One thing you should always look out for — regardless of the type of loan you’re applying for — is a loan origination fee. Many lenders charge origination fees for new loans to help cover costs on their end. What these fees are called and what they amount to, however, can vary quite a bit from lender to lender.
Knowing these things about origination fees before you settle on a lender can help you make the best borrowing decision for your financial situation.
What Is a Loan Origination Fee?
An origination fee is a cost the lender charges for a new loan. It’s a one-time expense you are generally asked to pay at the time the loan closes. The fee covers the costs the lender incurs for processing and closing the loan.
How Are Origination Fees Determined?
Loan origination fees depend on a number of factors. They include:
• Loan type
• Amount of loan
• Credit score
• Inclusion of a cosigner
• Your financial situation, including assets, liabilities, and total income
Do I Have to Pay Origination Fees?
You don’t necessarily have to pay origination fees — while most lenders charge this fee, not all do. Additionally, origination fees may be negotiable. If you ask, a lender could simply lower the fee, or they could offer a credit to offset at least a portion of it. Or, they might agree to lower the fees if you pay a higher interest rate.
To minimize the sting of loan origination fees, research your loan options. Compare how much you’d pay overall for different loan offers, factoring in the term of the loan, the interest rate, and any fees.
One way to effectively compare and contrast different loan options is to check each loan’s annual percentage rate (APR), an important mortgage basic to understand. A loan’s APR provides a more comprehensive look at the cost you’ll incur over the life of the loan. This is because the APR factors in the fees and costs associated with the loan, in addition to the loan’s interest rate.
The Truth in Lending Act requires lenders to disclose an APR for all types of loans. Along with the APR, you’ll also see any fees that a lender may charge listed, including prepayment penalties.
How Much Are Loan Origination Fees?
How much a lender charges — and what the fee is called — varies based on the type of loan and the lender.
A traditional origination fee is usually calculated based on a percentage of the loan amount — and that percentage depends on the type of loan. For a mortgage, for instance, an origination fee is generally 0.50% to 1%. Origination fees for personal loans, on the other hand, can range from 1% to 8% of the loan amount, depending on a borrower’s credit score as well as the length, amount, and sometimes intended use of the loan.
There are a variety of other origination fees that lenders may charge, and these can be flat charges rather than percentages of loan amounts. Other fees that lenders may charge to originate a loan could be called processing, underwriting, administration, or document preparation fees.
Can Loan Origination Fees Affect Your Taxes?
Loan origination fees, categorized by the IRS as points, may be deductible as home mortgage interest. This can be the case even if the seller pays them. Borrowers who can deduct all of the interest on their mortgage may even be able to deduct all of the points, or loan origination fees, paid on their mortgage.
To claim this deduction, borrowers must meet certain conditions laid out by the IRS. They’ll then need to itemize deductions on Schedule A (Form 1040), Itemized Deductions.
The Takeaway
Loan origination fees are important to consider when shopping for a loan during the home-buying process. These fees are charged by lenders to help cover their costs of processing and closing a new loan application. While many lenders charge origination fees, not all do, and some may be willing to negotiate.
Origination fees are just one reason it’s important to shop around and compare home loans. With a SoFi Home Loan, for instance, qualified first-time homebuyers can make a down payment as low as 3%.
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.
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About one out of four U.S. consumers report living paycheck to paycheck, with no money left at the end of the month to save or invest, according to a survey conducted in 2024.
With so many people barely paying their bills, you may wonder if living below your means — or spending less money than you make — is even possible. The answer is yes, with a sound budget, determination, and some smart strategies. Learn the details here.
Financial experts say the chances of living on less than you make increase if you haven’t yet bought a house or started a family, but don’t stop reading if you’re already in the thick of those responsibilities. Even with those commitments, you can still live below your means, gaining financial freedom with the right mindset and goals.
Key Points
• Living below your means you spend less money than you earn every month.
• You can live below your means with a sound budget, determination, and smart money-management strategies.
• Financial freedom can be achieved by living below your means, even with commitments like a house or family.
• Living below your means can allow you to save for emergencies and larger purchases, as well as have more financial freedom and confidence.
• Living below your means can also lead to less stress about money and the ability to build wealth.
What Does ‘Living Below Your Means’ Mean?
If you live below your means, you get by on less money than you earn every month. For example: If your household income is, say, $40,000, but you make ends meet by spending $5,000 less than that amount, you’re left with money to put in your savings account or invest for important goals.
In other words, you aren’t having to borrow money to pay your rent, nor are you building up high-interest credit card debt to cover your monthly spending.
How Much Money Qualifies as Living Below Your Means?
No set amount of money qualifies as living below your means vs. living beyond your means. No matter what your income, living below means is defined as spending less than you earn. If you earn $4,000 every month, but only spend $3,500, then you are living $500 below your means. This makes it possible to build wealth. If you spend $3,900 per month, then you are living $100 below your means.
Any little bit of a cash cushion in your checking account can qualify you as living below your means.
Benefits of Living Below Your Means
Living beneath your means can be a wise financial move — one that pays off in an array of ways. Here are a dozen good reasons to start living on less than you make so you can enjoy the benefits of financial independence.
1. Being Prepared for Emergencies
If you have wiggle room in your finances, you can start putting money into an emergency fund every month and build a safety cushion. This gives you peace of mind when unexpected expenses arise, such as a flat tire, broken washing machine, or a major dental bill.
Planning a family beach vacation or girls’ weekend away? Will you need a new laptop soon? If you live below your means (for example, driving your trusty old car rather than financing a new model), you will have more breathing room in your budget to save for key expenses. Ordering takeout for your family’s dinner every two weeks vs. every week could add up to $100 or more in monthly savings, which could be better used elsewhere.
3. More Financial Freedom and Confidence
A major benefit of living below your means is gaining financial freedom. When you aren’t living paycheck to paycheck, you won’t feel that money stress. You won’t watch your credit card debt continue to climb upwards. You may, however, see your savings grow.
Living beneath your means can help you be a responsible spender and saver. Achieving this financial discipline will give you a feeling of control and confidence, and it can also open the door to more possibilities.
4. Having a Healthier Lifestyle
Living below your means typically gives you the room to be more mindful about both your spending and your lifestyle. When you watch your pennies, you’re more likely to make meals at home, which can be healthier and have more reasonable portion sizes than, say, a stuffed pizza or bucket of fried chicken delivered to your door.
You may also avoid high-priced gas or Ubers and walk or bike more, which is better for you and the planet.
5. Less Stress and Worry About Money
A recent survey found that 73% of Americans said their number-one worry was, not too surprisingly, money. When you are living below your means, you may well eliminate some of this stress. Having some room in your budget means you don’t have to break out your plastic to buy groceries or see your checking account balance head towards negative territory. Phew!
6. Spending Less Money on Consumerism and Materialism
When you are focused on living beneath your means, you may recognize that constant consumerism is bad for the planet and your pocketbook. More and more of us are embracing the minimalist way of life, bypassing new jeans in favor of thrift-shop pairs. Same goes for cookware, furniture, and books.
Reduce, reuse, recycle is a mantra that’s been gaining ground. Too often, our need for new goods is short and they end up in a landfill, where they never die. Buying used can help prevent this while padding out your savings.
7. Having Funds for a Rainy Day…or a Sunny One
Maybe your favorite armchair’s upholstery rips. Wouldn’t it be nice to have funds available to fix it without feeling money anxiety? Or perhaps the kids would love an overnight stay at a lodge with a water park. If you have been living below your means and setting aside some cash, this may be your moment to forge ahead.
That’s where your rainy day fund or splurge savings come in. Neither of these situations are good uses of an emergency fund, but they can be worthwhile expenses drawn upon other cash cushions.
When you live below your means, you have a surplus of cash that you can invest to build wealth. One smart move: If your employer has a 401(k) program, sign up. Money will be swept from your paycheck (before you even see it) into a retirement investment account. This is an example of paying yourself first and is also one of the best ways to build future wealth.
Another idea: If you get a raise (nice work!), invest it rather than amping up your spending to account for the extra money, which is called lifestyle creep. Also, if you are not living paycheck to paycheck, when you get a windfall (say, a tax refund), you can also invest that, rather than using it to buy necessities.
10. Developing a Stronger Money Mindset
How do you think about money: with shame, because of debt burdens? Or with pride and contentment, knowing you have cleared the deck and are even socking away some money by living below your means? The more you take control of your finances and improve your money mindset, the better your outlook on life is likely to be.
11. Having Financial Security
When you live below your means, you know you can handle bills without worry and dread over late notices, collection agency phone calls, fees, and service interruptions. Living on a leaner budget also means you can save extra dough for unexpected expenses that pop up. These might include, for example, new clothes for your college roommate’s wedding or fees for a professional class you really want to take.
By living below your means, you are likely taking a giant step or two toward achieving financial security and not feeling on the brink of money trouble.
12. Being Able to Invest Your Money
This is empowering. When you have some extra cash, contact a financial advisor (ask friends and relatives for a referral or see if your bank has one on the team) and consider investing in the stock market, which can be both fun and financially wise.
Historically, the market returns approximately 10% per year, which can boost your long-term savings, such as your retirement fund. Some risk is involved, though.
If you are risk-averse, you might prefer to put some funds into a high-yield savings account that’s insured by the Federal Deposit Insurance Corporation (FDIC). Your money will grow, thanks to the power of compound interest.
Tips for Living Below Your Means
If you’re convinced of the value of living beneath your means, the next step can be to take action to do so. Here are some strategies to make that happen.
Tracking All of Your Spending
Recording where your money goes is the first step to living below your means. For one month, track every dollar that leaves your wallet, from a tip at the coffee place to a gift for your sister. Not just rent and gas, but also pharmacy co-pays, the juice you got on your way to work, and parking meter charges. Look into a free budgeting app to help you stay on task; many financial institutions (such as online banks) provide these for their clients, or there are plenty of third-party options available online.
Budgeting
Once you know what you spend in a given month (including debt payments), compare this to your take-home income. Re-evaluate what you truly need and what can be eliminated in your quest to live below your means.
Some expenses are fixed, like a monthly mortgage or commuter fare. But others are more variable. Take a close look at grocery bills, streaming services, dining out, and shopping. Consider a town library card vs. buying books; making your own iced tea vs. spending $4 to have the barista pour one; and perhaps give up your gym membership in exchange for free online-taught workouts or jogging in a local park.
Take time to consider your lifestyle and goals; you can do this solo or with a financial planner. Things to consider are your short-, medium-, and long-term aspirations (from funding a wedding to building a robust retirement fund), boosting an emergency savings fund, having an investment portfolio, and possibly an estate plan.
When you trim expenses and live below your means, you can sock money away to achieve all this and more.
Downsizing
Could you consider downsizing? Moving to a smaller space or more affordable city, trading in your gas guzzler for a greener car? These moves can reduce the cost of your monthly needs and deliver the wiggle room in your budget you seek.
You might also consider selling things you no longer want or need, whether that’s gently worn clothing, furniture sitting in your basement, or an iPad you haven’t touched in months. Depending on the item, you might be able to sell it on eBay, Etsy, Facebook Marketplace, Poshmark, or ThredUP, among others.
Eliminating Unnecessary Expenses
Get serious about axing unnecessary expenses. In addition to ditching a cappuccino-a-day habit, scroll through your monthly credit card statement and cancel any excess services. You may have forgotten how many streaming services you signed up for during the early days of the pandemic, or perhaps you are paying for a fax or postage service you almost never use, or a meal-kit plan that keeps raising its prices. Keep what you cannot part with, and trim the extras to bring your spending in line. It’s a key aspect of living within your means.
Having Multiple Streams of Income
While cutting costs is one way to help live beneath your means, another tactic is to increase your income. More money coming in, minus your current spending, should yield some spare cash. Perhaps you could take in a roommate for a while, or start a part-time gig (whether dog-walking or website design) in your free time. One of the benefits of a side hustle in bringing in extra funds.
Organizing Bills and Monthly Expenses
Above all, when learning to live below your means, stay organized at tracking money in and money out. As noted above, use an online finance tool (easy to find from your bank, in the app store, or online). This can help you always know where you stand financially as unexpected expenses and bills pop up.
Improving Your Money Mindset
Take stock of, and pride in, what you do day by day to live below your means. Recognize your progress, no matter how minor. Every dollar you don’t spend is helping you live below your means.
Hopefully, you can bid farewell to money shame (which can lead to overspending and still more money shame), FOMO spending, and splurge-related regrets. You will be more aware of where your money goes and hopefully on a path to building wealth.
The Takeaway
Living below your means, or spending less than you earn, is possible with the right budgeting steps and a healthy money mindset. Following a trimmer budget on your existing income can help you put away funds for important milestones, such as the down payment for your first house. It can also help you get past living paycheck to paycheck and accumulating credit card debt.
Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with eligible direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.
Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy 3.30% APY on SoFi Checking and Savings with eligible direct deposit.
FAQ
What is considered living above your means?
Living above or beyond your means is defined as spending more money than you earn. Three signs of this pattern: Running out of money and having to use credit cards to get through the month; not having an emergency fund; and not having money in savings.
Why is it important to live below your means?
Living below your means is important for your mind and your finances. Instead of overspending, you’ll be able to set money aside for tangible goals, from a savings cushion to a college fund. When you conserve money rather than blowing it, you can reap the reward of watching it grow, building your wealth, and reducing your financial stress.
Does living below your means deprive you of fun?
Living below your means does not deprive you of fun. You can save for and budget for splurges like vacations and dining out; the important part is making that intentional and not going into debt. You’ll also find plenty to see and do for free or at a low cost, from bike rides to free town concerts.
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Exchange-traded funds (ETFs) are funds that can be used to build a relatively simple and low-cost diverse portfolio. There are many investing benefits to ETFs, which is why they’ve grown in popularity both for DIY investors and for more traditional money managers. However, there are cons investors should be aware of, too.
Key Points
• ETFs offer diversified exposure across various assets, potentially reducing large swings in overall portfolio value.
• They tend to be cost-effective due to lower management fees compared to mutual funds.
• ETFs provide flexibility with real-time trading, similar to stocks.
• Tax efficiency is enhanced in ETFs because of fewer capital gains distributions.
• However, ETFs can have hidden costs like bid-ask spreads and brokerage fees.
What Are the Benefits of ETFs?
Exchange-traded funds (ETFs) have become increasingly popular in recent years, especially with the rise of online investing allowing people to buy and sell them quickly.
As an investment tool, ETFs have become popular: there were almost 10,000 ETFs in the world with trillions of dollars in assets under management (AUM) at the end of 2023. In the U.S., there was more than $7 trillion in AUM in ETFs.
Here are some of the benefits of ETFs, which has helped spur their popularity.
ETFs Trade Similar to Stocks
ETFs are traded on stock exchanges and can be bought and sold throughout the day, like individual stocks. The market determines the price for a share of an ETF and changes throughout the day. This means investors can buy and sell ETFs efficiently, making them a convenient investment option.
Portfolio Diversification
An additional benefit of an ETF is that you don’t need a lot of money to invest in many different things. One share of an ETF offers investors a way to diversify their portfolio by investing in a basket of assets, such as stocks, bonds, or commodities, rather than just a single asset. This can help to reduce the overall risk of an investment portfolio.
Accessible Across Markets
There is also a range of ETFs on the market now: stocks, bonds, commodities, real estate, and hybrids that offer a mix. ETFs also vary in how they target certain assets — aggressively or defensively, specific to one asset class or broad. So investors should be able to find what they want and build a diverse portfolio.
Lower Costs
Most ETFs are passively managed and track a benchmark index, meaning portfolio managers don’t actively manage the fund to try to beat the market or an index. Passive investing, as opposed to active investing, may be more cost-effective because there tends to be less overhead and fewer investment fees.
Because there is often less overhead, ETFs generally charge investors a lower operating expense ratio than actively managed mutual funds. The operating expense ratio is the annual rate the fund charges to pay for portfolio management, administration, and other costs.
There are other costs investors need to consider, like commissions for trades and a bid/ask spread.
ETFs tend to be more tax efficient than mutual funds because they typically generate fewer capital gains and capital gains taxes. This is because passively managed ETFs tend to have lower turnover than actively managed mutual funds, which means they sell fewer assets and, thus, result in fewer capital gains.
Transparency
ETFs generally disclose their holdings daily, so investors can see exactly what assets the ETF holds. This can be helpful for investors who want to know what they are investing in.
Flexibility
ETFs can be used as a part of various investment strategies, including as part of a long-term buy-and-hold strategy or as a short-term trading tool. This makes them a flexible investment option for a wide range of investors.
Moreover, investors can trade thematic ETFs — funds focusing on a specific trend or niche industry, like robotics, artificial intelligence, or gender equality. However, there are pros and cons to thematic ETFs. While they allow investors to make more targeted investments, the shares of these funds can be volatile. Because they’re so focused, these ETFs may also diminish the most important benefit of ETFs: broad, diverse exposure.
Disadvantages of ETFs
While ETFs offer many benefits to investors, there are also some potential disadvantages to consider. These disadvantages include the following:
Lack of Personalization
Because ETFs are not actively managed, they do not consider an investor’s specific financial goals or risk tolerance. A lack of personalization means that ETF investors may be unable to tailor their investment portfolio to their particular financial needs.
Tracking Error
ETFs are usually designed to track the performance of a particular index or basket of assets. However, the performance of the ETF may not precisely match the performance of the underlying index due to various factors, such as the fund’s expenses or the timing of when it buys and sells assets. This is known as a tracking error.
Short-Term Trading Costs
ETFs can be traded on the market throughout the day, making them attractive to short-term traders. However, the commission costs of trading ETFs can add up over time, which can eat into investment returns.
Limited Choices
While many ETFs are available, the range of options may be limited compared to other investment vehicles, such as mutual funds. Thus, investors may be unable to find an ETF that perfectly matches their investment needs.
Certain ETFs may use financial instruments, such as futures contracts or swaps, to gain exposure to specific assets. These instruments carry counterparty risk, which means that there is a risk that the counterparty will not fulfill its obligations under the contract. This can expose ETF investors to additional risks.
Complexity
Some ETFs use complex investment strategies, such as leveraged or inverse ETFs, which can be difficult for some investors to understand. Complex investing strategies can make it challenging for investors to fully understand the risks and potential returns of these types of ETFs.
Market Risk
ETFs, like all investments, are subject to market risk, meaning the value of an ETF can go up or down depending on the performance of the underlying assets.
What to Consider When Investing in ETFs
When investing in ETFs, it is essential to consider the following factors:
• Investment objective: Determine your investment goals and how ETFs fit into your overall investment strategy. This can help you choose an ETF that aligns with your financial goals and risk tolerance.
• Asset class: Consider which asset classes you want to invest in and whether an ETF that tracks those assets is available. For example, if you want to invest in large-cap domestic stocks, look for an ETF that tracks a particular large-cap domestic stock index.
• Diversification: ETFs offer a way to diversify your investment portfolio by investing in a basket of assets rather than just a single asset. Consider the level of diversification an ETF offers and whether it aligns with your investment goals.
• Expenses: ETFs typically have lower fees than mutual funds because they are not actively managed. However, it is still important to compare the expenses of different ETFs to ensure you are getting the best value for your money.
• Tax considerations: ETFs tend to be more tax efficient than mutual funds because they generate fewer capital gains. However, it is still important to consider the tax implications of investing in an ETF and whether it aligns with your overall financial plan.
Investing With SoFi
ETFs are becoming increasingly more popular and ubiquitous in the financial markets, with some being more targeted in focus than others. So, being aware of an ETF’s investments can be important for an investor who chooses to put dollars into this financial vehicle. But, as with any investment, they have their pros and cons, which investors should familiarize themselves with before investing.
Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.
Opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.¹
FAQ
What is the benefit of investing in an exchange-traded fund?
Exchange-traded funds (ETFs) offer investors a convenient and cost-effective way to diversify their portfolios by investing in a basket of assets. ETFs are also typically more tax efficient than mutual funds and offer investors the ability to buy and sell their shares on a stock exchange.
Are ETFs a good investment?
Depending on their investment goals and risk tolerance, ETFs may be a good investment for some investors. ETFs offer a convenient and cost-effective way to diversify a portfolio and provide access to a wide range of asset classes. However, it is important for investors to consider the specific ETF they are considering and how it fits into their overall investment plan.
Why are ETFs better than stocks?
For some investors, ETFs may be a better investment option than individual stocks because they offer diversification by investing in a basket of assets rather than just a single stock.
Is an ETF better than a mutual fund?
Whether an ETF is better than a mutual fund depends on the specific circumstances of the investor and their investment goals. ETFs tend to have lower fees than mutual funds because they are not actively managed and may also be more tax efficient due to their lower turnover. However, mutual funds offer a more comprehensive range of investment options and may be more suitable for some investors.
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SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
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.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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Hypothecation may not be a word you’ve heard before, but it describes a transaction you may have participated in. Hypothecation is what happens when a piece of collateral, like a house, is offered in order to secure a loan.
Auto loans and mortgages frequently involve hypothecation, since it allows the lender to repossess the car or house if the borrower is later unable to pay.
There are, though, some more subtle details to understand about hypothecation, particularly if you’re in the market for a home loan. Read on to learn about hypothecation loans.
Note: SoFi does not offer hypothecation. However, SoFi does offer home equity loan options.
What Is Hypothecation?
Hypothecation is essentially the fancy word for pledging collateral. If you’re taking out a secured loan — one in which a physical asset can be taken by the lender if you, as the borrower, default — you’re participating in hypothecation. (Hypothecation is also possible in certain investing scenarios. We’ll briefly talk about that later.)
As mentioned above, some of the most common hypothecation loans are auto loans and mortgages. If you’ve ever purchased a car, it’s likely you have (or had) a hypothecation loan, unless you paid the full purchase price in cash.
It’s important to understand that, just because the asset is offered as collateral, it doesn’t mean the owner loses legal possession or ownership rights of it. For instance, with an auto loan, the car is yours even though the lender might hold the title until the loan is paid off.
You also maintain your rights to the positive parts of ownership, such as income generation and appreciation. This is perhaps most obvious in the case of homeownership. Even if you’re paying a mortgage on your property, you still have the right to lease the place out and collect the rental income.
However, the lender has the right to seize the property if you fail to make your mortgage payments. (Which would be a bad day for both you and your renters.)
Why Is Hypothecation Important?
Hypothecation makes it easier to qualify for a loan — particularly a loan for a lot of money — because the collateral makes the transaction less risky for the lender.
For instance, hypothecation is the only way that most people are able to qualify for a mortgage. If those loans weren’t secured with collateral, lenders might have very steep eligibility requirements before they would pay out hundreds of thousands of dollars for a home on a piece of land!
Unsecured loans, however, are possible. A personal loan is a good example.
With an unsecured loan, you’re not at risk of having anything repossessed from you, and you can use the money for just about anything you want.
It’s a trade-off: Unsecured loans are riskier for the lender, so they tend to be harder to qualify for and to carry higher interest rates than secured loans.
On the other hand, if you compare a car loan and personal loan of equal length, you’ll likely be subject to a stricter eligibility screening to get the unsecured loan and pay more interest on it in the end.
Along with hypothecation in the context of a secured loan for a physical asset, like a house or a car, hypothecation also occurs in investing — though usually only if you take on advanced investment techniques.
Hypothecation occurs when investors participate in margin lending: borrowing money from a broker in order to purchase a stock market security (like a share of a company).
This technique can help active, short-term investors buy into securities they might not otherwise be able to afford, which can lead to gains if they hedge their bets right.
But here’s the catch: The other securities in the investor’s portfolio are used as collateral, and can be sold by the broker if the margin purchase ends up being a loss.
TL;DR: Unless you’re a well-studied day trader, buying on margin probably isn’t for you and you should not worry about hypothecation in your investment portfolio. But you’ll want to know it can happen in investing, too.
A mortgage is a classic example of a hypothecation loan: The lending institution foots the six-digit (or seven-digit) cost of the home upfront, but retains the right to seize the property if you’re unable to make your mortgage payments.
Hypothecation also occurs with investment property loans. A lender might require additional collateral to lessen the risk of providing a commercial property loan. A borrower might hypothecate their primary home, another piece of property, a boat, a car, or even stocks to secure the loan.
Given the size of most home loans and the risk of losing the home, you may wonder if taking out a mortgage is worth it at all.
Even though any kind of loan involves going into debt and taking on some level of risk, homeownership is still usually seen as a positive financial move. That’s because much of the money you pay into your mortgage each month ends up back in your own pocket in some capacity…as opposed to your landlord’s bank account.
As you pay off a mortgage, you’re slowly building equity in your home. Homes have historically tended to increase in value.
There is such a thing as rehypothecation, which is what happens when the collateral you offer is in turn offered by the lender in its own negotiations.
But this, as anyone who lived through the 2008 housing crisis knows, can have dire consequences. Remember The Big Short? Rehypothecation was part of the reason the housing market became so fragile and eventually fell apart. It is practiced much less frequently these days.
The Takeaway
Hypothecation simply means that collateral, like a house or a car, is pledged to secure a loan. Mortgages are a classic example of hypothecation, and hypothecation is the reason most of us are able to qualify for such a large loan.
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Student loan interest rates are rising. In July 2024, interest rates rose to their highest level in 16 years. Rates for undergraduate loans have increased almost 19% over last year and 44% over the past five years. Some loan rates for graduate students have never been as high as they are now.
Why are student loan interest rates so high? Some of it comes down to perception: Interest rates are up after a decade of historical lows. But other factors also come into play.
Read on to learn how student loan interest rates are set, why interest rates are going up, and the different options available for managing high-interest student loans.
Key Points
• Federal student loan interest rates have risen to their highest levels in years, and rates for some loans for graduate students are at record highs.
• Interest rates on federal student loans are set annually by Congress, influenced by the 10-year Treasury note rate plus a fixed increase. Rates are capped at specific limits.
• Private lenders determine interest rates on private student loans, using benchmarks such as the prime rate. Borrowers’ credit scores and credit history also impact private loan rates.
• Students who don’t have a strong credit history may need a cosigner on a private student loan to qualify for more favorable rates.
• Methods to help pay off student loans include paying any accruing interest while in school, using an income-driven repayment plan after graduation, and refinancing student loans.
Understanding Student Loans
There are two main types of student loans — federal and private student loans. Federal loans are offered by the Department of Education (DOE) and they include Direct Subsized and Unsubsidized student loans for undergraduate students, and Direct Unsubsidized loans and Direct PLUS loans for graduate or professional students.
• Direct Subsidized loans are for undergraduates who have financial need. You fill out the Free Application for Student Aid (FAFSA), and your school determines how much you can borrow. The interest on the loan is paid by the DOE while you’re in school and for a six-month grace period after graduation.
• Direct Unsubsidized loans are available for undergrads and graduate students. A borrower does not have to prove financial need for these loans. Again, your school determines the amount you can borrow. However, unlike Direct Subsidized loans, the interest on Direct Unsubsidized loans begins to accrue as soon as the loan is disbursed.
• Direct PLUS loans are for eligible parents (typically called a parent PLUS loan) and grad students. To be approved for one of these loans, a borrower must undergo a credit check and cannot have an adverse credit history. Interest accrues on Direct PLUS loans while the student is in school.
Here’s a look at how the interest rates on these federal loans have increased over the last four years:
School Year 2021 – 2022
School Year 2022 – 2023
School Year 2023 – 2024
School Year 2024 – 2025
Direct Subsidized and Unsubsidized Loans for Undergrads
3.73%
4.99%
5.50%
6.53%
Direct Unsubsidized Loans for Graduate or Professional Students
5.28%
6.54%
7.05%
8.08%
Direct PLUS Loans for Graduate or Professional Students or Parents of Undergrads
6.28%
7.54%
8.05%
9.08%
There are several different repayment plans for federal student loans, including the standard 10-year plan; graduated repayment in which your monthly payments gradually increase over 10 years; extended payment, which gives you up to 25 years to repay your loans; and income-driven repayment plans that base your monthly payments on your income and family size. Federal loans come with benefits such as federal loan forgiveness.
Private student loans are issued by private lenders, such as banks, credit unions, and online lenders. Their interest rates and loan terms differ from lender to lender. The interest rates on private student loans may be fixed or variable, and the rate you get depends on your credit history. You can use student loan refinancing later on for potentially better interest rates and terms on your private loans, if you’re eligible. (Federal loans can be refinanced as well, but they then become private loans and lose the federal benefits mentioned above.)
By using our student loan refinance calculator, you can check the interest rate and repayment terms you could qualify for — and find out if refinancing makes sense for your situation.
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Factors Contributing to High Interest Rates
Congress sets federal student loan interest rates, while private loan rates depend on the credit rating of the borrower (or their student loan cosigner, if they have one). But that’s not the whole story.
The federal government adjusts federal student loan rates every year based on 10-year Treasury notes, plus a fixed increase. Rates are also capped, so they can’t rise above a certain limit. Here are the formulas:
• Direct Unsubsidized Loans for Undergraduates: 10-year Treasury + 2.05%, capped at 8.25%
• Direct Unsubsidized Loans for Graduates: 10-year Treasury + 3.60%, capped at 9.50%
• PLUS Loans to Graduate Students and Parents: 10-year Treasury + 4.60% Capped 10.50%
The rates for Treasury notes are set based partly on global market conditions and the state of the economy. When market conditions are in flux, the rates for Treasury notes tend to rise.
Federal student loan interest rates are fixed over the life of the loan. That means, if you get a federal student loan for your freshman year, the rate it was issued with won’t change despite Congress setting a new rate every year. If you need to take out another federal student loan for your sophomore year, however, you’ll then get the new rate, not the previous one.
Private student loan rates vary by lender and fluctuate with market trends. A borrower’s credit history also determines the rate they get for a private student loan.
Another factor is that student loans are unsecured. Unsecured loans are not tied to an asset that can serve as collateral. Secured loans, by comparison, are backed by something of value, such as a car or house, which can be seized if you default. But lenders can’t seize a degree. So student loan interest rates may be higher than secured loan rates because the lender’s risk is higher.
Comparison of Federal and Private Student Loan Interest Rates
Why are student loan interest rates so high? As noted above, private student loan rates will fluctuate with market trends and from lender to lender. They also depend on a borrower’s credit score. As of November 2024, some private student loan rates start at about 4% and go up to around 17%.
Private student loan rates for 10-year loans may be higher than the federal interest rate when you are comparing rates concurrently on offer. The rates may be lower for a loan that has a shorter term length than the standard 10 years of federal loans.
What’s more, private student loan rates and student loan refinance rates that are currently on offer can very well be lower than the federal interest rate you received at the time of getting your loan. And you can shop around with private lenders for the best interest rates.
Pros and Cons of Federal and Private Student Loans
Both federal and private student loans have advantages and drawbacks.
Pros of federal student loans include:
• Interest rates for federal loans are fixed over the life of the loan
• The rates for federal loans may be lower than the rates you might get for private student loans
• Depending on the type of federal loan you have, the government may pay your interest while you are in school and during the six-month grace period after graduation
• Federal loans have federal programs and protections such as income-driven repayment plans and federal deferment options
Cons of federal student loans include:
• You can’t shop around for interest rates
• If you take out a new loan in subsequent years, you may get a higher rate than you got with your initial loans
• Borrowing limits may be lower compared to private student loans
Pros of private student loans include:
• You can shop around with different private lenders for lower rates
• Borrowers (or cosigners) with very good or excellent credit can get lower interest rates
• May offer higher borrowing limits than federal loans, spending on what a borrower is eligible for
Cons of private student loans include:
• Borrowers with poor credit will get higher interest rates or may not be able to qualify for a loan
• If the loan has a variable interest rate, it may rise over time
• Private loan student holders don’t have access to the same programs and protections that federal student loan borrowers do
• Deferment and forbearance options (if any) depend on the lender
Interest Rates for Graduate and Professional Degrees
For graduate students and those pursuing advanced professional degrees, interest rates on federal Direct PLUS loans and Direct Unsubsidized Loans for graduate and professional students are substantially higher than the interest rate for Direct Subsidized and Unsubsidized loans for undergrads.
For the 2024-2025 school year, the interest rates are:
Direct PLUS loan: 9.08% Direct Unsubsidized loans for graduate and professional students: 8.08% Direct Subsidized and Unsubsidized loans for undergraduate students: 6.53%
The higher rates on loans for graduate and professional students add significantly to the cost of borrowing. Not only that, the interest on these loans begins accruing immediately and while the borrower is in school, which also adds to the overall amount they’ll need to repay.
It’s worth noting that loans for graduate students have much higher borrowing limits than federal loans for undergrads. Graduate students can usually borrow up to $20,500 each year, with a lifetime cap of $138,500. Undergrad borrowers can typically borrow $5,500 for the first year, $6,500 for the second year, and $7,500 for the next two years, up to a total of $31,000.
Credit Score Impact on Private Student Loan Interest Rates
Private lenders will look at your creditworthiness when determining your interest rate. This involves considering such factors as:
• Credit score: Lenders have different requirements when it comes to credit scores for private student loans, but many look for a score of at least 650. As a student, you may not have that high a score, and in that case, you may need a cosigner on the loan in order to be approved.
• Credit history: When entering college, most students have little to no credit history. That means the lender could be unsure of their ability to repay the loan since students don’t typically have a history of paying any loans. This can lead to a higher interest rate.
• Your cosigner’s finances: Since many private student loan applicants are relatively new to debt and have no credit history, they might be required to provide a cosigner, as previously mentioned. A cosigner shares the burden of debt with you, meaning they’re also on the hook to pay it back if you can’t. A cosigner with a strong credit history can potentially help secure a lower interest rate on private student loans.
To help build your credit as a student, having student loans can help. Managing your student loans responsibly is a good way to help establish credit.
In addition, you might consider getting a credit card with a lower line of credit and use it to cover a few small expenses such as groceries and transportation. Be sure to pay your bill on time each month and in full if you can. Strategies like these can help you build credit over time.
Whether you’re still in school or you’ve just graduated, you have options that may save you money. But it’s important to be proactive. Here are some potential actions you could take:
If You’re Still in College or Grad School
Borrowers with Direct Unsubsidized loans are responsible for the interest that accrues while they’re in school and immediately after. They don’t have to make payments while enrolled, but not making payments means that, in certain situations, interest may “capitalize” — that is, it will be added to the principal. In other words, a borrower would be paying interest on the interest.
To save yourself money on interest, consider making interest-only payments during school until your full repayment period begins after graduation. It will take a small bite out of your budget now, but it can save you money in the long run.
If you have Direct Subsidized loans, no interest will accrue until your grace period ends.
If You Graduated
Borrowers are automatically placed on the standard repayment plan, unless they select another option. The standard repayment plan spreads repayment over 10 years. Other options, such as the extended plan, extend the repayment term, which can make payments more manageable in the present, but that means you may pay more in interest over the life of the loan.
With an income-driven repayment (IDR) plan, your monthly student loan payments are based on your income and family size. Your monthly payments are typically a percentage of your discretionary income, which usually means you’ll have lower payments. At the end of the repayment period, which is 20 or 25 years, depending on the IDR plan, your remaining loan balance is forgiven.
You could also explore student loan forgiveness through a state or federal program. Borrowers with federal student loans who work in public service may be eligible for the Public Service Loan Forgiveness (PSLF) program. If you work for a qualifying employer such as a not-for-profit organization or the government, PSLF may forgive the remaining balance on your eligible Direct loans after 120 qualifying payments are made under an IDR plan or the standard 10 year repayment plan.
In addition, check with your state to find out what loan forgiveness programs they may offer.
Refinancing Student Loans
Refinancing is one way to deal with high-interest student loan debt if you don’t qualify for federal protections. You can potentially lower your interest rate or your monthly payments.
If you’re considering refinancing to save money, you could be a strong candidate if you’ve strengthened your credit since you first took out your loans. Unlike when you were first headed to college, you may now have a credit history for lenders to take into account. If you’ve never missed a payment and have continually built your credit, you might qualify for a lower interest rate.
Having a stable income can also help. Being able to show a consistent salary to a private lender may help make you a less risky investment, which in turn could also help you secure a more competitive interest rate.
Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.
With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.
SoFi Student Loan Refinance Terms and conditions apply. SoFi Refinance Student Loans are private loans. When you refinance federal loans with a SoFi loan, YOU FORFEIT YOUR ELIGIBILITY FOR ALL FEDERAL LOAN BENEFITS, including all flexible federal repayment and forgiveness options that are or may become available to federal student loan borrowers including, but not limited to: Public Service Loan Forgiveness (PSLF), Income-Based Repayment, Income-Contingent Repayment, extended repayment plans, PAYE or SAVE. Lowest rates reserved for the most creditworthy borrowers. Learn more at SoFi.com/eligibility. SoFi Refinance Student Loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891 (www.nmlsconsumeraccess.org).
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