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For most Americans, mortgages are a necessary part of life. Without them, we couldn’t afford the homes where we start a life and perhaps a family. To pay for that cost, you likely need a mortgage.

However, the cost of a mortgage goes well beyond the amount of the loan. There are both upfront and ongoing costs that will be a factor in the cost of the mortgage. In this article, we will look closer at a $400,000 mortgage and what the monthly cost might look like.

Total Cost of a $400K Mortgage

To determine the total cost of a $400,000 mortgage, we must consider more than just the $400K price tag. Upfront and ongoing costs are involved, which are factors in what you ultimately pay.

💡 Quick Tip: SoFi’s Lock and Look ⁺ feature allows you to lock in a low mortgage financing rate for up to 90 days while you search for the perfect place to call home.

Upfront Costs

There are several upfront costs related to your mortgage. Common upfront costs include:

•   Closing costs: From mortgage origination fees and application fees to home inspection and appraisal, you must pay closing costs upfront. These are generally equal to 3% to 6% of the home principal amount.

•   Down payment: Different mortgage types have different down payment requirements. However, depending on the mortgage type, you might be able to put as little as 3% down. First-time homebuyers can sometimes put less down.

•   Property taxes: You may have to pay at least some money toward property taxes at the outset. For example, you might be required to pay six months’ property taxes.

Long-Term Costs

Long-term costs will likely be the largest cost associated with your home purchase. Here are some long-term costs to consider:

•   Mortgage payments: This is the monthly payment against the loan that financed the home purchase.

•   Home maintenance: Homeowners often do work on their homes, from the purely aesthetic to the absolutely necessary. However, these projects can be costly.

•   Property taxes: In most states, you must pay property taxes to your state or municipality. Property taxes can run into the thousands per year.

•   Homeowners insurance: Homeowners insurance isn’t a huge expense, relatively speaking. But the average cost of Progressive’s homeowners policy is between $83 and $138 per month.

Estimated Monthly Payments on a $400K Mortgage

The monthly payment on a $400K mortgage won’t always be the same. Certain factors like the down payment, annual percentage rate (APR), and term will affect how much you pay per month.

For instance, suppose you have a fixed 30-year $400K mortgage at 5% APR. In this case, your monthly payment would be $2,147. If you have a fixed 15-year $400K mortgage at 4.5% APR, your monthly cost would be $3,059. Keep in mind that these estimates don’t include escrow costs. There are also different types of mortgages, such as fixed and adjustable-rate. Your loan repayment may vary significantly depending on the type.

Monthly Payment Breakdown by APR and Term

Certain factors affect how much you pay per month on your mortgage. The biggest factors are typically your APR and mortgage term. Generally, a higher APR increases your monthly payment, as does a shorter repayment term. Use a mortgage calculator to estimate your monthly payment. Here are a few examples of how these calculations may vary depending on the APR and term:

Interest rate	15-year term	30-year term
3%	$2,762	$1,686
3.5%	$2,859	$1,796
4%	$2,958	$1,909
4.5%	$3,059	$2,026
5%	$3,163	$2,147
5.5%	$3,268	$2,271
6%	$3,375	$2,398
6.5%	$3,484	$2,528

How Much Interest Is Accrued on a $400K Mortgage?

As mentioned, the interest accrued on a $400,000 mortgage depends on several factors. However, the most important are the mortgage term and the APR. Generally, a shorter repayment term will result in higher monthly payments but less interest overall. For example, when comparing a 15-year vs. 30-year mortgage, we see that the 15-year mortgage results in less interest, despite higher monthly payments.

Fifteen-year mortgages often have lower APRs than 30-year mortgages as well. A lower APR also means you pay less interest. However, 15-year mortgages typically have much higher monthly payments than 30-year mortgages.


💡 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.

$400K Mortgage Amortization Breakdown

Once approved for a fixed-rate mortgage, you typically pay the same amount each month. However, most of the money you pay will go toward interest in the first few years. Eventually, you can expect to pay more toward the principal than interest. For instance, here is an example of a 30-year $400,000 mortgage with a 6% APR:

Year	Beginning balance	Interest paid	Principal paid	Principal paid
1	$400,000.00	$23,866.38	$4,912.05	$395,087.95
2	$395,087.95	$23,563.41	$5,215.01	$389,872.94
3	$389,872.94	$23,241.76	$5,536.66	$384,336.28
4	$384,336.28	$22,900.27	$5,878.15	$378,458.13
5	$378,458.13	$22,537.72	$6,240.70	$372,217.43
6	$372,217.43	$22,152.81	$6,625.62	$365,591.81
7	$365,591.81	$21,744.16	$7,034.27	$358,557.54
8	$358,557.54	$21,310.30	$7,468.13	$351,089.42
9	$351,089.42	$20,849.68	$7,928.74	$343,160.67
10	$343,160.67	$20,360.65	$8,417.77	$334,742.90
11	$334,742.90	$19,841.46	$8,936.96	$325,805.94
12	$325,805.94	$19,290.25	$9,488.17	$316,317.76
13	$316,317.76	$18,705.04	$10,073.38	$306,244.38
14	$306,244.38	$18,083.74	$10,694.69	$295,549.69
15	$295,549.69	$17,424.11	$11,354.31	$284,195.38
16	$284,195.38	$16,723.80	$12,054.62	$272,140.76
17	$272,140.76	$15,980.30	$12,798.13	$259,342.63
18	$259,342.63	$15,190.94	$13,587.49	$245,755.14
19	$245,755.14	$14,352.89	$14,425.53	$231,329.61
20	$231,329.61	$13,463.16	$15,315.27	$216,014.34
21	$216,014.34	$12,518.55	$16,259.88	$199,754.47
22	$199,754.47	$11,515.67	$17,262.75	$182,491.71
23	$182,491.71	$10,450.94	$18,327.48	$164,164.23
24	$164,164.23	$9,320.54	$19,457.88	$144,706.35
25	$144,706.35	$8,120.42	$20,658.00	$124,048.35
26	$124,048.35	$6,846.28	$21,932.14	$102,116.21
27	$102,116.21	$5,493.56	$23,284.87	$78,831.34
28	$78,831.34	$4,057.40	$24,721.03	$54,110.31
29	$54,110.31	$2,532.66	$26,245.77	$27,864.55
30	$27,864.55	$913.88	$27,864.55	$0.00

What Is Required to Get a $400K Mortgage?

Getting a $400K mortgage usually requires sufficient income and a large enough down payment. The average down payment is 13%. If your income is on the low end, you might be able to make up for it with a larger down payment. Likewise, having a higher income may help if your down payment is small.

It may help to use a housing affordability calculator. This will give you a rough estimate of what you can afford based on your income, monthly expenses, and your down payment.

Your credit score can also be important when applying for a $400K mortgage. Credit scores help lenders determine how likely you are to repay your debts. Thus, a higher credit score can increase your approval odds. There is no definite rule, but a credit score of at least 620 can help when applying for a conventional loan. If you want to learn more about this process, there are mortgage resources that can help.

“If you have multiple debts, you want to make your minimum payments so you don’t hurt your credit score,” Kendall Meade, a Certified Financial Planner at SoFi said. “If you have cash left over after that, you should develop a strategy for which debts to pay off first,” she suggested.

How Much House Can You Afford Quiz

The Takeaway

Buying a home is the largest purchase most Americans make in their lifetime. Many costs come with buying a home, including upfront costs like a down payment and ongoing costs like monthly mortgage payments. Your mortgage payment is likely to be the largest monthly expense you have, and it can vary widely depending on the APR and mortgage term. On a $400,000 mortgage, the monthly payment could range from $1,600 to $2,600, as you can see above.

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

How much house can I afford on a $120,000 salary?

How much house you can afford depends on several factors, and salary is just one of them. You must also consider your mortgage interest rate, down payment, and other debts. If you have $40,000 for a down payment, spend $3,500 per month (not including rent), and your APR is 4.5%, you can afford a home up to about $400,000.

How do you calculate monthly mortgage payments?

To calculate monthly mortgage payments, you must know the loan amount, interest rate, and loan term. The easiest way to calculate your payment is to plug these numbers into an online mortgage calculator.

What is the average total monthly mortgage payment?

The national median monthly mortgage payment in the United States is $1,964 as of February 2023, according to the Mortgage Bankers Association.

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Photo credit: iStock/MihailDechev

*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.

⁺Lock and Look program: Terms and conditions apply. Applies to conventional purchase loans only. Rate will lock for 91 calendar days at the time of preapproval. An executed purchase contract is required within 60 days of your initial rate lock. If current market pricing improves by 0.25 percentage points or more from the original locked rate, you may request your loan officer to review your loan application to determine if you qualify for a one-time float down. SoFi reserves the right to change or terminate this offer at any time with or without notice to you.

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

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

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.

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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If you’re planning to buy a higher-priced home, you may be looking to finance your purchase with a jumbo loan. And you’re probably also wondering about the difference between a jumbo and a conventional loan.

A jumbo loan is necessary to purchase a home where the loan amount is above the conforming loan limit values set by the Federal Housing Finance Agency (FHFA). Conforming loan limits change every year. For 2023, the limit for a single-unit property is $726,200 for most counties across the U.S. In high-cost areas, this amount increases to $1,089,300.

If you’re buying a home below this amount, you can finance with a traditional, conventional, conforming mortgage, or perhaps through one of several first-time home buyer programs. But if you need a mortgage that goes above the conforming loan limit, you’re going to be looking at a jumbo loan, so it’s time to get familiar with how to qualify and how the costs compare to other loans.

Recommended: The Cost of Living by State

What’s the Difference Between Jumbo and Conventional Loans?

Here’s a surprise: There isn’t really a difference between a jumbo and a conventional loan. Jumbo loans are conventional. “Conventional” simply means that a loan isn’t backed by a specific government agency such as the Federal Housing Administration (FHA), United States Department of Agriculture (USDA), or U.S. Department of Veterans Affairs (VA).

Many people get tangled up in the terminology. While jumbo loans are conventional, they are not “conforming.” Though the terms conventional and conforming are often used interchangeably (and mistakenly), a conforming loan is one that falls within the FHFA limits, meaning the lender can sell it to Fannie Mae and Freddie Mac to increase its liquidity. (Again, in 2023, the amount is $726,200 for most areas in the U.S., but can go up to $1,089,300 for high cost of living areas. If you’re wondering about your specific region, have a look at the conforming loan levels by state.)

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

A jumbo loan exceeds these limits and is, thus, non-conforming. So when you’re comparing jumbo loans against other loans, you’re really comparing non-conforming loans against conforming loans. Other differences that affect borrowers are summarized in the table below:

	Conforming Loan	Jumbo Non-conforming Loan
Loan amount	Below $726,200 for most areas, $1,089,300 for high-cost areas	Above $726,200 for most areas, above $1,089,300 for high-cost areas
Loan type	Fixed or variable rate	Fixed or variable rate
Down payment	Can be as low as 3%	Usually 10% or more
Credit score	660+	700+
Income requirements	Lower income requirements	Higher income requirements. For example, a payment on a $726,200 mortgage at 6.7% interest would be $4,969. In order for your payment to not exceed 28% of your monthly income (the margin of safety, you would need to make $17,746 per month or $212,952 per year.
Cash reserves or assets	Not required	6 to 12 months may be needed
How the loan is backed	Backed by Fannie Mae and Freddie Mac	Not backed by Fannie Mae or Freddie Mac

How to Qualify for a Jumbo Loan

Requirements for jumbo loans are more stringent than those for other types of loans. Because these types of mortgages can’t be sold to Fannie Mae or Freddie Mac, the lender takes on more risk should the borrower default.

These requirements include:

•   Debt-to-income (DTI) ratio. You need plenty of income to qualify for a jumbo loan. Qualified mortgages require a DTI of 43% or lower.

•   High credit score. Lenders want to be sure you’ll repay the loan, especially since it’s a much larger amount. A credit score of 700 or above is recommended.

•   Assets. Lenders look for cash that can be used to pay the mortgage. To be safe, you may want to put aside enough money to cover the mortgage for 6 to 12 months.

What to Know About Jumbo Loan Mortgage Rates

Prospective jumbo loan borrowers often wonder, “Are jumbo loan rates higher than other loans?” Jumbo conventional loans don’t automatically have higher interest rates and can be competitive with conforming conventional loan interest rates. They fluctuate with market conditions. Sometimes, they’re even lower than conventional loan interest rates.

You may be able to check your jumbo loan rate with your lender before submitting a full application.

Jumbo Loan Closing Costs

With a larger loan amount, you can also expect jumbo loan closing costs to be higher. While many closing costs are fixed, there are others that are larger due to percentage-based compensation closing costs.

Should I Choose a Jumbo Mortgage?

If you have the option to choose between a jumbo loan vs. a conforming loan, (such as when you have enough money to reduce the principal loan amount so that it qualifies as a conforming loan), you’ll want to ask yourself if it’s worth it to put down the extra money to qualify for a conforming conventional loan. There are some specific scenarios where a jumbo loan vs. a conforming loan makes sense.

💡 Quick Tip: To see a house in person, particularly in a tight or expensive market, you may need to show the real estate agent proof that you’re preapproved for a mortgage. SoFi’s online application makes the process simple.

When to Choose a Jumbo Mortgage

Borrowers who should consider jumbo mortgages:

•   If you’re looking for a luxury home

•   If you’re buying a vacation home

•   If you live in a high-cost area

•   If you have a great credit score

•   If you have a strong DTI ratio

•   If you have plenty of income

When to Choose a Conventional Mortgage

Borrowers who should consider conventional mortgages:

•   If you have moderate income

•   If you’re looking for a moderately priced home

•   If the mortgage amount is below the conforming loan limits

•   If you need a down payment lower than 10%

•   If your cash reserves after your down payment will be limited

If you’re close to the conforming loan limits, you may also want to consider a piggyback mortgage. If you’re able to obtain a piggyback loan, you may be able to buy your home with a conventional, conforming mortgage instead of a jumbo loan.

How it works: A piggyback loan allows you to take a second loan to “piggyback” off the first mortgage with the purpose of lending you enough money to avoid a jumbo mortgage or the PMI that comes with a down payment less than 20%. It’s essentially a second mortgage, and you’ll be making a second payment to cover it.

The Takeaway

When it comes to whether or not to choose a jumbo loan, the decision may be made for you based on the price of the home you want to buy. Mortgages above the conforming loan limit need jumbo loan financing. If you want a conforming, conventional loan, you’ll need to get a mortgage below $726,200 for most areas in the U.S. and $1,089,300 for high cost of living areas.

When you’re ready to take the next step, consider what SoFi Home Loans have to offer. Jumbo loans are offered with competitive interest rates, no private mortgage insurance, and down payments as low as 10%.

SoFi Mortgage Loans: We make the home loan process smart and simple.

FAQ

Are jumbo rates higher than a conventional mortgage?

Jumbo rates fluctuate with market conditions. They may be on par with rates of loans that fall within the limits for conforming loans set by the Federal Housing Finance Agency (so-called conforming loans). Sometimes, they’re even lower.

What is the downside of a jumbo mortgage?

Possible downsides of a jumbo mortgage include requirements for a higher down payment, higher credit score, more cash reserves, and a higher monthly payment because of the higher home price.

Do jumbo loans have PMI?

Private mortgage insurance is not always required on jumbo loans. Whether or not PMI is needed will depend on your lender and the size of your down payment.

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Photo credit: iStock/courtneyk

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

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.

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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Whether you’re borrowing money from a lender or depositing money in a savings account, interest rates will play into your financial picture. And understanding exactly how they work is crucial to making the best possible decisions for your money.

Here’s the scoop.

Interest Rate Definition

Interest rate is the cost of borrowing or the payoff of saving. Specifically, it refers to the percentage of interest a lender charges for a loan as well as the percentage of interest earned on an interest-bearing account or security.

Interest rates change frequently, but the average personal loan interest rate is dependent on several factors, including the amount borrowed, credit history, and income, among others. A borrower with an excellent credit score and a dependable income, for instance, will likely be considered low risk and may be offered a lower interest rate. On the flip side, some vehicles like payday loans are considered riskier for lenders and tend to have higher interest rates.

Recommended: What Is a No-Interest Loan? A Personal Loan Guide

How Interest Rates Work

Whether you’re borrowing or saving money, the interest rate is applied to the balance during set periods of time called compounding periods.

For borrowers, this extra charge can add to outstanding debt. For savers, savings interest can be one way to earn money without much effort.

Let’s look at some specific examples.

You might take out a personal loan with an APR of 5.99%. That means you’ll pay an additional 5.99% of the loan balance each year in addition to the principal payments, which is paid to the lender for servicing the loan.

Or, if you hold a high-yield savings account that offers a 1% APY return, you can expect that account to grow by 1% of its balance each year.

Of course, the interest you might earn in a savings account is usually substantially lower than what you might earn on higher-risk investments.

And when it comes to any of the multiple uses of a personal loan, paying interest means you’re paying substantially more than you would if you were able to cover the expense out of pocket.

Fixed vs Variable Interest Rates

Lenders charge fixed or variable interest rates. What’s the difference between the two? Let’s take a look.

As the name suggests, fixed interest rates remain the same throughout a set period of time or the entire term of the loan. Fixed rates can be higher than variable rates. Borrowers who prefer more predictable payments — or are borrowing when interest rates are low — may decide to go with a fixed-rate loan.

Pros of Fixed Interest Rates	Cons of Fixed Interest Rates
Rates won’t increase	Fixed rates can be higher than variable rates
Predictable monthly payments	Borrowers would need to refinance to get a lower rate, which may involve paying more in fees
Consistent payment schedule can make budgeting easier	Borrowers won’t benefit if interest rates decrease

Variable interest rates change periodically, depending on changes in the market. This means the amount of your payments will vary. Generally speaking, variable-rate loans can be riskier for consumers, so they tend to have lower initial rates than fixed-rate loans. However, it’s important to note that when interest rates rise, so can the cost of borrowing. When borrowers decide to renegotiate from a variable-rate to a fixed-rate loan, they may face additional fees and a new loan length.

A variable-rate loan may be a good move for borrowers who plan to pay off the loan quickly or can take on the risk.

Pros of Variable Interest Rates	Cons of Variable Interest Rates
Monthly payments may go down when interest rates decrease	Interest rates fluctuate depending on changes in the market
Rates can be lower (at first) than fixed-rate loans	Repayment amounts can vary, which can make budgeting difficult
Borrowers may receive better introductory rates when taking out a loan	May face extra fees and extended payoff time if you renegotiate to a fixed-rate loan

Types of Interest

While all interest does one of two things — accrue as a result of saving money or in payment to the bank for a loan — it can be calculated and assessed in different ways. Here are a few common types of interest rates explained.

Simple Interest

Simple interest is interest that is calculated, simply, based on the balance of your account or loan. This is unlike compound interest, which is based on the principal balance (the original money you borrowed) as well as interest accrued over time.

Most mortgages and auto loans are calculated using simple interest. That means you won’t pay additional interest on any interest charged on the loan.

For example, let’s say a driver takes out a simple interest loan to pay for a new car. The loan amount is $31,500, and the annual interest rate on the loan is 4%. The term of the loan is five years. The driver will pay $580.12 per month. After five years, when the loan is satisfied, they will have paid a total of $34,807.23.

Compound Interest

Compound interest, on the other hand, means that interest is charged on not only the principal but also whatever interest accrues over the lifetime of that loan.

Say you take out an unsecured personal loan in the amount of $20,000 to pay for home remodeling. The loan is offered to you at an interest rate of 6.99% compounded monthly, and you must also pay an upfront fee of $500 for the loan. You’ll pay it back over the course of five years.

Over the course of those 60 payments, you’ll pay $3,755.78 in interest, not including the $500 extra you paid in fees. Each month, you’ll pay back some of the principal as well as the interest charged to you.

By the time you’re done with your home remodel, you’ll have paid $24,255.78 altogether, and that’s on a personal loan with a fairly low rate. In other words, you’ll have paid 20% more for the project than you would have if you’d funded it out of pocket.

Recommended: Simple Interest vs. Compound Interest

Amortized Interest

Amortizing loans are common in personal finance. If you have a home loan, auto loan, personal loan, or student loan, you likely have an amortizing loan.

Amortization is when a borrower makes monthly (usually equal) payments toward the loan principal and interest. Early payments largely go toward the calculated interest, while payments closer to the end of the loan term go more toward the principal.

The interest on an amortized loan is calculated based on the balance of the loan every time a payment is made. As you make more payments, the amount of interest you owe will decrease.

To see how payments are spread out over the life of the loan, borrowers can consult an amortization schedule. A mortgage calculator also shows amortization over time for a loan.

But here’s a look at a sample calculation:

Let’s say you take out a $200,000 mortgage over 10 years at a 5% fixed interest rate. Your monthly payments will be $2,121.31. Next, divide the interest rate by 12 equal monthly payments. That equals 0.4166% of interest per month. This means that in the first month of your loan, you’ll pay $833.33 toward interest and the remaining $1,287.98 toward your principal.

Now, how about the second month? To calculate what you’ll owe, deduct your monthly payment from the starting balance. (This will give you the “balance after payment” for the chart.) Be sure to add to the chart the $833.33 you paid in interest and the $1,287.98 you paid toward the principal. Repeat the calculation of monthly interest and principal breakdown for the rest of the chart, which includes 12 months of payments.

Date	Starting Balance	Interest	Principal	Balance after payment
July 2023	$200,000	$833.33	$1,287.98	$198,712.02
August 2023	$198,712.02	$827.97	$1,293.34	$197,418.68
September 2023	$197,418.68	$822.58	$1,298.73	$196,119.95
October 2023	$196,119.95	$817.17	$1,304.14	$194,815.80
November 2023	$194,815.80	$811.73	$1,309.58	$193,506.23
December 2023	$193,506.23	$806.28	$1,315.03	$192,191.19
January 2024	$192,191.19	$800.80	$1,320.51	$190,870.68
February 2024	$190,870.68	$795.29	$1,326.02	$189,544.66
March 2024	$189,544.66	$789.77	$1,331.54	$188,213.12
April 2024	$188,213.12	$784.22	$1,337.09	$186,876.03
May 2024	$186,876.03	$778.65	$1,342.66	$185,533.37
June 2024	$185,533.37	$773.06	$1,348.25	$184,185.12

Precomputed Interest

Loans that calculate interest on a pre-computed basis are less common than loans with either simple or compound interest. They’re also controversial and have been banned in some states. Precomputed interest has been banned nationally since 1992 for loans with terms longer than 61 months.

This method of computing interest is also known as the Rule of 78 and was originally based on a 12-month loan. The name is taken from adding up the numbers of the months in a year (or a 12-month loan), the sum of which is 78.

1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10 + 11 + 12 = 78

Interest is calculated ahead — precomputed — for each month and added to each month’s payment, giving more weight to interest in the beginning of the loan and tapering off until the end of the loan term. In the case of a 12-month loan, the first month’s interest would be 12/78 of the total interest, the second month’s interest would be 11/78 of the total interest, and so on.

Here’s an example: Let’s say a borrower takes out a personal loan with a 12-month term that will accrue $5,000 in interest charges. According to the Rule of 78, here’s what the borrower would pay in interest each month:

Month	Fraction of total interest charged	Monthly interest charge
1	12/78	$769
2	11/78	$705
3	10/78	$641
4	9/78	$577
5	8/78	$513
6	7/78	$449
7	6/78	$385
8	5/78	$321
9	4/78	$256
10	3/78	$192
11	2/78	$128
12	1/78	$64

A loan with precomputed interest has a greater effect on someone who plans to pay off their loan early than one who plans to make regular payments over the entire life of the loan.

APR vs APY

Whether compound or simple, interest rates are generally expressed as APR (Annual Percentage Rate) or APY (Annual Percentage Yield). These figures make it easier for borrowers to see what they can expect to pay or earn in interest over the course of an entire year of the loan or interest-bearing account’s lifetime.

However, APY takes compound interest into account, whereas usually APR does not — but on the other hand, APR takes into account various loan fees and other costs, which APY might skip.

APR (Annual Percentage Rate)	APY (Annual Percentage Yield)
Expresses what you pay when you borrow money	Expresses what you earn on an interest-bearing account
Factors in base interest rate over the course of one year	Factors in base interest rate over the course of one year
Factors in fees and other loan costs	Does not factor in fees and other loan costs
Does not factor in compounding	Factors in compounding

Recommended: APY vs. Interest Rate: What’s the Difference?

How Are Interest Rates Determined?

Lenders use several factors to determine the interest rate on a personal loan, including details about your financial background and about the loan itself. What kind of financial questions can you expect?

When lenders talk about a borrower’s creditworthiness, they’re usually referring to elements of your financial background. This may include:

•   Your credit history

•   Your income and employment

•   How much debt you already have

•   Whether you have a cosigner

The loan terms can also affect the rate. For example, personal loan rates can be affected by:

•   The size of the loan

•   The duration of the loan

Loan term is something borrowers should be thinking about as well. A longer loan term might sound appealing because it makes each monthly payment lower. But it’s important to understand that a longer-term loan may cost you significantly more over time due to interest charges.


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

Interest Rates and Discrimination

Generally speaking, the higher your credit score and income level, the easier it is to qualify for loans with better terms and lower interest rates — which, of course, can make it more difficult for people in lower socioeconomic positions to climb their way out.

Discriminatory lending has had a long history in the U.S. Before federal laws protecting against discrimination in lending practice, lenders would regularly base credit decisions on factors such as applicant’s race, color, religion, sex, and other group identifiers rather than their creditworthiness.

The practice of “redlining” was begun in the 1930s as a way to restrict federal funding for neighborhoods deemed risky by federal mortgage lenders. It persisted for decades, and the detrimental effects can still be felt today by residents of minority neighborhoods.

Since residents of redlined neighborhoods were excluded from approval for regular mortgage loans, they were forced to look for other financing options, which were often exploitive. If they could not find any lender willing to loan to them, they continued renting, unable to gain equity in homeownership.

The Takeaway

The interest rate is the cost of borrowing money — it’s a percentage of the total amount of the loan. It can also refer to the rate at which interest is earned on money in a savings account, certificate of deposit, or certain investments. The amount of interest you’ll pay is usually expressed using percentages, which will be listed as either APR (Annual Percentage Rate) or APY (Annual Percentage Yield), depending on which kind of financial product you’re talking about.

Lenders charge fixed or variable interest rates. Fixed interest rates remain unchanged for a set period of time or for the life of the loan, and may be a smart choice for borrowers who want a predictable payment schedule or are taking out a loan when interest rates are low. Variable interest rates can change depending on the market, which means the payment amount will vary. Though potentially riskier, these loans may offer lower initial rates. However, when interest rates rise, so can the cost of borrowing.

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 the definition of interest rate?

An interest rate is expressed as a percentage and is used to calculate how much interest you would pay on a loan in one year (APR), or how much you would earn on an interest-bearing account in one year (APY).

What is an example of an interest rate?

Simple, compound, or precomputed interest rates are types of interest rates commonly used.

What is the difference between interest and interest rate?

Interest is the money you’re charged when you take out a loan — or earn for leaving your money in a deposit account to grow. Interest rate is the percentage you’re being charged or are earning.

What happens when interest rates are high?

Interest rate increases tend to lead to higher interest rates on personal loans, mortgages, and credit cards. It can also mean costlier financing for borrowers.

Can you adjust the interest rate on a personal loan?

Possibly. One way to lower the interest rate on a personal loan is to refinance it with another lender.

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Photo credit: iStock/Remitski

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Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.

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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When an IRA account holder passes away, they might choose to leave their account to a loved one. But whether the recipient is surprised or knew about the inheritance ahead of time, they may have questions about what to do with this inherited IRA.

How does an inherited IRA work? The key to properly handling an inherited IRA is to understand what it means for you as a beneficiary. Your relationship with the deceased, for example, could impact the tax consequences on the inheritance. Plus there are inherited IRA distribution rules you’ll need to know.

An inherited IRA can also be a tremendous financial opportunity, as long as you understand the inheritance IRA rules. Here’s what you should know about the beneficiary IRA distribution rules.

What Is an Inherited IRA?

An inherited IRA, also called a beneficiary IRA, is a type of account you open to hold the funds passed down to you from a deceased person’s IRA. The original retirement account could have been any IRA, such as a Roth, traditional IRA, SEP IRA, or SIMPLE IRA. The deceased’s 401(k) plan can also be used to fund an inherited IRA.

Spouses won’t necessarily need to open an inherited IRA, because spouses are allowed to transfer any inherited assets directly into their own retirement accounts. However, any other beneficiary of the deceased’s account — such as someone who inherited an IRA from a parent — will need to open an inherited IRA, whether or not they already have a retirement account.

Some people prefer to open their inherited IRA account with the same firm that initially held the money for the deceased. It can make it simpler for the beneficiary while planning after the loved one’s passing. However, you can set up your IRA account with almost any bank or brokerage.

💡 Quick Tip: Did you know that opening a brokerage account online typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

How Does an Inherited IRA Work?

When it comes to IRAs, there are two types of beneficiaries: designated and non-designated. Designated includes people, such as a spouse, child, or friend. Non-designated beneficiaries are entities like estates, charities, and trusts.

This article focuses on designated beneficiaries. While your relationship with the deceased may impact your options and any inherited IRA distribution rules, as can the age of the deceased at the time of death, certain inheritance IRA rules apply to everyone:

1.    You cannot make additional contributions to the inherited IRA. You can only make changes to the investments or buy and sell assets held by the IRA.

2.    You must withdraw from the inherited IRA. The required minimum distribution (RMD) rules depend on your age and relationship to the deceased, but according to inherited Roth IRA distribution rules, withdrawals are required even if the original IRA was a Roth IRA (which typically does not have RMD requirements).

What Are the RMD Rules for Inherited IRAs?

When it comes to required minimum distributions, there are different rules for inherited IRA RMDs for spouses and non-spouses.

One recent difference between the rules for spouse and non-spouse beneficiaries is a result of the SECURE Act, established in early 2020. It states that non-spouse beneficiaries have to withdraw all the funds from their inherited IRA within a maximum of 10 years. After that time, the IRS will impose a 50% penalty tax on any funds remaining.

Spouses, on the other hand, can take yearly distributions from the account based on their own life expectancy.

RMD Rules for Spouses

Once a spouse takes ownership of the deceased’s IRA account, they can either roll over the assets into their own pre-existing IRA within 60 days, or transfer funds to their newly opened inherited IRA they can withdraw based on their age.

Note that taking a distribution from the account if you are under age 59 ½ results in a 10% early withdrawal penalty.

RMD Rules for Non-Spouses

For non-spouses (relatives, friends, and grown children who inherited an IRA from a parent), once you’ve opened an inherited IRA and transferred the inherited funds into it, RMDs generally must start before December 31st following a year from the person’s death. All assets must be withdrawn within 10 years, though there are some exceptions: if the heir is disabled, more than a decade younger than the original account owner, or a minor.

Multiple Beneficiaries

If there is more than one beneficiary of an inherited IRA, the IRA can be split into different accounts so that there is one for each person. However, in general, you must each start taking RMDs by December 31st of the year following the year of the original account holder’s death, and all assets must be withdrawn from each account within 10 years (aside from the exceptions noted above).

Inherited IRA Examples

These are some of the different instances of inherited IRAs and how they can be handled.

Spouse inherits and becomes the owner of the IRA: When the surviving spouse is the sole beneficiary of the IRA, they can opt to become the owner of it by rolling over the funds into their own IRA. The rollover must be done within 60 days.This could be a good option for someone who is younger than the original owner of the IRA because it delays the RMDs until the surviving spouse turns 73.

Non-spouse designated beneficiaries: An adult child or friend of the original IRA owner can open an inherited IRA account and transfer the inherited funds into it. They generally must start taking RMDs by December 31 of the year after the year in which the original account holder passed away. And they must withdraw all funds from the account 10 years after the original owner’s death.

Both a spouse and a non-spouse inherit the IRA: In this instance of multiple beneficiaries, the original account can be split into two new accounts. That way, each person can proceed by following the RMD rules for their specific situation.

How Do I Avoid Taxes on an Inherited IRA?

Money from IRAs is generally taxed upon withdrawals, so your ordinary tax rate would apply to any tax-deferred IRA that was inherited — traditional, SEP IRA, or SIMPLE IRA.

However, if you have inherited the deceased’s Roth IRA, which allows for tax-free distributions, you should be able to make withdrawals tax-free, as long as the original account was set up at least five years ago.

Spouses who inherit Roth accounts have an extra opportunity to mitigate the bite of taxes. Since spousal heirs have the power to take ownership of the original account, they can convert their own IRA into a Roth IRA after the funds roll over. Though the spouse would be expected to pay taxes on the amount converted, it may ultimately be financially beneficial if they expect higher taxes during their retirement.

Recommended: Is a Backdoor Roth IRA Right For You?

The Takeaway

Once you inherit an IRA, it’s up to you to familiarize yourself with the inherited IRA rules and requirements that apply to your specific situation. No matter what your circumstance, inheriting an IRA account has the potential to put you in a better financial position in your own retirement.

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).

Help grow your nest egg with a SoFi IRA.

FAQ

Are RMDs required for inherited IRAs in 2023?

The IRS recently delayed the final RMD rule changes regarding inherited IRAs to calendar year 2024. That’s because rules regarding RMDs have changed in the last few years, leaving many people confused. What this means is that the IRS will, in some cases, waive penalties for missed RMDs on inherited IRAs in 2023 — but only if the original owner died after 2019 and had already started taking RMDs.

What are the disadvantages of an inherited IRA?

The disadvantages of an inherited IRA is knowing how to navigate and follow the many complex rules regarding distributions and RMDs, and understanding the tax implications for your specific situation. However, it’s important to realize that an inherited IRA is a financial opportunity and it could help provide you with money for your own retirement.

How do you calculate your required minimum distribution?

To help calculate your required minimum distribution, you can consult IRS Publication 590-B. There you can find information and tables to help you determine what your specific RMD would be.

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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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