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Investing in individual bonds can be complicated, but exchange-traded funds (ETFs) that invest in bonds — a.k.a. bond ETFs — can provide a more straightforward way to invest in fixed income securities.

Investors may associate ETFs with stocks, thanks to the popular ETFs that track stock indices like the S&P 500. ETFs also happen to trade on stock exchanges, like the New York Stock Exchange.

Bond ETFs work similarly. Though the ETF holds bonds and not stocks, it trades on a stock exchange. Said another way, a bond ETF is a bundle of bonds that an investor can trade like a stock.

Bond ETFs make it possible for investors to buy a diversified set of bonds, without the time and effort it would take to build a portfolio of individual bonds.

Before getting into the specifics of bond ETFs, it will be helpful to understand ETFs and bonds separately. Let’s begin with ETFs.

ETF 101: Reviewing the Basics

An investment fund provides a way to pool money with other investors so that money can then be spread across many different investments (sometimes referred to as a “basket” of investments).

For most small investors, it would be too costly to individually purchase 500 individual stocks or 1,000 individual bonds. But such a thing becomes possible when doing it alongside thousands of other investors. Though different vehicles, mutual funds and ETFs provide investors with an incredible opportunity to diversify their investments.

For retail investors, investment funds come in two major varieties: mutual funds and exchange-traded funds. Mutual funds and ETFs are constructed differently — ETFs were built to trade on an exchange, as the name implies — but both can be useful tools in gaining broad diversification.

Whether investors will choose a mutual fund or ETF will likely depend on their preference, and context. For example, someone using a workplace retirement plan may only have access to mutual funds, so that’s what they use.

Someone who is investing independently may choose ETFs, because it’s possible to purchase them without any of the normally associated trading costs.

Whether an investor is using a mutual fund or an ETF, what’s most important is what’s held inside that fund. Think of an ETF as a basket that holds an array of securities, like stocks or bonds.

Most ETFs will hold just one type of security — only stocks or only bonds, for example. A bond ETF could be broad, or it could contain a narrower sliver of the bond market, like corporate bonds, green bonds, or short-term treasury bonds.


💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

What Is a Bond?

Effectively, a bond is a loan to an organization: i.e. a company, government, or other entity. Investors loan the entity their money, and then the entity pays interest on the amount of that loan.

Bonds are quite different from stocks, which offer investors the opportunity to buy shares of ownership in a company or entity.

There are countless types of bonds. Treasuries are loans to the U.S. government. Municipal bonds are loans to a state or local government. Companies sometimes issue bonds in order to raise money. These entities are borrowing money from investors and issuing IOUs in the form of bonds.

How Bonds Work

When investors buy a bond, they are agreeing to the rate of interest and other terms set by the bond. Because bonds pay a fixed rate of interest, bonds are sometimes referred to as fixed-income investments.

Bonds typically make interest payments, sometimes referred to as coupon payments, twice annually.

Example of a Bond

Let’s say an investor buys a Coca-Cola bond for $10,000 that pays a 4% rate of interest over 20 years. The bond earns $400 every year, earning the investor a total of $8,000 over the 20-year period. At the end of the period, the $10,000 “principal” investment is returned. As long as the investor holds the bond for the full 20 years, there should be no surprises.

Because bonds pay a fixed rate of return, their earnings potential is largely predictable. But there is limited upside on what can be earned on a bond. For this reason, bonds are considered to be a safer, less volatile complement to stock holdings, which have a higher potential for returns over time.

Types of Bonds

Bonds are issued by different entities and are often categorized by the issuer. There are four categories of bonds available to investors.

Treasury bonds: Bonds issued by the U.S. government.

Municipal bonds: Bonds issued by local governments or government agencies.

Corporate bonds: Bonds issued by a public corporation.

Mortgage and asset-backed bonds: Bonds that pass through the interest paid on a bundle of debts, such as a bundle of mortgages, student loans, car loans, or other financial assets.

As one could imagine, there are many subtypes within these broad categories.

When it comes to risk, the bond market produces a wide range. Corporate, municipal, and asset-backed bonds are generally considered to be higher risk than treasury bonds.

Whereas a business or even a municipal government could potentially “default” on a loan, it is highly unlikely that the U.S. government would go bankrupt. (As yet, the U.S. government has never defaulted on a treasury bond.)

Because they are considered low risk, U.S. treasury bonds typically pay less interest than the other bond types. This is an important trade-off to understand. Higher-risk investments should pay a higher rate of interest in order to compensate the investor for taking on that additional risk.

This is why it is possible to see bonds with high rates of interest issued by unstable governments or by highly speculative companies. These are often referred to simply as high-yield bonds or junk bonds.

Bonds can also vary by their maturity dates. It is possible to purchase bonds with a wide range of timelines, ranging from the very short (a few days) to the very long (30 years). Although it depends on the current state of interest rates, long-term bonds tend to pay more than short-term bonds. This should make intuitive sense; investors want to be compensated for locking their money up for longer periods.

Benefits of Bond ETFs

While bonds offer certain benefits to investors, including relatively low risk and predictable income, these instruments are complex. Owning and managing a portfolio of bonds requires experience and sophistication. This is where bond ETFs come in. In some ways, bond ETFs give retail investors easier access to the bond market.

Bond ETFs can be purchased in small dollar amounts.

For some bonds, the starting price is $1,000. This can be prohibitive for small investors who don’t have $1,000 to start building their bond portfolio, let alone a diversified one.

Generally, ETFs are sold by the share, and the cost of one share varies by ETF. Some trading platforms allow for the purchase of partial shares, which allows investors to get started with as little as $1.

They provide diversification.

It is possible to buy into a fund of hundreds or thousands of bonds using a bond ETF. This type of portfolio diversification would be otherwise impossible to achieve for small investors trying to build a bond portfolio on their own. ETFs make diversification a possibility, even at very small dollar amounts.

They are low cost.

ETFs, by their nature, are low cost. Because they are typically passive funds by style, the management fee embedded within the fund — called the expense ratio — is typically quite low. Compare this to an actively managed mutual fund of bonds, where the expense ratios can top 1%.

There’s another fee that investors will want to be aware of, called a trading cost or transaction fee. This is the cost of buying and selling ETFs (and stocks). These fees can be quite prohibitive for smaller investors. Luckily, there are ways to buy ETFs without paying any trading or transaction fees.

They are easy to buy and sell.

Individual bonds are not always easy to buy and sell. Said another way, they are not particularly liquid. Bonds do not trade on an open exchange, like stocks and ETFs. It is likely that an investor would need to involve a professional to broker the transaction.

ETFs, on the other hand, are very easy to sell. Most banks and trading platforms allow investors to do it themselves, online. This way, an investment can be sold quickly if needed.


💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

Downsides of Bond ETFs

Bond ETFs do have their downsides, though.

Bond ETFs reveal underlying price changes in the bonds, which some investors may find disconcerting. Because yes, it is possible for bonds, and a bond ETF, to lose value.

When holding an individual bond or a portfolio of bonds, an investor is not provided minute-by-minute updates of the market value of that investment. In this way, a bond is like a house. There is no ticker sitting above anyone’s house that tells them the value of that property at that very second.

This is not the case with a bond ETF, where price changes can be felt in near real time. It will be important that investors are prepared for this. It is generally not wise to make a decision about long-term investments based on recent price gyrations, not just with stocks but with bonds, too.

The Takeaway

The first step is to research bond ETFs, as there are many kinds. Bond ETFs can be broad and cover a wide sample of the bond market, or they can be narrower. For example, it is possible to buy a long-term treasury bond ETF or a bond ETF that only holds certain municipal bonds.

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

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

SOIN20151

Getting mortgage preapproval can give you an edge in the home-buying process, especially when the housing market is tight. A mortgage preapproval from a lender lets sellers know that you have tentatively been approved for a specific loan type and amount. Not only does this show that you’re a serious home shopper, it also helps give you a good sense of your budget as you go house-hunting.

Here, you’ll learn the ins and outs of how to get preapproved for a home loan, including:

•   What is mortgage preapproval?

•   How do mortgage preapproval and prequalification compare?

•   What are the pros and cons of mortgage preapproval?

•   How can you improve your chances of getting preapproved for a mortgage loan?

•   What can you do if you aren’t preapproved for a mortgage?

What Is Mortgage Preapproval?

Mortgage preapproval involves a thorough review of your credit and financial history. If you look like a good candidate for a mortgage, a lender will issue a letter stating that you qualify for a loan of a certain loan amount and at a certain interest rate. The letter is an offer, but not a commitment, to lend you a specific amount. It’s good for up to 90 days, depending on the lender.

You’ll want to shop for homes within the price range of your preapproved mortgage. Armed with your preapproval for a home loan, you can show sellers that you are a serious buyer with the means to purchase a property. In the eyes of the seller, preapproval can often push you ahead of other potential buyers who have not yet been approved for a mortgage and make it easier to compete when there are multiple offers on a house.

Once you find a house that you want to buy, you can make an offer immediately based on the loan amount for which you are preapproved. And if the seller accepts, it will be time to finalize your mortgage application. At this point, a loan underwriter will review your application and conduct other due diligence measures, such as having the house appraised to make sure it is valued at the price it’s selling for. If all goes well, the lender will issue another letter called a commitment letter, which officially seals the deal on your loan, and you can schedule a closing date.

When Should I Get Preapproved for a Home Loan?

Preapproval typically lasts for 90 days, at most, so you want to seek it when you are actively in the market for a new home. Maybe you’ve done some initial online research into available properties. Hopefully, you’ve also had a good look at your finances and thought about how much you have available to spend on a down payment as well as what amount of monthly mortgage payments you can afford long-term. It takes around 10 days after you submit a request to be preapproved, so factor that timing into your house search as well.

Mortgage Preapproval vs. Prequalification

If you are house hunting, you will likely hear two different terms regarding early mortgage moves: prequalification vs. preapproval. Prequalification is a simple, less involved view of your financial qualifications for a mortgage. Preapproval for a home loan is a more in-depth review of your finances and an indicator that your loan application will likely move forward smoothly. Each has its advantages, and its moment.

Mortgage Prequalification

Getting prequalified for a home loan involves a review of a few financial details — usually self-reported — such as income, assets, and debt. The lender will then estimate how much of a mortgage you can afford.

Pros of Mortgage Prequalification

•   It’s fast. The process can often be done in minutes, by phone or online.

•   You’ll zero in on house prices. Prequalifying for a home loan quickly gives you an idea of what your monthly payment might be and how much house you can afford.

•   You can shop around. You can prequalify with multiple lenders to see what types of terms and interest rates they offer.

•   It’s easy on your credit score. Prequalification will not affect your credit score because it only requires a “soft inquiry” into your credit record.

Cons of Mortgage Prequalification

•   It’s no guarantee. Because it is an unverified, high-level look at your finances, prequalification doesn’t ensure that you will actually qualify for a mortgage.

•   It won’t help you bargain. Being prequalified won’t help you negotiate a lower price with a seller or compete against other bidders in a competitive market.

Mortgage Preapproval

Requesting a mortgage preapproval is a more complicated process than getting prequalified. You’ll have to fill out an application with your chosen lender and agree to a credit check. The credit check will be a “hard pull” which will ding your credit score by a few points. You’ll also provide information about your income and assets. The evaluation process can take 10 days or more. Again, preapproval doesn’t mean it’s a done deal that you’ll get the loan, but it is a solid indication of your financial situation and ability to purchase a home.

There are a number of advantages to getting preapproval for a home loan, especially if you’re shopping in a fast-moving market.

Pros of Mortgage Preapproval:

•   It gives you an edge. Sellers will see that you are a serious buyer and have assurance that your financing won’t fall through and sink the deal.

•   It helps you get loan shopping done. When you’ve found your dream house, you don’t want to delay putting in an offer because you have to spend time getting your documents together and pursuing a loan. Going through the preapproval process helps you take care of these details before you’re in a fast-moving market.

Cons of Mortgage Preapproval:

•   A mortgage preapproval expires. How long does a mortgage preapproval last? As noted above, the letter is only good for a certain period of time, usually 90 days, so you’ll want to make sure you’re seriously ready to start shopping once you have your mortgage preapproval in hand.

•   The application is time-consuming. You’ll need to provide a lot of documentation to get a mortgage preapproval and agree to a hard credit inquiry, which can drag down your credit score, though usually only by a bit.

•   Nothing is guaranteed. Even though your home loan preapproval letter likely has details on your loan amount and type, it is only tentative approval — you still can’t be 100% sure that you will get the loan.

Here are the basic comparison points of prequalification vs. preapproval:

Steps to Get Preapproved for a Home Loan

Getting preapproved for a home loan will take some time, so it’s good to get the process started before you are ready to make an offer on a home. Here are some important steps along the way.

Check Your Credit Score

If you’ve established a credit history, a first step before applying for a mortgage is to check your credit reports, which are a history of your credit compiled from sources like banks, credit card companies, collection agencies, and the government.

The information is collected by the three main credit reporting bureaus: TransUnion®, Equifax®, and Experian®. You’ll want to make sure that the information on your credit reports is correct. Ordering the reports is free once a year through AnnualCreditReport.com .

If you find any mistakes in your credit report, contact the credit reporting agencies immediately to let them know. You don’t want any incorrect information weighing down your credit score, putting your chances for preapproval at risk.

The free credit reports provided by the nationwide credit reporting agencies do not include your credit score, a number typically between 300 and 850. You can purchase your score directly from the credit reporting agencies, or from FICO®. Your credit card company also may provide your credit score for free, or you could try a money tracker app that updates your credit score weekly and tracks your spending at no cost.

Calculate Your Potential Mortgage

To help with the prequalification and preapproval process, use the mortgage calculator below to see what your estimated monthly mortgage would be based on down payment, interest rate, and loan terms.

Gather Documentation

Your credit score is only one of many factors a potential lender will consider when deciding on your mortgage qualification. So collect the many other documents you will need to paint a full picture of your financial life. Ask the lender what is needed, specifically. The list will likely include:

•   Recent pay stubs

•   Recent bank and investment account statements

•   Two years of tax returns and/or W2s, possibly more if you are self-employed

•   Verification of alimony or child support payments received and the court documents spelling out the terms of the payments

•   Social Security award letter, if you derive income from Social Security

•   Certificate of Eligibility from the VA, if you are applying for a VA loan

•   Gift letter documenting any money you are receiving from family or other sources toward a down payment

Receive Your Mortgage Preapproval Letter

Your first instinct when you receive preapproval will likely be to jump for joy. Next, take a moment to ask the lender if they made any assumptions about your finances in order to issue the letter, or if they flagged anything that could lead to you being denied a mortgage later on, or that could increase your costs. Doing this could help you head off future problems that might scuttle a deal.

Upping Your Odds of Mortgage Preapproval

There are a number of steps you can take to increase your chances of preapproval or to increase the amount your lender may approve you for.

Build Your Credit

When you apply for any type of loan, lenders want to see that you have a history of properly managing your debt before offering you credit themselves.

You can build your credit history by opening and using a credit card and paying your bills on time. Or you could consider having regular payments, such as your rent, tracked and added to your credit score.

Recommended: What Credit Score Is Needed to Buy a House?

Stay on Top of Debt

Your ability to pay your bills on time has a big impact on your credit score. If your budget allows, you should aim to make payments in full.

If you have any debts that are dragging down your credit score — for example, debts that are in collection — it’s smart to work on paying them off first, as this could help build your score.

“Really look at your budget and work your way backwards,” explains Brian Walsh, CFP® at SoFi, on planning for a home mortgage.

Recommended: Fixed-Rate vs. Adjustable-Rate Mortgages

Watch Your Debt-to-Income Ratio

Your debt-to-income ratio is your monthly debt payments divided by your monthly gross income. If you have $1,000 a month in debt payments and make $5,000 a month, your debt-to-income (DTI) ratio is $1,000 divided by $5,000, or 20%.

Mortgage lenders typically like to see a DTI ratio of 36% or less. Some may qualify borrowers with a higher DTI, up to 43%. Lenders may assume that borrowers with a high DTI ratio will have a harder time making their mortgage payments.

If you’re seeking preapproval for a mortgage, it may be beneficial to keep the ratio in check by avoiding large purchases. For example, you may want to hold off on buying a new car until you’ve been preapproved.

Prove Consistent Income

Your lender will want to know that you have enough money coming in each month to cover a potential mortgage payment, so the lender will likely want proof of consistent income for at least two years (that means pay stubs, W-2s, etc.).

For some potential borrowers, such as freelancers, this may be a tricky process since they may have income from various sources. Keep all pay stubs, tax returns, and other proof of income, and be prepared to show those to your lender.

What Happens If Your Mortgage Preapproval is Rejected?

Rejection hurts. But if you aren’t preapproved or you aren’t approved for a large enough mortgage to buy the house you want, you also aren’t powerless. You can ask the lender why it said “no.” This will give you an idea about what you might need to work on in order to secure the mortgage you want.

Then you may want to work on the factors that your lender saw as a sticking point to preapproval. You can continue to work to build your credit score, lower your DTI ratio, or save for a higher down payment.

If you’re able to pay more upfront, you will typically lower your monthly mortgage payments. Once you’ve worked to make yourself a better candidate for a mortgage, you can apply for preapproval again.

Dream Home Quiz

The Takeaway

In a competitive market, having a mortgage preapproval letter in hand may give a house hunter an edge. After all, the letter states that the would-be buyer tentatively qualifies for a home loan of a certain amount.

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

FAQ

What happens during the preapproval process?

During the mortgage preapproval process you’ll provide lots of background information on your finances. A potential lender will also check your credit score. If the lender feels you’re a suitable candidate for a loan, you’ll receive a letter that you can show a seller to better your chances when making an offer on a home.

Do preapprovals hurt your credit score?

The lender will do a “hard pull” to obtain your credit score prior to a preapproval. This may cause your rating to drop by a few points, but it should rebound quickly if you pay your bills on time.

How far in advance should I get preapproved for a mortgage?

Get preapproved for a mortgage when you have a sense of the housing costs where you are shopping for a home, and you are ready to start looking in earnest.

Which is better preapproval or prequalification?

Prequalification and preapproval each have a place in the homebuying process. Prequalification is helpful when you are trying to get a sense of what you can afford and which lender might offer the best terms. It’s time for preapproval when you are serious about searching for a home and have researched possible lenders.

Is it OK to get multiple preapprovals?

You only need one preapproval, but it is fine to get a few if you want to see what loan amounts and rates you might qualify for. Make all applications within a 45-day window — the time frame during which multiple lenders can check your credit without each check having an additional impact on your score.

*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.

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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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