Mar
22
2023
What Is a Money Market Account and How Does it Work?
Money market accounts can offer higher interest rates than a traditional checking account but may come with high minimum balances and fees.
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Student Loan Consolidation and Refinancing
Mar
21
2023
What Is a Swaption? Guide to Understanding Swap Options
A swaption, also known as a swap option, is an option contract that grants the owner the right but not the obligation to enter into a swap contract with specified terms. The swap contracts tend to be interest rate swaps, but can be other types of swaps as well.
With swaptions, one party can exchange a currency of the same value, an interest rate, or the liability of repaying a loan. Read on for how they work, the different types, pros and cons, and more.
How Swaptions Work
As mentioned above, a swaption is an option on a swap rate. Like other types of options contracts, the buyer pays a premium to enter into the swaption, and beyond that they are not obligated to act on the contract.
Although Swaptions are a type of option, they are more similar to a swap than to an option. Similarities to swaps include:
• They are traded over-the-counter instead of on centralized exchanges.
• They are customizable and offer a lot of flexibility since they are not standardized exchange products.
When two parties want to enter into a swap option agreement, they decide on the terms of the contract, such as the the premium, the expiration date, the notional amount, the swap’s legs (fixed vs. float), the benchmark for the floating leg, and the frequency of adjustment for the variable leg.
Recommended: Options Trading 101 Guide
Who Often Uses Swaptions
Swaptions are typically used by institutional investors instead of retail investors, although some private banks offer them to their clients. Large corporations, investment banks, commercial banks, and hedge funds use them for various purposes. It takes a lot of work and experience to create a portfolio of swaptions, so they generally aren’t used by individuals or small firms.
They are often used to hedge against macroeconomic risks such as interest rate risk or securities risks. If an institution thinks interest rates might change, they can enter into an agreement to protect against that. Financial institutions can also use them to change their interest payoff terms.
They tend to be used to hedge specific financings, but they can also be used to hedge a broader change in future interest rates. This can be useful if an institution holds a lot of debt maturities for the year and doesn’t want to risk losses.
The way swaptions are generally set up, their strikes are a strike above the current 10 year swap rate. Therefore the borrower takes on risk between the current rate and the higher rate, but not more than that.
Swaptions can be purchased in most major currencies, such as the U.S. Dollar, Euro, and British Pound.
Recommended: Popular Options Trading Terminology to Know
What Are the Different Types of Swaptions?
There are different types of swap options that each have different types of ‘legs’ in the predetermined swap contract they represent. The two types of options are payer and receiver.
Payer Swaption
If a buyer enters into a payer swaption, they are purchasing the right but not the obligation to enter into a future swap contract. When exercised, the buyer would become the fixed-rate (non-changing) payer and receive the floating rate (variable) payments.
Fixed interest rates don’t change with the market, they stay the same through the duration of a loan. Floating rates change based on a reference rate, the most common one being LIBOR. LIBOR is an average of interest rates that are collected from some of the top banks in London.
Receiver Swaption
In a receiver swaption contract, the swap holder has the option to pay the floating rate and receive the fixed rate.
When Can a Swaption Be Exercised?
There are also swaptions that have different terms of execution. The three most common are:
American
American swaptions can be exercised on any date prior to and including the expiration date.
European
European options can only be exercised on the expiration date, making them less flexible.
Bermudan
Bermudan swaptions have several specific dates when they can be exercised prior to the expiration date.
Finally, user-friendly options trading is here.*
Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.
*Check out the OCC Options Disclosure Document.
Swaption Example
A borrower wants to purchase rate protection on their current floating rate debt maturities totalling $50 million. They decide that they would like to purchase the right, but not the obligation, to pay a fixed rate on their debts for ten years.
For this right, they are willing to take on the risk of 10 year interest rates up to 3.8%, but no higher than that.
The borrower enters into an agreement with a settlement date in the current year, for a notional amount of $50 million, with a 10 year term and a strike of 3.8%. The premium they must pay to enter in this contract is $400,000.
Including the premium, the rate is actually hedged higher than 3.8%, but for the sake of this example we will call the strike 3.8%.
If the strike is lower or the settlement date is farther in the future, this increases the value of the swaption and therefore increases the cost of the premium.
The borrower enters into this agreement to hedge against a large increase in swap rates but without choosing a specific rate they want when the contract expires.
It’s important to note that the swaption isn’t tied to the 10 year Treasury, it’s tied to 10 year swap rates, although their movements tend to be related. Also, swaptions are derivatives, so they aren’t the underlying assets themselves, but contracts derived from rates or assets.
When the settlement date occurs, there are two ways the swaption could turn out.
- If 10 year swap rates are below 3.8%, the option contract expires, the lender keeps the premium and the borrower uses the current swap rate.
- If 10 year swap rates are higher than 3.8%, the borrower exercises the option. In this case the provider of the swaption pays the borrower the difference between the swap rate and 3.8%. The borrower locks in the current swap rate for a swap agreement, and uses the payment they received to buy down the rate on this new swap.
Pros and Cons of Swaptions
There are a few reasons why financial institutions use swaptions, but there can be downsides to them as well. Some of the pros and cons of swap options are:
| Pros | Cons |
|---|---|
| Can be used to hedge against risk when there is a possibility that an interest rate will go up. | Swaptions can have longer durations than other types of options. |
| If the swaption is not exercised, the buyer loses the premium amount they put in. | There is a risk of the other party defaulting on the agreement. |
The Takeaway
Entering into swaption agreements is one type of options trading strategy commonly used by institutional investors. They are usually used to help with restructuring a current financial position, alter a portfolio, hedge options positions on bonds, or adjust payoff profiles.
There are other types of options on the market that retail investors often trade.
If you’re ready to try your hand at options trading, You can set up an online options trading account and trade from the SoFi mobile app or through the web platform.
And if you have any questions, SoFi offers educational resources about options to learn more. SoFi doesn’t charge commissions, and members have access to complimentary financial advice from a professional.
SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
SOIN0821366
Mar
21
2023
What Are Asian Options and How Are They Priced?
Asian options (also known as average strike options or average options) are a type of exotic option that is priced according to the average price of the underlying commodity, as opposed to the spot price.
Read on for how they’re priced, how they work, pros and cons, and more.
What Is an Asian Option?
Asian options are a type of exotic option that trade differently than standard American or European options.
American and European options allow the holder to exercise an option at a strike price known on the purchase date. They differ in when the option can be exercised.
American options can be exercised at any time up to and including the expiration date. European options can only be exercised on the expiration date.
Asian options, on the other hand, are priced based on the average price of the asset over a period of time and like European options they are exercised on the expiration date.
The various parameters of an Asian option are negotiable, but there are two different types of Asian options, average strike options and average price options.
Average strike options are sold with an unknown strike price. The strike price will be determined based on the average price of the underlying asset at selected time intervals.
Average price options are sold at a known strike price. The exercise price will be determined based on the average price of the underlying asset at selected time intervals.
In addition, both types of Asian options may be priced according to arithmetic or geometric averages.
Who Buys Asian Options?
Asian options are usually purchased to solve a particular business problem:
- A buyer wants to lock in an average price or exchange rate over a period of time.
- A buyer wants to protect against price manipulation in the market.
- A buyer wants to protect against volatility in the price movement of the underlying asset.
- A buyer wants to mitigate against inefficient pricing due to an asset being thinly traded.
How Asian Options Work
Like standard options, the price of a call or put in Asian options depends on the price of the underlying asset when the option expires. But unlike standard options, the price of an Asian option will depend on the average price of the underlying over a specified period of time.
Different kinds of Asian options will define average in different ways, so make sure that you check the details of the contract before investing. It’s common for Asian options to define average either as an arithmetic or geometric mean over a period of time.
One example might be for an Asian option to be priced as the arithmetic mean of the underlying stock’s price as measured every 30 days.
Maximum Payoff
Like standard options, the maximum payoff for an Asian option will depend on whether it is a call or put option. Even though the prices in an Asian option are determined by the average price instead of the spot price, the maximum payoff for Asian options works in the same way.
For a call option, the maximum payoff is unlimited, since there is no limit on how high the stock’s price can go.
For the purchase of a put option, the maximum payoff will be if the stock’s price goes to zero.
Maximum Loss
Losses on Asian options are limited to the premiums paid at initiation of the trade. Because of average pricing and lowering the volatility of large price swings, the purchase premiums are also typically lower than available with regular options.
Breakeven
The breakeven price of an Asian option depends on the strike price of the option and the amount of premium that you paid for the option originally. If you paid $1.50 for a call option with a strike price of $50. Your breakeven price in this scenario will be $51.50 (the strike price of 50 plus the $1.50 in premium paid originally).
If the stock’s average price when the option expires is above $51.50, you will earn a profit on the option investment.
It’s more complicated to know in advance what the breakeven will be on an Average strike option but the calculation is the same.
Finally, user-friendly options trading is here.*
Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.
*Check out the OCC Options Disclosure Document.
Pros and Cons of Asian Options
Here are some of the pros and cons of trading with Asian options:
| Pros | Cons |
|---|---|
| Less volatility than standard options due to the averaging of the price | Not supported by all brokers |
| Generally less expensive than standard options due to lower volatility | Lower liquidity than standard options |
| Useful for traders who have exposure to the underlying asset over time, like suppliers of commodities | More complicated to price than standard options |
Asian Option Pricing
Because Asian options are priced based on an average price instead of the closing price on the date of expiration, they experience lower volatility. This makes intuitive sense, since averaging several price values over time will tend to dampen out extreme values. Because volatility is a key measure of the price of an option, the lower volatility of Asian options generally means lower prices for options.
How Asian Option Pricing Works
The pricing of Asian options is calculated using an average value. Different types of Asian options calculate the average in different ways, and it’s important to understand how the average will be calculated before you purchase the contract. The two most common ways that an average is calculated with Asian options are the arithmetic mean and the geometric mean.
Asian Options Pricing Example – Average Price Option
On March 1, you buy a 90-day call option for stock XYZ with a strike price of $50. This option costs you $1.25 and the average price is defined as the arithmetic mean of the underlying asset price taken every 30 days.
XYZ has a price of $51.00, $48.50 and $52.00 at the 30, 60 and 90 day mark. The arithmetic mean of those 3 prices is ($51 + $48.50 + $52) / 3, or $50.50. Since the option has a strike price of $50, the option closes with a value of $0.50 (calculated price at expiration less spot price, $50.50 – $50).
Because you purchased the option for $1.25 originally, in this scenario you would take a loss on the position.
As with standard options, if the average price of the underlying asset is below the strike price (for a call option), the option expires worthless.
Asian Options Pricing Example – Average Strike Price Option
On March 1, you buy a 90-day call option for stock XYZ. This option costs you $1.25 and the average strike price is defined as the arithmetic mean of the underlying asset price taken every 30 days.
XYZ has a price of $51.00, $48.50 and $52.00 at the 30, 60 and 90 day mark. The arithmetic mean of those 3 prices is ($51 + $48.50 + $52) / 3, or $50.50. Therefore, at expiration the strike price will be $50.50. The option closes with a value of $1.50 (price at expiration less calculated spot price, $52 – $50.50).
Because you purchased the option for $1.25 originally, in this scenario you would have a gain on the position.
The Takeaway
Unlike standard options that are valued based on the spot price of the underlying asset when the option expires, Asian options are valued based on an average price taken in discrete time periods before expiration.
Because the value of an Asian option is based on an average of prices, there is less volatility in the prices. Lower volatility leads to generally cheaper prices than standard options.
If you’re ready to try your hand at online stock options trading, You can set up an Active Invest account and trade options from the SoFi mobile app or through the web platform.
And if you have any questions, SoFi offers educational resources about options to learn more. SoFi doesn’t charge commissions, and members have access to complimentary financial advice from a professional.
FAQ
Are Asian options cheaper?
Asian options are usually (but not always) cheaper than standard American or European options. This is because Asian options are priced using an average price rather than the spot price of the underlying commodity on the date of expiration. Because an average price is used, this makes Asian options less volatile, and consequently, generally cheaper.
How are Asian options priced?
Rather than using the spot price of the underlying stock or commodity on the date of the option’s expiration, Asian options are priced using an average price over the preceding period of time. While there are different methods for calculating the average price, it’s usually calculated as either the arithmetic or geometric mean of the underlying stock or commodity.
Why can’t Black-Scholes models value Asian options?
The Black-Scholes pricing model is one of the most common ways to price standard American or European options. To price options, the Black-Scholes method makes a variety of assumptions about the price of the underlying stock. One assumption required by Black-Scholes is that the stock’s price will move following something called Brownian motion. Because arithmetically-priced Asian options do not follow Brownian Motion, the standard Black-Scholes pricing model does not apply.
Photo credit: iStock/Boris Jovanovic
SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
SOIN0422028
Mar
21
2023
What You Need to Know About Foreign Currency Bank Accounts
A foreign currency bank account, also known as a multicurrency account, can facilitate transactions made in foreign currencies; that is, not in U.S. dollars. This can be a significant benefit for businesses. They may use multicurrency (or foreign currency) bank accounts for international transactions as well as to support operations overseas. This can offer a major convenience because of the flexibility with different currencies.
But these multicurrency accounts aren’t just for businesses. Some Individuals may also want to fund a bank account with foreign currency in certain situations. Read on to learn more about this topic, including:
• What a foreign currency account is
• How to open a multicurrency account
• The pros and cons of a foreign currency account
• The fees associated with this kind of bank account
🛈 Currently, SoFi does not allow bank accounts to be opened in any currency other than USD.
What Is a Multicurrency Account?
A foreign currency bank account, or multicurrency account, is an account that’s designed to hold money denominated in foreign currencies. It may also be referred to as a borderless account. It is a simpler way to deal with regular deposits of foreign currencies.
The types of currencies accepted for deposit or used for withdrawals can be determined by the bank. Some of the currencies your bank may process include:
• Australian dollars (AUD)
• Canadian dollars (CAD)
• Euros (EUR)
• Great Britain pound sterling (GBP)
• Japanese yen (JPY).
As mentioned, foreign currency accounts can be opened for business or personal reasons. Businesses that operate globally may require these accounts in order to send payments to vendors or receive payments from international clients.
You might open a foreign currency account for yourself, as an individual, in a few different circumstances. Perhaps you live or are working abroad, Or maybe you regularly make payments overseas or need to send money to friends and family internationally.
How Does a Multicurrency Account Work?
With a multicurrency account, you are able to deposit, hold, and send money in different currencies, just as the name implies. Depending on the financial institution, you may be able to earn interest on deposits, as well.
You may be able to convert funds back and forth into foreign currencies as needed without paying the usual fees associated with these operations.
A multicurrency bank account that’s set up as a savings account might follow typical savings account rules. For example, the bank may limit you to six withdrawals from the account per month (though these regulations have been loosened since the COVID-19 pandemic; check with your financial institution). If that limit applies and you exceed it, the bank may impose an excess withdrawal fee. Keep in mind that any fees assessed for a foreign currency account may be processed in U.S. dollars.
Multicurrency accounts at Federal Deposit Insurance Corporation (FDIC) member banks enjoy FDIC protection, up to the established limit. The FDIC insures banking customers up to $250,000 per depositor, per financial institution, per ownership category. This may well reassure you about the safety of your funds.
One thing to note is that foreign currency bank accounts aren’t used for forex trading. If you’re interested in trading foreign currency as an investment, you’d need to open a separate brokerage account for that. There are a number of online brokerages that offer the option to trade forex alongside other investments, such as stocks and exchange-traded funds (ETFs).
Typical Requirements to Apply for a Foreign Currency Bank Account
If you’re interested in opening a foreign currency account, it’s important to know what documents you’ll need. That way, you can gather the necessary materials and speed through the application process. The specifics can vary from bank to bank but generally, you must:
• Be of minimum age to open an account, typically 18 or 19
• Have a valid, government-issued form of identification
• Provide identifying information, including your name, address, date of birth and Social Security number
• Meet minimum-deposit requirements
• Provide proof of income and employment
The requirements to open a foreign currency account aren’t that different from those for a foreigner opening an account in the U.S. Whether you can apply for a foreign currency bank account online or not will depend on the bank. Some banks do allow you to start the application online, while others require you to open an account over the phone or in-person at a branch. Check with yours to learn the exact protocol.
You may also need to already have at least one other account open with the bank before you can apply for a multicurrency account. If the bank imposes this requirement, you may also need to maintain a specific minimum balance in that account to qualify.
Pros of Foreign Currency Account
If you’re curious about multicurrency accounts, it may well be because you are tangled in some red tape as you try to bank in, say, both U.S. dollars and euros. A foreign currency bank account can help meet certain money management needs, like toggling back and forth between two kinds of currency.
Here, the pros of multicurrency accounts.
• When you deposit funds into your account, you can hold it as multiple currencies, including leftover foreign currency from travel, in one place. You don’t have to exchange foreign currency before you can use it.
• You typically avoid foreign transaction fees you might otherwise incur.
• Being able to switch among different currencies could allow you to leverage the most favorable exchange rates.
• You may be able to earn interest on your balances.
• If the institution where your account is has FDIC insurance, you are covered for $250,000 per depositor, per ownership category, in the rare event of a bank failure.
• Multicurrency bank accounts can be used for personal or business purposes.
• Sending payments or money in foreign currencies can be more convenient.
A foreign currency account could also come in handy if you travel. You can use a linked debit card to make purchases or withdraw cash in each country you visit, without having to get traveler’s checks from your bank.
So how do traveler’s checks work? If you’ve never used them, you might not know that these are paper financial instruments that can be used the same way you would a paper check or cash. Thanks to the convenience of credit cards and debit cards, however, travelers don’t need to rely on them as much to make payments when visiting destinations outside the U.S.
Cons of Foreign Currency Account
While a multicurrency bank account might be appropriate in some situations, there are a few drawbacks to consider. Specifically:
• Your financial institution might charge you account and minimum balance fees the same as you might pay for any other bank account.
• Interest rates and APYs may be low.
• Initial deposit requirements or minimum balance requirements may be on the higher end.
• Changing currency rates can affect the value of the money in your account.
Another drawback of foreign currency accounts is that not all banks offer them. And some banks may only offer these accounts for businesses, not individuals.
Multicurrency Account Fees
Foreign currency accounts can have fees, just as any other type of bank account may. Depending on the bank, some of the fees you might pay include:
• Monthly maintenance fees
• Excess withdrawal fees (for savings accounts)
• Overdraft or non-sufficient funds (NSF) fees
• Foreign transaction fees
• Currency conversion fees
When comparing multicurrency bank accounts, take time to review the details thoroughly. It’s important to understand which currencies you can hold, which fees you might pay, and whether you’re required to maintain a minimum balance in the account.
Once you’ve scoped those details out, see if the benefits of this kind of account will outweigh the fees. It could wind up being a good way to simplify your banking life if your financial life requires frequent foreign transactions.
The Takeaway
Foreign currency accounts can simplify money management if you regularly send or receive money in currencies other than U.S. dollars. Opening one of these multicurrency bank accounts is not that different from opening any other type of account. It can be a major convenience if your daily life involves receiving and/or sending funds overseas — and a good way to take control of your international financial life.
FAQ
What is the purpose of a multicurrency account?
A multicurrency or foreign-currency bank account allows you to receive, hold, and send funds in more than one currency. This can be convenient for businesses and individuals who frequently make international transactions and would like to have an account that recognizes multiple currencies.
What types of banks offer multicurrency accounts?
Many but not all banks offer multicurrency accounts. Some of the U.S. banks that offer foreign currency accounts at press time include Citi, HSBC, and TIAA Bank. For businesses, Wells Fargo and PNC offer foreign currency accounts. You can contact your current bank to find out if multicurrency accounts are available.
How does a multicurrency account work?
A multicurrency bank account allows you to deposit, keep, and send funds in more than one currency. You can decide if you keep the funds in different currencies or convert them. This kind of account can help you conduct international transactions without necessarily paying all the usual fees involved.
Photo credit: iStock/RgStudio
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As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.
SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.
SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.
Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.
Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.
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.
SOBK0123030
Mar
21
2023
Credit Card Definition and Explanation
A card is a small, rectangular piece of plastic or metal that lets you make purchases. Whether you’re buying lunch or a new piece of furniture, a credit card enables you to borrow funds from a credit issuer to pay the merchant. Then, every month, you’ll receive a statement in the mail with your balance, which you’ll want to pay off every billing cycle. Otherwise, you’ll owe interest on the remaining amount.
While the concept sounds simple, it’s easy to rack up debt if you’re not careful. With that in mind, here’s credit cards explained in-depth.
Credit Card Meaning
Banks and other financial institutions issue credit cards to consumers to extend revolving lines of credit. A revolving line of credit means the cardholder can borrow money up to their credit limit and then repay it on a continuing basis.
With other lines of credit, like a personal loan, you take out a lump sum amount and agree to repay it within a specific timeframe. During this timeframe, you make fixed installment payments. Whereas with a credit card, you can repeatedly borrow against the limit, which gives you more flexibility to use the card as needed.
When you receive your credit card, you’ll note several different numbers on it. There’s the credit card account number, alongside your name and the credit card issuer’s logo. Also on a credit card are the credit card expiration date, which marks when the card is valid through, and the CVV number on a credit card, which offers an extra layer of security in purchases made online or over the phone.
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How Does a Credit Card Work?
Once you have a new credit card in hand, you can use it to make purchases at places that accept credit card payments. Then, every month, you’ll receive a statement either electronically or in the mail, depending on your preference. The statement will include all purchases, your outstanding balance, and the minimum monthly payment due.
You’re required to make at least the minimum payment on your account to keep it open and in good standing. However, you also can opt to pay your entire balance in full or decide on another amount (as long as it meets the minimum payment requirement). If you were to pay an amount that exceeds your total balance, then you’d end up with a negative balance on your credit card.
If you aren’t able to make the minimum credit card payment, the outstanding balance will roll over to the next month and begin accruing interest and fees — which can significantly add up over time. Therefore, it’s best to get in the habit of paying off your credit card every month to avoid paying an exorbitant amount of interest. But, if your finances don’t allow you to pay the entire balance, you could make smaller payments throughout the month to minimize the amount of accumulating interest.
To ensure you make your monthly payments, you can usually set up auto-pay for the minimum payment. This way, you won’t miss a payment and get charged a late fee. Unfortunately, late payments also can end up on your credit report, which can negatively affect your credit score.
How Does Credit Card Interest Work?
Every credit card comes with an annual percentage rate (APR), which represents the annualized cost of borrowing including interest and fees and marks an important part of how credit cards work.
Some credit cards have more than one APR, such as a balance transfer APR, an introductory APR, or a cash advance APR. While introductory APRs are usually lower than the standard rate but only last for a promotional period, cash advance APRs are typically higher than the standard purchase APR.
You will pay interest based on the APR on a credit card if you have an outstanding balance that carries over from one month to the next. Credit issuers use your average daily balance, interest rate, and the number of days in the billing cycle to calculate the interest amount.
Usually, credit issuers offer a grace period where interest will not accrue. This period is typically between the statement date and due date, commonly 21 days.
Credit vs. Debit Cards
They may look alike, but there are notable and important differences between credit cards and debit cards. For starters, you’re not borrowing funds with a debit card. Instead, you’re drawing on funds in the bank account attached to the debit card. As such, you can’t incur interest charges, nor can you rack up debt. However, you can’t use a debit card to help establish your credit.
In general, debit cards offer less robust consumer protections against fraud in theft than credit cards do. They also don’t typically offer rewards or other benefits that credit cards can have.
6 Common Types of Credit Cards
Now that you understand how credit cards work, here are some available credit card options.
1. Reward Cards
You can earn cashback, points, or even miles when you spend money using a rewards credit card. Some credit cards may also offer a sign-up bonus. For example, a credit card could offer 100,000 points when you spend $4,000 or more within the first three months of enrolling.
You can usually find a card offering rewards that coincides with your spending habits. For example, if you love shopping at a particular store, retail-branded cards have lucrative benefits for frequent shoppers.
Keep in mind that you typically have to have a good credit score to qualify for a rewards credit card. But, even if you do qualify, it’s essential to keep your spending habits in check. Reward cards incentivize you to spend money, so you don’t want to end up overspending and getting into a pile of debt you can’t climb out of.
2. Credit Builder Cards
If you have little to no credit or need to build your credit back up, a credit builder credit card is a viable solution. You’ll likely start with a lower credit card limit and an APR that’s higher than the average credit card interest rate to reduce the credit card issuer’s risk.
Credit builder credit cards usually don’t come with the bells and whistles that rewards cards offer. Instead, the card can help you build your credit. With that said, you’ll want to use your credit card responsibly, making on-time monthly payments and paying off your balance every month. Not doing so could negatively impact your credit history and cost you a lot of money.
3. Balance Transfer Cards
Do you have a high-interest outstanding credit card balance? Using a balance transfer credit card is one solution for helping you tackle your debt. Balance transfer credit cards let you move your current credit card debt to a new account with a lower interest rate. Additionally, transferring your balance means you’ll only have to stay on top of one payment a month, rather than multiple.
Having a good credit score can help you qualify for a balance transfer credit card. If you qualify, you could receive a lower ongoing rate or even a 0% introductory rate, which usually will last for six to 18 months. You’ll want to try to pay off your balance within that promotional period, before the higher APR kicks in.
Note that balance credit cards often charge a fee for transferring a balance — usually 3% to 5% of the amount transferred. So, make sure you factor in the additional fees before you move over your existing balance.
4. Secured Credit Cards
Another option for those with little to no credit or poor credit history is a secured credit card. With a secured credit card, you make a refundable deposit, which protects the card issuer from defaulted payments. If you default, the credit card issuer can use the deposit to recoup the loss.
Your deposit is usually the amount of your credit limit. For example, if you are approved for a $500 limit, you may need to put down $500. Though your deposit will be tied up while the account is open, a secured credit card can allow you to build your credit when used responsibly. Just keep in mind that while secured credit cards are generally easier to qualify for, they also tend to have higher APRs and fees.
If you decide to close a secured credit card account, you can usually get your deposit back. The card issuer may also give you the option to upgrade to an unsecured card if you’ve proven your creditworthiness. In this case, you’d receive a refund as well.
5. Travel Credit Cards
If you’re a frequent flier or visit hotels often, a travel credit card can be a lucrative choice. Many airline and hotel brands have credit cards that let you earn miles, points, or rewards to use toward your travel adventures. Some credit cards may also come with a sign-up bonus or extra perks such as free checked bags, access to VIP lounges, and travel insurance.
When selecting a card, you’ll want to find the card that makes sense for the way you travel. That way, you can get the most out of your credit card. Travel credit cards usually require applicants to have good to excellent credit for approval. So, before applying, make sure to check your credit score to see if it’s acceptable.
6. 0% Introductory APR Credit Cards
If you’re getting ready to make a big purchase, a 0% introductory APR credit card might be worth considering. With this type of credit card, the card issuer gives you a 0% introductory rate to make purchases during a specific time frame. This way, you can make the purchase without paying interest on the expensive item(s).
However, you’ll want to make sure you repay the entire amount before the introductory period ends to avoid interest. Before you swipe, make sure you have a plan to pay off the balance within that time frame.
Also note that to qualify for a 0% introductory APR credit card, you usually must have good to excellent credit.
Pros and Cons of Credit Cards
Here’s an overview of the pros and cons of credit cards, which are helpful for anyone just getting familiar with the credit card definition to be aware of:
| Pros of Credit Cards | Cons of Credit Cards |
|---|---|
| Convenient method of payment | Allows you to pay over time |
| Can help to build credit | Makes it easy to track spending |
| Provides fraud protection | May offer rewards and other benefits |
| Potential to damage credit | Possible to rack up debt |
| Interest | Fees |
Pros
Reasons a credit card can be worthwhile include:
• Convenience. A credit card offers much greater convenience than, say, carrying around a wad of cash. You can easily swipe or tap your card at any merchant that accepts credit card payments, which the vast majority do.
• Pay over time. Another benefit of a credit card is that it allows you to pay over time for a purchase. Say you’re in an emergency and need to access funds immediately, but know you’ll be good to pay back the amount soon. Or maybe you’re making a big purchase and don’t want to have to shell out for it all at once, instead spreading out payments throughout the month.
• Build positive credit history. Credit cards give you the means to establish a strong payment history, which can help boost your credit score. When you need to apply for a personal loan or mortgage in the future, a higher credit score can help you qualify for better terms and rates.
• Track spending. Credit cards are valuable tools for budgeting since many cards let you track your spending on an app or online. Also, some credit cards give you the ability to categorize your expenses to see where your money is going and make adjustments accordingly.
• Get fraud protection. If your debit card information is stolen, fraudsters can directly access your bank account. But, if you use a credit card, you usually have more fraud protection benefits in places such as purchase protection and identity theft protection. For instance, you can dispute a credit card charge and even receive a credit card chargeback.
• Earn rewards. Many credit cards offer a reward program that gives you points or cashback when spending money. For example, you could earn money for traveling, shopping, or even statement credits.
Cons
Remember, while credit cards are a valuable financial tool, they can also hinder you if not used responsibly. Here are some downsides to keep in mind:
• Potential to damage credit. Just as you can boost your score with a credit card, you can also damage it.
• Possible to rack up debt. Credit cards can make it easy to rack up a mountain of debt that can continue ballooning, thanks to interest. It’s not easy to get rid of credit card debt either (for instance, here’s what happens to credit card debt when you die).
• Interest. Credit cards generally have higher APRs compared to other types of debt — usually well into the double digits. It can make purchases much more expensive if you’re paying a hefty amount of interest on top of the actual cost.
• Fees. Another downside of credit cards is the potential to incur fees. Some are avoidable, like late fees or cash advance fees, while others can be harder to avoid, such as if your credit card of choice charges an annual fee.
How to Apply for a Credit Card
Before you apply for a new credit card, you’ll want to check your credit score. You can pull a free copy of your credit report at AnnualCreditReport.com. Knowing your credit score will help you determine whether you meet the approval requirements for the cards you’re interested in.
Once you decide on some card options, you can usually get prequalified online. If you prequalify for a card, your approval odds could be in your favor (though you’re still not actually approved). Also, when companies process your preapproval, they only complete a soft credit inquiry, which won’t impact your credit like a hard inquiry does. However, when you’re ready to apply, the credit issuer will conduct a hard credit inquiry.
If you’re approved for the card you apply for, you should receive your credit card in the mail within 14 days.
Recommended: How to Apply for a Credit Card
The Takeaway
A credit card, in simplest terms, is a physical card you can use to make purchases and pay bills. A credit card typically comes with a credit limit, or the maximum amount of money that the credit card company allows you to borrow.
You’ll receive a statement each month that details the purchases you made, the total outstanding balance, and also the minimum payment due. You’re required to pay the minimum amount due each month in order to remain in good standing with the credit card issuer and avoid harming your credit score. Paying off your balance in full each month enables you to avoid interest charges.
Before you apply for a credit card, it’s important to research your options to understand which card may be best for your current situation and financial needs.
Whether you're looking to build credit, apply for a new credit card, or save money with the cards you have, it's important to understand the options that are best for you. Learn more about credit cards by exploring this credit card guide.
FAQ
What are the main differences between credit and debit cards?
Debit cards use the money in your checking account to pay for purchases. When you make a purchase using a credit card, on the other hand, you’re using a line of credit to borrow money. Therefore, you usually have to pay interest on your transactions with a credit card if you don’t repay your balance right away.
How do I choose a credit card?
It’s helpful to select a credit card that matches your needs and financial habits. You’ll also want to make sure you meet the card issuer’s approval criteria. For example, if a credit card requires a credit score of 700 and your score is 650, you may have to explore other options or take steps to improve your credit before applying.
How long does it take to get a credit card?
Once you submit a credit card application, it may take just minutes before you’re approved. Usually, you’ll receive your credit card within 14 days of approval. You can call the credit issuer and request expedited processing if you need your credit card sooner.
Photo credit: iStock/Nodar Chernishev
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.
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .
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