers can give permission for the lender to electronically debit the funds from their bank account on a certain date. If the borrower doesn’t repay the loan by the due date, the lender can cash the check or debit the funds. Either way, the lender gets paid.

In some states, borrowers may be able to roll over the amount of the loan, paying only the fees when it comes due, while the lender pushes out the due date.

To qualify for a payday loan, you generally need to be 18 years or older and have proof of income, a valid ID, and an active bank, credit union, or prepaid card account.

Risks of a Payday Loan

The risks of payday loans include sky-high fees and the potential for falling into a cycle of debt. Many states set a limit on payday loan fees, but they can still run from $10 to $30 for every $100 borrowed. Consider that a $15 fee for $100 is the equivalent of a nearly 400% APR.

By comparison, the average personal loan interest rate as of December 2024 is 12.33%, according to the Federal Reserve of St. Louis.

Pros and Cons of Payday Loans

Before signing on for a payday loan, carefully consider the advantages and disadvantages.

Pros of Payday Loans

 Cons of Payday Loans
Provide quick access to cash, often with same-day turnarounds. Very expensive, with fees equivalent to a 400% APR.
No credit check required. To qualify, you typically need to be 18 years old, have a government I.D., bank account, and regular source of income. Lenders don’t consider your ability to repay the loan, and the loan doesn’t help you build credit. As a result, these lenders are considered “predatory.”
Unsecured: Borrowers are not required to put up property as collateral. Borrowers can get trapped in a cycle of debt. If they are unable to pay back the loan, borrowers will pay expensive fees each time they roll over or renew their loan.

Exploring Installment Loans

When a borrower receives an installment loan, their lender will give them a lump sum upfront, which the borrower has to repay in fixed payments with interest over a set period of time.

Personal loans are a good example of an installment loan.

They can range in size from a few hundred dollars to $100,000, and the money can be used for any reason, from covering unexpected expenses or consolidating debt to remodeling a home. Repayment terms may stretch from a few months to a few years.

How Installment Loans Work

During the loan application process, lenders will consider factors such as a borrower’s credit score and reports, their income, and the amount and length of the loan.

Typically, borrowers with good credit scores will receive the best terms and interest rate options. These loans may have variable interest rates or fixed, meaning they don’t change over the life of the loan.

Installment loans may be secured or unsecured. Unsecured loans, such as unsecured personal loans, do not use collateral to back the loans. Secured loans do require collateral and may offer borrowers a lower interest rate since they present less risk to the lender.

Pros and Cons of Installment Loans

Personal installment loans tend to offer borrowers the option of borrowing at lower rates than are available through revolving credit or payday loans. However, it’s still important to consider disadvantages in addition to benefits.

Pros of Installment Loans

 Cons of Installment Loans
Borrowers can finance a big purchase over 2-12 years. Interest rates may be higher than other alternatives, such as a home equity line of credit.
Payments typically remain fixed over the life of the loan, unless the borrower chooses a variable interest rate. May be subject to fees, such as closing costs.
Secured loans don’t require collateral, while unsecured loans may offer lower interest rates. Missed payments can damage credit scores. Defaulted loans may be sent to collections.

Pros and Cons of Installment Loans

Eligibility requirements vary by lender, but generally speaking, you’ll need:

•   Proof of identity

•   Proof of income

•   Proof of address

Your credit score is an important factor, as it helps determine the interest rate you’re offered.

Key Differences Between Payday Loans and Installment Loans

By now you’ve likely got a good sense that installment loans and payday loans differ in some important ways. Here’s a side-by-side comparison.

Payday Loans

 Installment Loans
Repayment terms Payment is due on the borrower’s next payday, usually two to four weeks from the date the loan was taken out. Loan is repaid in regular installments, often monthly, typically over 2 to 7 years. Large personal loans can be repaid over 12 years.
Loan amounts Often limited to $500. Can range between a few hundred dollars and $100,000.
Interest rates Payday loans don’t charge interest, but they do charge costly fees that can be the equivalent of up to 400% APR. Interest rates vary, depending on a borrower’s credit history, among other factors. The average personal loan interest rate is 12.33%.
Use cases Payday loans are typically targeted to borrowers with poor credit and few other lending options. Loan money can be used for any reason. Some installment loans, such as auto loans or mortgages, are limited in how they can be used. Personal loans can be used for any purpose.
Risk Payday loans are predatory loans that can trap borrowers in a cycle of debt. Lenders don’t consider a borrower’s ability to repay the loan, and the loan won’t help build credit. Failure to repay an installment loan on time can damage credit. Defaulting on secured loans may result in loss of property.
Credit requirement None. The application process for installment loans requires a credit check.

Choosing the Right Loan for Your Needs

As you can see, there are important differences between payday and installment loans. Not sure which sort of loan is right for you? A good place to start is to determine what your short- and long-term financial goals are and which type of loan best aligns with them. Interest rates, terms, fees, and repayment options are all factors to consider.

You’ll also want to assess your repayment capabilities. Can your income cover your normal expenses plus the loan debt? Finally, check your credit score and the eligibility requirements of potential lenders to see where your application is more likely to be approved.

The Takeaway

Payday loans and installment loans both provide quick cash to cover emergency expenses. However, because of their astronomical fees — equivalent to a 400% APR — payday loans fall under the heading of “predatory lending.” On the other hand, installment loans vary in their terms but generally are a much better deal, provided that you meet eligibility requirements.

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’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.

FAQ

Are payday loans installment loans?

No, payday loans usually require you to pay off the loan amount in full on your next payday, usually two to four weeks from when the loan was made.

What is an installment loan?

When you take out an installment loan, you immediately receive the money you’re borrowing. You then pay it back to your lender in a series of regular fixed payments known as installments.

Are personal loans installment loans?

Personal loans are one type of installment loan. Money from the loan can be used for any purpose, such as debt consolidation or a home remodel.

Photo credit: iStock/Prostock-Studio
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.

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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Dec
12
2024
Personal Loan Glossary: Loan Terms To Know Before Applying

Personal Loan Glossary: Loan Terms To Know Before Applying

By | personal_loan, Terminology | Comments Off on Personal Loan Glossary: Loan Terms To Know Before Applying

Applying for a personal loan is a big financial decision — and it’s important to know exactly what you’re getting into before you sign any paperwork. Finance has vocabulary that may be unfamiliar to some people, which can make it difficult to understand.

This easy-to-reference glossary may help you read your new loan agreement with confidence and understand what each clause of the document means. From APR to cosigners vs. co-borrowers, we’ve got you covered.

Key Points

•   Personal loans are disbursed in lump sums and repaid in equal installments.

•   Key loan terms include principal, interest, APR, origination fee, borrower, and lender.

•   Prepayment fees may apply for early payoff; origination fees are charged at initiation.

•   Collateral secures loans, reducing lender risk; unsecured loans rely on trust and may have higher interest.

•   Understanding loan terminology aids in navigating the loan process and choosing suitable loans.

What Is a Personal Loan?

Before we dive in, a quick bit of review to get us started: What is a personal loan? A personal loan is a closed-end loan that is disbursed in one lump sum and repaid in equal installments over a set amount of time.

There are many types of personal loans, and it’s common for them to be unsecured, which means there’s no collateral required.

People use personal loan funds for many reasons, from home renovations to debt consolidation to vacations.

What Are the Main Terms Used in a Personal Loan Agreement?

Understanding personal loan terminology will help you navigate the loan process with confidence.

Amortization

Amortization refers to listing the loan’s repayment schedule over the life of the loan, which the lender does when processing the loan. An amortization schedule lists the amounts of principal, interest, and escrow (if included in the loan) that each payment consists of.

A loan may be re-amortized, also. For example, the remaining repayments can be recalculated if you’re thinking of making a lump sum payment on the loan. You would be able to see the change in interest owed over the life of the loan and how much quicker the loan could possibly be paid in full. With this information, you could determine if the extra payment would be worthwhile for your financial situation.

Annual Percentage Rate

An annual percentage rate (APR) is the percentage of the loan principal you can expect to pay in interest over the course of a single year, including any additional fees that might be charged by the lender.

Application Fee

Some loans may require you to pay a fee when you apply for the loan. Not every lender charges an application fee, though, so it’s worth shopping around to find one that doesn’t.

Automatic Payment

Many lenders make it possible to set up an automatic bill payment that will be taken directly from your bank account on the loan’s monthly due date. This strategy can simplify your financial housekeeping — but make sure you’ll have enough funding in the account each month to avoid an overdraft.

Borrower

The borrower is the person or party who is borrowing money as part of the loan agreement. (Most likely, that’s you.)

Collateral

Collateral is an asset a borrower offers to secure a loan, making it less risky for the lender. For example, in a mortgage, the house is used as collateral — which is why a bank can seize and sell a home if the buyer goes into default, a process called foreclosure. Similarly, in an auto loan, the car is used as collateral, which is why it can be repossessed by the bank if the borrower fails to make the loan payments.

Co-borrower

If a loan applicant doesn’t have strong enough financial credentials to be approved for a loan on their own, they might choose to add a co-borrower to the application. This person, ideally with a more robust financial profile than the primary borrower, will also be financially responsible for the loan.

Co-borrowers are applying for a loan together and typically have shared ownership of the borrowed money or asset it purchased. For example, you and your spouse might apply as co-borrowers on an auto loan for a jointly owned car.

Cosigner

Similar to a co-borrower, a cosigner can help bolster the primary loan applicant’s chances of approval. A parent may be a cosigner on their child’s student loans. This person will be responsible for making the loan payments if the primary borrower fails to do so, but they have no ownership of the loan proceeds or asset they purchased.

Credit Agency

A credit agency, also known as a credit bureau, is a company that compiles information on individuals’ and businesses’ debts. These are the companies that calculate and report credit scores to creditors that make an inquiry.

The three main credit bureaus are Equifax, Experian, and TransUnion. You can request a full credit report from each of them once a week at no charge, which you can access at AnnualCreditReport.com .

Recommended: Everything About Tri-Merge Credit Reports

Credit History

Credit history refers to the broad scope of your experience with debt. Positive credit history is one that shows timely payments on debts owed to creditors. Negative credit history will reflect missed or late payments on debts. Some people, typically young people who have never taken on debt, will have no credit history. However, there are ways to build credit over time.

Credit Report

A credit report is a document that details your credit history, including both open and closed accounts, on-time or late payment history, accounts in default or collections, bankruptcies, liens, judgments, and other financial information. It’s important to check your credit reports regularly to detect any incorrect information and correct it as early as possible.

Credit Score

Your credit score sums up your creditworthiness with a numeric score.

Lenders most commonly refer to your FICO® Score, which can range from 300 to 850. VantageScore, which uses the same scoring range, is also used by lenders, but less commonly.

The higher your credit score, the less of a credit risk lenders tend to assume you will be. The average credit score of U.S. consumers is 717 (FICO).

Debt Consolidation

Debt consolidation is an approach to debt repayment wherein you take out one larger debt — like a personal loan — in order to pay off multiple, smaller debts such as credit cards. Doing so can help simplify your monthly finances by having fewer payments to make. You could potentially pay less in interest than you would on the former debts or lower your monthly debt payments, making it easier to meet your financial obligations each month.

Default

Defaulting on a loan means failing to repay it as agreed (for example, not making payments at all), and can lead to a loan going into collections.

Fixed Interest Rates

Fixed interest rates are those that don’t change over time. You’ll pay the same set amount of interest on the loan for its entire term. Comparing rates on personal loans from several lenders is a good way to find a rate that works with your financial situation.

Floating Interest Rates

Floating interest rates rise and lower in accordance with the market. They might also be called adjustable or variable interest rates.

Guarantor

A guarantor is similar to a cosigner or co-borrower in that they can bolster the strength of a loan application. Like a cosigner, a guarantor has no ownership of the loan proceeds or asset purchased with them. The biggest difference between a cosigner vs. guarantor is that a guarantor is only called upon to repay the loan if the primary borrower goes into default.

Gross Income

Your gross income equals the money you earn each year from working, investment returns, and other sources before deductions or withholding.

Installment Loans

Installment loans are loans that are repaid in regular monthly installments. Personal loans, auto loans, and mortgage loans are examples of installment loans.

Interest Rate

The interest rate is the base percentage charged when borrowing money. It does not include fees or other charges that may be associated with a loan.

Hard Credit Check

A lender will perform a hard credit check, or hard inquiry when you apply for a loan or open a line of credit. A large number of hard credit checks in a short period of time can have a negative effect on your credit score.

Late Payment

A late payment is a debt payment made after its due date. Since payment history is one of the most important factors used to calculate your credit score, late payments can have a major negative impact on your credit score.

Lender

The lender is the party lending the money, whether that’s a bank or credit union, or a friend or family member.

Line of Credit

If you don’t need a lump sum of money at one time, a line of credit might be an option when looking for financing. Lines of credit have limits, but the borrower can draw funds as needed instead of all at once. The borrowed funds can be repaid and borrowed again, up to the credit limit.

Recommended: Personal Loan vs Personal Line of Credit

Loan Agreement

The loan agreement is the legally binding contract you sign with your lender to initiate a loan. It will include details about each party’s rights and responsibilities. For the borrower, it may include the loan amount, interest rate, APR, potential fees and penalties, the payment schedule, and other information. It’s important to read the loan agreement carefully and ask questions about anything that you don’t understand.

Origination Fee

Some lenders might charge an origination fee when a loan is initiated — an up-front fee that remunerates the lender for the work of setting up the loan. These fees are typically a percentage of the principal and vary by lender.

Payday Loans

Payday loans are a type of short-term loan, typically for small amounts, meant to fill in a financial gap until the borrower’s next payday.

Despite their relatively low balances, these loans can be exorbitantly expensive. The Consumer Financial Protection Bureau says their rates can typically hover around 400% APR. Payday loans are usually worth avoiding in favor of other, lower-cost loan options.

Payment Terms

The payment terms of a loan are the terms and conditions the borrower agrees to when signing a loan agreement. Your payment terms can include how long the loan will last, how much will be repaid each month, the amount that can be charged for late payment, and other loan details.

Prepayment Fees

Prepayment fees, or penalties, are sometimes charged by lenders when a borrower pays their loan in full before its final payment due date. The lender will not make as much profit from the loan if the borrower pays it off early, and a prepayment fee is a way to recoup some of that loss.

Principal

The principal amount of a loan is the amount borrowed, not including interest or fees. For example, if you take out a personal loan for $10,000, that $10,000 is the principal amount. You’ll pay the lender more than that over the lifetime of the loan with interest factored in.

Revolving Credit

Revolving credit allows you to borrow funds as needed, up to your credit limit, making at least a minimum payment each month you have a balance. Credit cards are a common form of revolving credit.

Secured Loan

A secured loan requires the borrower to pledge collateral, an asset owned by the borrower, to the lender as a guarantee that they’ll repay the loan. If the borrower defaults on the loan, the lender can take ownership of the asset in repayment of the loan. Common examples of secured loans are mortgages or auto loans.

Unsecured Loan

The foundation of unsecured personal loans is trust. The lender trusts that the borrower will repay the loan without requiring collateral to back up that promise. Unsecured loans can come with higher interest rates than secured loans, however, because they present additional risk to the lender.

The Takeaway

When you’re acquainted with personal loan vocabulary, you have a better chance of getting a personal loan that fits your unique financial situation and needs, and understanding your loan agreement before signing it.

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’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.

FAQ

What is personal loan terminology?

Personal loan terminology is terms and definitions of words and phrases you might see in a loan agreement or other documents related to a personal loan.

What are the main terms used in a personal loan agreement?

Common references in a personal loan agreement are principal, interest, APR, origination fee, borrower, and lender.

What is the definition of a personal loan?

A personal loan is a closed-end loan disbursed in one lump sum and repaid in equal installments over a set amount of time.

Photo credit: iStock/nd3000

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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.

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.

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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