Oct
17
2025
The Ultimate List of Financial Ratios

The Ultimate List of Financial Ratios

By | Growing Wealth, invest, Investing | Comments Off on The Ultimate List of Financial Ratios

Financial ratios compare specific data points from a company’s balance sheet to capture aspects of that company’s performance. For example, the price-to-earnings (P/E) ratio compares the price per share to the company’s earnings per share as a way of assessing whether the company is overvalued or undervalued.

Other ratios may be used to evaluate other aspects of a company’s financial health: its debt, efficiency, profitability, liquidity, and more.

The use of financial ratios is often used in quantitative or fundamental analysis, though they can also be used for technical analysis. For example, a value investor may use certain types of financial ratios to indicate whether the market has undervalued a company or how much potential its stock has for long-term price appreciation.

Meanwhile, a trend trader may check key financial ratios to determine if a current pricing trend is likely to hold.

With either strategy, informed investors must understand the different kinds of commonly used financial ratios, and how to interpret them.

Key Points

•  Financial ratios serve as tools for evaluating aspects of a company’s financial health, assisting both business owners and investors in decision-making.

•  Key financial ratios include earnings per share (EPS), price-to-earnings (P/E), and debt to equity (D/E), each providing insights into profitability, valuation, and leverage.

•  Liquidity ratios, such as the current ratio and quick ratio, help assess a company’s ability to meet short-term obligations, crucial for evaluating newer firms.

•  Profitability ratios, including gross margin and return on assets, gauge how effectively a company generates income from its operations and assets.

•  Coverage ratios, like the debt-service coverage ratio and interest coverage ratio, measure a company’s capacity to manage its debt obligations, providing insights into financial stability.

What Are Financial Ratios?

A financial ratio is a means of expressing the relationship between two pieces of numerical data, which then provides a measurable insight. When discussing ratios in a business or investment setting, you’re typically talking about information that’s included in a company’s financial statements.

Financial ratios can provide insight into a company, in terms of things like valuation, revenues, and profitability. Various ratios can also aid in comparing two companies.

For example, say you’re considering investing in the tech sector, and you are evaluating two potential companies. One has a share price of $10 while the other has a share price of $55. Basing your decision solely on price alone could be a mistake if you don’t understand what’s driving share prices or how the market values each company.

That’s where financial ratios become useful for understanding the bigger picture of a company’s health and performance. In this example, knowing the P/E ratio of each company — again, which compares the price-per-share to the company’s earnings-per-share (EPS) — can give an investor a sense of each company’s market value versus its current profitability.

Recommended: How to Read Financial Statements

21 Key Financial Ratios

Investors tend to use some financial ratios more often or place more significance on certain ratios when evaluating business or companies, whether investing online or through a brokerage.

Bear in mind that most financial ratios are hard to interpret alone; most have to be taken in context — either in light of other financial data, other companies’ performance, or industry benchmarks.

Here are some of the most important financial ratios to know when buying stocks.

1. Earnings Per Share (EPS)

Earnings per share or EPS measures earnings and profitability. This metric can tell you how likely a company is to generate profits for its investors. A higher EPS typically indicates better profitability, though this rule works best when making apples-to-apples comparisons for companies within the same industry.

EPS Formula:

EPS = Net profit / Number of common shares

To find net profit, you’d subtract total expenses from total revenue. (Investors might also refer to net profit as net income.)

EPS Example:

So, assume a company has a net profit of $2 million, with 12,000,000 shares outstanding. Following the EPS formula, the earnings per share works out to $0.166.

2. Price-to-Earnings (P/E)

Price-to-earnings ratio or P/E, as noted above, helps investors determine whether a company’s stock price is low or high compared to other companies, or to its own past performance. More specifically, the price-to-earnings ratio can give you a sense of how expensive a stock is relative to its competitors, or how the stock’s price is trending over time.

P/E Formula:

P/E = Current stock price / Current earnings per share

P/E Example:

Here’s how it works: A company’s stock is trading at $50 per share. Its EPS for the past 12 months averaged $5. The price-to-earnings ratio works out to 10 — which means investors are willing to pay $10 for every one dollar of earnings. In order to know whether the company’s P/E is high (potentially overvalued) or low (potentially undervalued), the investors typically compare the current P/E ratio to previous ratios, as well as to other companies in the industry.

3. Debt to Equity (D/E)

Debt to equity or D/E is a leverage ratio. This ratio tells investors how much debt a company has in relation to how much equity it holds.

D/E Formula:

D/E = Total liabilities / Shareholders equity

In this formula, liabilities represent money the company owes. Equity represents assets minus liabilities or the company’s book value.

D/E Example:

Say a company has $5 million in debt and $10 million in shareholder equity. Its debt-to-equity ratio would be 0.5. As a general rule, a lower debt to equity ratio is better as it means the company has fewer debt obligations.

4. Return on Equity (ROE)

Return on equity or ROE is another financial ratio that’s used to measure profitability. In simple terms, it’s used to illustrate the return on shareholder equity based on how a company spends its money.

ROE Formula:

ROE = Net income – Preferred dividends / Value of average common equity

ROE Example:

Assume a company has net income of $2 million and pays out preferred dividends of $200,000. The total value of common equity is $10 million. Using the formula, return on equity would equal 0.18 or 18%. A higher ROE means the company generates more profits.

Liquidity Ratios

Liquidity ratios can give you an idea of how easily a company can pay its debts and other liabilities. In other words, liquidity ratios indicate cash flow strength. That can be especially important when considering newer companies, which may face more significant cash flow challenges compared to established companies.

5. Current Ratio

Also known as the working-capital ratio, the current ratio tells you how likely a company is able to meet its financial obligations for the next 12 months. You might check this ratio if you’re interested in whether a company has enough assets to pay off short-term liabilities.

Formula:

Current Ratio = Current Assets / Current Liabilities

Example:

Say a company has $1 million in current assets and $500,000 in current liabilities. It has a current ratio of 2, meaning for every $1 a company has in current liabilities it has $2 in current assets. Generally speaking, a ratio between 1.5 and 2 indicates the company can manage its debts; above 2 a company has strong positive cashflow.

6. Quick Ratio

The quick ratio, also called the acid-test ratio, measures liquidity based on assets and liabilities. But it deducts the value of inventory from these calculations.

Formula:

Quick Ratio = Current Assets – Inventory / Current Liabilities

Example:

Quick ratio is also useful for determining how easily a company can pay its debts. For example, say a company has current assets of $5 million, inventory of $1 million and current liabilities of $500,000. Its quick ratio would be 8, so for every $1 in liabilities the company has $8 in assets.

7. Cash Ratio

A cash ratio tells you how much cash a company has on hand, relative to its total liabilities, and it’s considered a more conservative measure of liquidity than, say, the current or quick ratios. Essentially, it tells you the portion of liabilities the company could pay immediately with cash alone.

Formula:

Cash Ratio = (Cash + Cash Equivalents) / Total Current Liabilities

Example:

A company that has $100,000 in cash and $500,000 in current liabilities would have a cash ratio of 0.2. That means it has enough cash on hand to pay 20% of its current liabilities.

8. Operating Cash Flow Ratio

Operating cash flow can tell you how much cash flow a business generates in a given time frame. This financial ratio is useful for determining how much cash a business has on hand at any given time that it can use to pay off its liabilities.

To calculate the operating cash flow ratio you’ll first need to determine its operating cash flow:

Operating Cash Flow = Net Income + Changes in Assets & Liabilities + Non-cash Expenses – Increase in Working Capital

Then, you calculate the cash flow ratio using this formula:

Formula:

Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities

Example:

For example, if a company has an operating cash flow of $1 million and current liabilities of $250,000, you could calculate that it has an operating cash flow ratio of 4, which means it has $4 in operating cash flow for every $1 of liabilities, in that time frame.

Solvency Ratios

Solvency ratios are financial ratios used to measure a company’s ability to pay its debts over the long term. As an investor, you might be interested in solvency ratios if you think a company may have too much debt or be a potential candidate for a bankruptcy filing. Solvency ratios can also be referred to as leverage ratios.

Debt to equity (D/E), noted above, is a key financial ratio used to measure solvency, though there are other leverage ratios that are helpful as well.

9. Debt Ratio

A company’s debt ratio measures the relationship between its debts and its assets. For instance, you might use a debt ratio to gauge whether a company could pay off its debts with the assets it has currently.

Formula:

Debt Ratio = Total Liabilities / Total Assets

Example:

The lower this number is the better, in terms of risk. A lower debt ratio means a company has less relative debt. So a company that has $25,000 in debt and $100,000 in assets, for example, would have a debt ratio of 0.25. Investors typically consider anything below 0.5 a lower risk.

10. Equity Ratio

Equity ratio is a measure of solvency based on assets and total equity. This ratio can tell you how much of the company is owned by investors and how much of it is leveraged by debt. An equity ratio above 50% can indicate that a company relies primarily on its own capital, and isn’t overleveraged.

Formula:

Equity Ratio = Total Equity / Total Assets

Example:

Investors typically favor a higher equity ratio, as it means the company’s shareholders are more heavily invested and the business isn’t bogged down by debt. So, for example, a company with $800,000 in total equity and $1.1 million in total assets has an equity ratio of 0.70 or 70%. This tells you shareholders own 70% of the company.

Profitability Ratios

Profitability ratios gauge a company’s ability to generate income from sales, balance sheet assets, operations and shareholder’s equity. In other words, how likely is the company to be able to turn a profit?

Return on equity (ROE), noted above, is one profitability ratio investors can use. You can also try these financial ratios for estimating profitability.

11. Gross Margin Ratio

Gross margin ratio compares a company’s gross margin to its net sales. This tells you how much profit a company makes from selling its goods and services after the cost of goods sold is factored in — an important consideration for investors.

Formula:

Gross Margin Ratio = Gross Margin / Net Sales

Example

A company that has a gross margin of $250,000 and $1 million in net sales has a gross margin ratio of 25%. Meanwhile, a company with a $250,000 gross margin and $2 million in net sales has a gross margin ratio of 12.5% and realizes a smaller profit percentage per sale.

12. Operating-Margin Ratio

Operating-margin ratio, sometimes called return on sales (ROS), measures how much total revenue is composed of operating income, or how much revenue a company has after its operating costs. It’s a measure of how efficiently a company generates its revenue and how much of that it turns into profit.

Formula:

Operating Margin Ratio = Operating Income / Net Sales

Example:

A higher operating-margin ratio suggests a more financially stable company with enough operating income to cover its operating costs. For example, if operating income is $250,000 and net sales are $500,000, that means 50 cents per dollar of sales goes toward variable costs.

13. Return on Assets Ratio

Return on assets, or ROA, measures net income produced by a company’s total assets. This lets you see how efficiently a company is using its assets to generate income.

Formula:

Return on Assets = Net Income / Average Total Assets

Example:

Investors typically favor a higher ratio as it shows that the company may be better at using its assets to generate income. For example, a company that has $10 million in net income and $2 million in average total assets generates $5 in income per $1 of assets.

Efficiency Ratios

Efficiency ratios or financial activity ratios give you a sense of how thoroughly a company is using the assets and resources it has on hand. In other words, they can tell you if a company is using its assets efficiently or not.

14. Asset Turnover Ratio

Asset turnover ratio measures how efficient a company’s operations are, as it is a way to see how much sales a company can generate from its assets.

Formula:

Asset Turnover Ratio = Net Sales / Average Total Assets

A higher asset turnover ratio is typically better, as it indicates greater efficiency in terms of how assets are being used to produce sales.

Example:

Say a company has $500,000 in net sales and $50,000 in average total assets. Their asset turnover ratio is 10, meaning every dollar in assets generates $10 in sales.

15. Inventory Turnover Ratio

Inventory turnover ratio illustrates how often a company turns over its inventory. Specifically, how many times a company sells and replaces its inventory in a given time frame.

Formula:

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

Example:

Investors use average inventory since a company’s inventory can increase or decrease throughout the year as demand ebbs and flows. As an example, if a company has a cost of goods sold equal to $1 million and average inventory of $500,000, its inventory turnover ratio is 2. That means it turns over inventory twice a year.

16. Receivables Turnover Ratio

Receivables turnover ratio measures how well companies manage their accounts receivable, and collect money from customers. Specifically, it considers how long it takes companies to collect on outstanding receivables, and convert credit into cash.

Formula:

Receivables Turnover Ratio = Net Annual Credit Sales / Average Accounts Receivable

Example:

If a company has $100,000 in net annual credit sales, for example, and $15,000 in average accounts receivable its receivables turnover ratio is 6.67. This means that the company collects and converts its credit sales to cash about 6.67 times per year. The higher the number is, the better, since it indicates the business is more efficient at getting customers to pay up.

Coverage Ratios

Coverage ratios are financial ratios that measure how well a company manages its obligations to suppliers, creditors, and anyone else to whom it owes money. Lenders may use coverage ratios to determine a business’s ability to pay back the money it borrows.

17. Debt-Service Coverage Ratio

Debt-service coverage reflects whether a company can pay all of its debts, including interest and principal, at any given time. This ratio can offer creditors insight into a company’s cash flow and debt situation.

Formula:

Debt-Service Coverage Ratio = Operating Income / Total Debt Service Costs

Example:

A ratio above 1 means the company has more than enough money to meet its debt servicing needs. A ratio equal to 1 means its operating income and debt service costs are the same. A ratio below 1 indicates that the company doesn’t have enough operating income to meet its debt service costs.

18. Interest-Coverage Ratio

Interest-coverage ratio is a financial ratio that can tell you whether a company is able to pay interest on its debt obligations on time. This is sometimes called the times interest earned (TIE) ratio. Its chief use is to help determine whether the company is creditworthy.

Formula:

Interest Coverage Ratio = EBIT ( Earnings Before Interest and Taxes) / Annual Interest Expense

Example:

Let’s say a company has an EBIT of $100,000. Meanwhile, annual interest expense is $25,000. That results in an interest coverage ratio of 4, which means the company has four times more earnings than interest payments.

19. Asset-Coverage Ratio

Asset-coverage ratio measures risk by determining how much of a company’s assets would need to be sold to cover its debts. This can give you an idea of a company’s financial stability overall.

Formula:

Asset Coverage Ratio = (Total Assets – Intangible Assets) – (Current Liabilities – Short-term Debt) / Total Debt

You can find all of this information on a company’s balance sheet. The rules for interpreting asset coverage ratio are similar to the ones for debt service coverage ratio.

So a ratio of 1 or higher would suggest the company has sufficient assets to cover its debts. A ratio of 1 would suggest that assets and liabilities are equal. A ratio below 1 means the company doesn’t have enough assets to cover its debts.

Recommended: What Is a Fixed Charge Coverage Ratio?

Market-Prospect Ratios

Market-prospect ratios make it easier to compare the stock price of a publicly traded company with other financial ratios. These ratios can help analyze trends in stock price movements over time. Earnings per share and price-to-earnings are two examples of market prospect ratios, discussed above. Investors can also look to dividend payout ratios and dividend yield to judge market prospects.

20. Dividend Payout Ratio

Dividend payout ratio can tell you how much of a company’s net income it pays out to investors as dividends during a specific time period. It’s the balance between the profits passed on to shareholders as dividends and the profits the company keeps.

Formula:

Dividend Payout Ratio = Total Dividends / Net Income

Example:

A company that pays out $1 million in total dividends and has a net income of $5 million has a dividend payout ratio of 0.2. That means 20% of net income goes to shareholders.

21. Dividend Yield

Dividend yield is a financial ratio that tracks how much cash dividends are paid out to common stock shareholders, relative to the market value per share. Investors use this metric to determine how much an investment generates in dividends.

Formula:

Dividend Yield = Cash Dividends Per Share / Market Value Per Share

Example:

For example, a company that pays out $5 in cash dividends per share for shares valued at $50 each are offering investors a dividend yield of 10%. This can be compared to the dividend yield of another company when choosing between investments.

Ratio Analysis: What Do Financial Ratios Tell You?

Financial statement ratios can be helpful when analyzing stocks. The various formulas included on this financial ratios list offer insight into a company’s profitability, cash flow, debts and assets, all of which can help you form a more complete picture of its overall health. That’s important if you tend to lean toward a fundamental analysis approach for choosing stocks.

Using financial ratios can also give you an idea of how much risk you might be taking on with a particular company, based on how well it manages its financial obligations. You can use these ratios to select companies that align with your risk tolerance and desired return profile.

Test your understanding of what you just read.

The Takeaway

Learning the basics of key financial ratios can be helpful when constructing a stock portfolio. Rather than focusing only on a stock’s price, you can use financial ratios to take a closer look under the hood of a company, to gauge its operating efficiency, level of debt, and profitability.

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


Invest with as little as $5 with a SoFi Active Investing account.

FAQ

Which ratios should you check before investing?

Many investors start with basics like the price-to-earnings (P/E) ratio, the debt-to-equity (D/E) ratio, and the working capital ratio. But different ratios can provide specific insights that may be more relevant to a certain company or industry, e.g., knowing the operating-margin ratio or the inventory-turnover ratio may be more useful in some cases versus others.

What is the best ratio when buying a stock?

There is no “best” ratio to use when buying a stock, because each financial ratio can reveal an important aspect of a company’s performance. Investors may want to consider using a combination of financial ratios in order to make favorable investment decisions.

What is a good P/E ratio?

In general, a lower P/E ratio may be more desirable than a higher P/E ratio, simply because a higher P/E may indicate that investors are paying more for every dollar of earnings — and the stock may be overvalued.

Photo credit: iStock/MStudioImages

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

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.

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOIN-Q325-093

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Oct
17
2025
Wash Trading: What Is It? Is It Legal?

Wash Trading: What Is It and How Does It Work?

By | Growing Wealth, invest, Investing | Comments Off on Wash Trading: What Is It and How Does It Work?

Wash trading is an illegal practice in which an investor buys and sells the same or a nearly identical stock or security within a certain period of time. Wash trading is a prohibited activity under the Commodity Exchange Act (CEA) of 1936 and the Securities Exchange Act of 1934.

Wash trading is basically an attempt at market manipulation and a way to portray false market activity. Read on to learn about the implications of wash trading and how it works.

Key Points

•  Wash trading is a prohibited practice in which investors engage in buying and selling the same or similar securities to create the illusion of trading activity.

•  This practice can be a form of market manipulation and a way to portray false market activity.

•  The goal of wash trading is often to influence pricing or trading activity.

•  Wash trading is illegal and may result in penalties from regulatory agencies.

•  A wash sale is different from wash trading. The wash sale rule prohibits an investor from taking a tax deduction on a loss when they purchase the same or substantially identical security within 30 days before or after the sale.

What Is Wash Trading?

Wash trading occurs when an investor buys and sells the same or a similar security investment around the same time. This is also called round-trip trading, since an investor is essentially ending where they began — with shares of the same security in their portfolio.

Wash trades can be used as a form of market manipulation. Investors may buy and sell the same securities in an attempt to influence pricing or trading activity. The goal may be to spur buying activity to send prices up or encourage selling to drive prices down.

Some investors and brokers might work together to influence trading volume, usually for the financial benefit of both sides. The broker, for example, might benefit from collecting commissions from other investors who want to purchase a stock being targeted for wash trading. The investor, on the other hand, may realize gains from the sale of securities through price manipulation.

Wash trading is different from insider trading, which requires the parties involved to have some special knowledge about a security that the general public doesn’t. However, if an investor or broker possesses insider knowledge they could potentially use it to complete wash trades.

How Does Wash Trading Work?

Essentially, a wash trade means an investor is buying and selling shares of the same security at around the same time. But the definition of wash trades goes further and takes the investor’s intent (and that of any broker they may be working with) into account. There are generally two conditions that must be met for a wash trade to exist:

•  Intent. The intent of the parties involved in a wash trade (i.e., the broker or the investor) must be that at least one individual involved in the transaction must have entered into it specifically for that purpose.

•  Result. The result of the transaction must be a wash trade, meaning the same asset was bought and sold at the same time or within a relatively short time span for accounts with the same or common beneficial ownership.

Beneficial ownership means accounts that are owned by the same individual or entity. Trades made between accounts with common beneficial ownership may draw the eye of financial regulators, as they can suggest wash trading activity is at work.

Wash trades don’t necessarily have to involve actual trades, however. They can also happen if investors and traders appear to make a trade on paper without any assets changing hands.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Example of a Wash Trade

Here’s a wash trade example:

Say an investor owns 100 shares of a stock and sells those shares at a $5,000 loss on September 1. On September 5, they purchase 100 shares of the same stock, then resell them for a $10,000 gain. This could be considered a wash trade if the investor engaged in the trading activity with the intent to manipulate the market.

Is Wash Trading Illegal?

Yes, wash trading is illegal. The Commodity Exchange Act prohibits wash trading. Prior to the passage of the Act, traders used wash trading to manipulate markets and stock prices. The Commodity Futures Trade Commission (CFTC) also enforces regulations regarding wash trading, including guidelines that bar brokers from profiting from wash trade activity.

It’s important to distinguish between wash trading and a wash sale, which is an IRS rule. The IRS wash sale rule does not allow investors to deduct capital losses on their taxes from sales or trades of stocks or other securities in particular circumstances.

Under the IRS rules, a wash sale occurs when an investor sells or trades stocks at a loss and within 30 days before or after the sale they:

•  Purchase substantially identical stock or securities

•  Acquire substantially identical stock or securities in a fully taxable trade

•  Acquire a contract or option to buy substantially identical stock or securities, or

•  Acquire substantially identical stock for your individual retirement arrangement (IRA) or Roth IRA

Wash sale rules also apply if an investor sells stock and their spouse or a corporation they control buys substantially identical stock. When a wash sale occurs, an investor is not able to claim a tax deduction for those losses.

Essentially, the IRS wash sale rule is a tax rule. Wash trading is a form of intentional market manipulation.

Difference Between Wash Trading & Market Making

Market making and wash trading are not the same thing. A market maker is a firm or individual that buys or sells securities at publicly quoted prices on-demand, and a market maker provides liquidity and facilitates trades between buyers and sellers. For example, if you’re trading through an online broker you’re using a market maker to complete the sale or purchase of securities.

Market making is not market manipulation. A market maker is, effectively, a middleman between investors and the markets. While they do profit from their role by maintaining spreads on the stocks they cover, this is secondary to fulfilling their purpose of keeping shares and capital moving.

Recommended: What Is a Brokerage Account?

How to Detect & Avoid Wash Trading

The simplest way to avoid wash trading as an investor is to be aware of what constitutes a wash trade. Again, this can mean the intent to manipulate the markets by placing similar trades within a short timeframe.

Investors may notice red flags that may signal wash trading, such as multiple trades that have identical quantities and prices, repeated buying and selling between certain traders, and unusual trading patterns or volumes. Financial institutions and regulators also monitor trading data to identify or help prevent manipulative or abusive trading.

To avoid a wash sale, conversely, an investor could be mindful of the securities they are buying and selling and the timeframe in which those transactions are completed. So selling XYZ stock at a loss, then buying it again 10 days later to sell it for a profit would likely constitute a wash sale if they executed the trade and attempted to deduct the initial loss on their taxes.

It’s also important to understand how the 30-day period works. The 30-day rule extends to the 30 days prior to the sale and 30 days after the sale. So effectively, an investor could avoid the wash sale rule by waiting 61 days to replace assets that they sold in their portfolio.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

The Takeaway

Wash trading involves selling certain securities and then replacing them in a portfolio with identical or very similar securities within a certain time period. This is typically done with the intent to manipulate the market. Wash trading is illegal.

Wash trading is not to be confused with the wash sale rule. For investors, understanding when the IRS wash sale rule applies can help them comply with tax guidelines. Those who are unclear about it, may wish to consult with a financial or tax professional.

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


Invest with as little as $5 with a SoFi Active Investing account.

FAQ

What’s considered wash trading

Wash trading is an illegal practice in which an investor buys and sells the same or a nearly identical security with the intent of falsely implying increased trading activity. It’s a form of market manipulation that could deceive other investors into making trades.

What’s the difference between wash trading and the wash sale rule?

Wash trading is an illegal practice with an intent to manipulate the market. The wash sales rule is a tax rule that says an investor cannot sell stock or securities for a loss and then buy substantially identical shares within 30 days before or after the sale and claim the deduction of the sale on their taxes.

Is a wash sale illegal?

No, a wash sale is not illegal. A wash sale is a tax rule that does not allow investors to claim a tax deduction if they sold a stock for a loss and then bought a substantially similar stock or security within 30 days before or after the sale.

How do day traders avoid wash sales?

To properly follow the IRS wash sales rule, an investor can wait for more than 30 days before or after the sale of a stock or security for a loss — meaning for a total of 61 days — before purchasing one that’s identical or substantially identical and then claiming the deduction for the sale on their taxes.

Photo credit: iStock/mapodile

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

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.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

This article is not intended to be legal advice. Please consult an attorney for advice.

Dollar Cost Averaging (DCA): Dollar cost averaging is an investment strategy that involves regularly investing a fixed amount of money, regardless of market conditions. This approach can help reduce the impact of market volatility and lower the average cost per share over time. However, it does not guarantee a profit or protect against losses in declining markets. Investors should consider their financial goals, risk tolerance, and market conditions when deciding whether to use dollar cost averaging. Past performance is not indicative of future results. You should consult with a financial advisor to determine if this strategy is appropriate for your individual circumstances.

SOIN-Q325-105

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Oct
17
2025

Best IRA for Young Adults: A 2025 Guide to Choosing Your Retirement Plan

By | invest, Investing, Preparing for Retirement | Comments Off on Best IRA for Young Adults: A 2025 Guide to Choosing Your Retirement Plan

Saving for retirement may be lower on the priority list for young adults as they deal with the right-now reality of paying rent, bills, and student loans. But the truth is, it’s never too soon to start saving for the future. The more time your money has to grow, the better. And saving even small amounts now could make a big difference later.

An individual retirement account (IRA) allows you to save for the future over the long term. It’s one option that could help young adults start investing in their future.

There are different types of IRAs, and each has different requirements and benefits. Read on to learn about different types of IRAs, how much you can contribute, the possible tax advantages, and everything else you need to know about choosing the best IRA for young adults.

Key Points

•   By saving and investing for retirement, a young adult could benefit from compounding returns, which can potentially help the growth of a nest egg over the long term.

•   Traditional IRA contributions may help reduce current taxable income because they are made with pre-tax dollars, and withdrawals are taxed in retirement.

•   Roth IRA contributions are made with after-tax dollars, and withdrawals in retirement are tax-free.

•   A Roth IRA may be an option for young adults in a low tax bracket now who expect to be in a higher tax bracket in retirement.

•   Automating contributions may potentially enhance the growth of retirement savings by making savings a recurring process.

Why Start an IRA in Your 20s and 30s?

When you begin saving and investing in your 20s and 30s, you have more time to build a nest egg. Starting an individual retirement account (IRA) early in adulthood may potentially help you benefit from compounding returns and also give you a tax-advantaged way to help your money grow.

The Power of Compounding Returns

The younger you are when you start investing, the more time you have to take advantage of the power of compounding, which can help your investment grow over time.

With compounding returns, if the money you invest earns a profit, and that profit is then reinvested, you earn money both on your original investment and on the returns. That means your gains could potentially multiply over time. The more time you have to invest, the more time your returns potentially have to compound.

Building a Tax-Advantaged Nest Egg Early

An IRA typically also has tax advantages that may help you build your savings more efficiently. For example, with a traditional IRA, you contribute pre-tax dollars and pay taxes on the distributions in retirement. With a Roth IRA, you contribute after-tax dollars, and your withdrawals in retirement are tax-free. One type of IRA or the other might make the most sense for an investor, or perhaps even a combination of both types.

Understanding the Types of IRAs

There are several types of IRAs, but two of the most common are traditional IRAs and Roth IRAs.

How much you can contribute to either type of IRA each year is determined by the IRS, and the amount generally changes yearly. In 2025, those under age 50 can contribute a maximum of $7,000 annually to a traditional or Roth IRA. (Those 50 and up can contribute an extra $1,000 per year in 2025 in what’s called a catch-up contribution.) An IRA calculator can help you figure out how much you can contribute, depending on the type of IRA you’re interested in, among other factors.

What Is a Roth IRA?

A key difference between Roth and traditional IRAs is how they’re taxed. With a Roth IRA, you contribute after-tax dollars. Your contributions are not tax deductible when you make them. However, your earnings grow tax-free in the account, and you withdraw your money tax-free in retirement.

What Is a Traditional IRA?

With a traditional IRA, you contribute pre-tax dollars. Generally speaking, you take deductions on your contributions upfront, which may lower your taxable income for the year, and then you pay taxes on the distributions when you take them in retirement. Your earnings in the account grow tax-deferred.

What Are SEP and Simple IRAs?

Individuals who are self-employed or own a small business might want to explore a SEP IRA or a SIMPLE IRA.

A SEP IRA is available for freelancers, independent contractors, and small business owners. Contributions are capped at a limit set by the IRS. In 2025, individuals can contribute up to the amount that’s the lesser of $70,000 or 25% of an individual’s compensation. Contributions to a SEP are made with pre-tax dollars and are tax deductible, and withdrawals are taxed in retirement.

A SIMPLE IRA is also an option for those who are self-employed as well as small businesses that have no other retirement savings plan. The tax and withdrawal rules for a SIMPLE IRA are the same as for a SEP IRA. One big difference between them: A SIMPLE IRA allows employees under age 50 to contribute up to $16,500 in 2025 (employers are required to contribute), while a SEP does not allow employee contributions, only employer contributions.

IRA Comparison: Roth vs. Traditional for Young Adults

For those exploring a Roth vs. traditional IRA for a young person, there are a number of different factors to weigh, including taxes, withdrawal rules, and income.

Taxes

An important consideration when looking at which IRA is best for young adults is taxes. For individuals who currently earn a lower income and are in a lower tax bracket, the upfront tax deductions with a traditional IRA may not be as beneficial. A Roth, with its tax-free distributions in retirement, might be worth exploring instead — especially if the individual expects to be in a higher tax bracket in retirement.

Your income also determines how much of your contributions you can deduct with a traditional IRA. Deduction limits depend on your modified adjusted gross income (MAGI), whether you are single or married, your tax filing status, and if you’re covered by a retirement plan at work.

For instance, in 2025, those who are single and not covered by a retirement plan at work can deduct the entire amount they contribute to a traditional IRA. However, if they are covered by a retirement plan from their employer, they can only deduct the full amount if their MAGI is $79,000 or less. If they earn more than $79,000 and less than $89,000, they can take a partial deduction. And if their MAGI is $89,000 or more, they can’t take any deductions.

Individuals who are married filing jointly and aren’t covered by a retirement plan at work can deduct the full amount of their traditional IRA contributions. But in 2025, if their spouse is covered by a workplace retirement plan, they can deduct the full amount only if their combined MAGI is $236,000 or less. If their combined MAGI is $246,000 or more, they can’t take a deduction.

And if they themselves are covered by a retirement plan at work, they can deduct the full amount of their traditional IRA contributions only if their combined MAGI is $126,000 or less. If their combined MAGI is $146,000 or more, they can’t take a deduction.

Withdrawals

Another important consideration when choosing an IRA is withdrawals. Both traditional and Roth IRAs have early withdrawal penalties.

There are some differences, however. With a traditional IRA, individuals who take withdrawals before age 59 ½ will generally be subject to a 10% penalty, plus taxes. A Roth IRA typically offers more flexibility: Individuals may withdraw their contributions penalty-free at any time before age 59 ½. However, any earnings can typically only be withdrawn tax- and penalty-free once the individual reaches age 59 ½ and the account has been open for at least five years.

That said, there are exceptions to the IRA withdrawal rules, including:

•   Death or disability of the individual who owns the account

•   Qualified higher education expenses for the account owner, spouse, or a child or grandchild

•   Up to $10,000 for first-time qualified homebuyers to help purchase a home

•   Health insurance premiums paid while an individual is unemployed

•   Unreimbursed medical expenses that are more than 7.5% of an individual’s adjusted gross income

The chart below gives a side-by-side comparison between a traditional and Roth IRA to help you quickly see what the key differences are.

Traditional IRA vs. Roth IRA: Key Differences

Traditional IRA Roth IRA
Contributions Made with pre-tax dollars Made with after-tax dollars
Pay taxes on withdrawals in retirement Yes No
Potential earnings Grow tax-deferred Grow tax-free
Contributions tax deductible Yes, if you meet income requirements No
Early withdrawal penalty May have to pay tax on earnings plus a 10% penalty before age 59 ½ No taxes or penalties on contributions, but earnings are subject to taxes and a 10% penalty before age 59 ½

Who Should Choose a Roth IRA?

How a Roth IRA works is that your MAGI must be below a certain level to qualify. In 2025, single individuals who earn up to $150,000 can contribute the full amount to a Roth. Single filers with a MAGI of $150,000 or more but less than $165,000 can contribute a partial amount, and those who earn $165,000 or more are not eligible to open or contribute to a Roth. For married couples who file jointly, the limit in 2025 is up to $236,000 for a full contribution to a Roth, and between $236,000 to $246,000 for a partial contribution.

Since young adults starting out in their career might be earning less than they will in the future, it could make sense for a young adult to open a Roth now when they may not have to worry about earning too much to qualify. Plus for individuals earning less now and who expect to have a higher income in retirement, taking tax-free withdrawals after age 59 ½ could make financial sense as well.

A Roth IRA calculator can help you determine how much you can contribute annually.

Who Should Choose a Traditional IRA?

With a traditional IRA, you contribute pre-tax dollars. That means you take deductions on your contributions upfront, which may lower your taxable income for the year, and then pay taxes on the distributions when you take them in retirement. If you’re earning more now than you expect your income to be in retirement, a traditional IRA may make sense for your situation.

2025 IRA Contribution & Income Limits at a Glance

The charts below offer a handy comparison on the contribution limits of traditional and Roth IRAs, the income eligibility limits for Roth IRAs, and the traditional IRA tax deduction limits for 2025.

2025 IRA Annual Contribution Limits

Age

 Maximum Annual Contribution (2025)
Under age 50 $7,000
Age 50 and over $8,000 (includes $1,000 “catch-up” contribution)

2025 Roth IRA Income Eligibility Limits

Tax Filing Status

 Can Make Full Contribution

 Can Make Partial Contribution

 Cannot Contribute
Single / Head of Household MAGI up to $150,000 MAGI between $150,000 – $165,000 MAGI of $165,000 or more
Married & Filing Jointly MAGI up to $236,000 MAGI between $236,000 – $246,000 MAGI of $246,000 or more

2025 Traditional IRA Deduction Limits (if Covered by a Workplace Plan)

Tax Filing Status

 Can Take Full Deduction

 Can Take Partial Deduction

 Cannot Take a Deduction
Single / Head of Household MAGI up through $79,000 MAGI between $79,000 – $89,000 MAGI of $89,000 or more
Married Filing Jointly MAGI up through $126,000 MAGI between $126,000 – $146,000 MAGI of $146,000 or more

Which IRA Is Right for You? [Interactive Quiz]

Building a Strong Investment Strategy

As you explore a suitable IRA for young adults, you’ll want to make sure that you’re getting the most out of your investing strategy to help you achieve your financial goals. Here are some ways to do that.

Contributing to a 401(k) and an IRA.

If your employer offers a 401(k), enrolling in it and contributing as much as you can may help you get started. If possible, aim to contribute enough to get the matching contribution, which is, essentially, “free” or extra money that can help you build your savings.

If you don’t have a workplace 401(k) — and even if you do — you might consider opening an IRA as another account to help save for retirement. Contribute as much as you are able to. With an IRA, you typically have more investment options than you do with a 401(k), and you can also choose the type of IRA that could give you potential tax advantages.

Automating your contributions.

With a 401(k), your contributions usually happen automatically. Opening an investment account for an IRA could help you do something similar. Many brokerages allow you to set up automatic repeating deposits in an IRA. This way you don’t have to even think about contributing to your account — it just happens.

Understanding your risk tolerance.

When you’re deciding what assets to invest in, consider your risk tolerance. All investments come with some risk, but some types are riskier than others. In general, assets that potentially offer higher returns (like stocks) come with higher risk.

If a drop in the market is going to send your anxiety level skyrocketing, you may want to make your portfolio a little more conservative. If you’re willing to take risks, you might want to be a bit more aggressive. Either way, try to find an asset allocation that balances your tolerance for risk with the amount of risk you may need to take to help meet your investment goals.

You might even choose to do automated investing to help match your financial aims and risk tolerance.

Diversifying your investments.

Building a diversified portfolio across a range of asset classes — such as stocks, bonds, and cash, for instance — rather than concentrating all of it in one area — may help you offset some investment risk. Just be aware that diversification doesn’t eliminate risk.

Reassessing your portfolio regularly.

Once or twice a year, review the performance of your portfolio to make sure it’s on track to help you get where you want to be in terms of your financial future.

How to Open an IRA in 3 Simple Steps

Opening an IRA is typically a straightforward process. This is what it entails:

1. Choose Your IRA Type (Roth or Traditional)

Explore a traditional IRA vs. A Roth IRA to decide which one is right for you. Be sure to take into consideration your income now and in retirement, the tax situation that makes the most sense for your situation, the contribution level, and early withdrawal rules.

You can open an IRA at any one of a number of financial institutions, including a bank or an online brokerage, among others.

2. Fund Your Account

After you open an IRA, contribute up to the annual limit if you can to help maximize your investments. If you’re not sure how to fund an IRA, you can start with a few basic techniques.

For instance, you could use your tax refund to contribute to an IRA. That way, you won’t be pulling money out of your savings or from the funds you have earmarked to pay your bills. The same is true if you get a raise or bonus at work, or if a relative gives you money for a birthday. Put those dollars into your IRA.

Another way to fund an IRA is to make small monthly contributions to it. You could start with $50 or $100 monthly. You could even set up a vault bank account specifically for money designated to your IRA so that you don’t end up spending it on something else.

3. Choose Your Investments

Once you fund your IRA, you can start investing your money.That means you need to decide what assets to invest in. Consider your time horizon (or how long you have to invest), your goals, and how much risk you are comfortable with.

As mentioned earlier, assets that can potentially provide higher returns like investing in stocks come with higher risk than fixed-income assets like bonds. Figure out an allocation of the different types of assets that will help you reach your goal without keeping you up at night.

Considerations for Young Adults Looking to Start Investing

Young adults who are ready to begin investing should typically aim to get started as soon as possible. Thanks to the power of compounding returns, the longer your money has to compound, the bigger your account balance may be when you reach retirement.

When choosing an IRA, consider the tax advantages of traditional and Roth IRAs to decide which type of account may be most beneficial for your situation. Once you’ve opened an IRA, try to contribute as much as you can afford to each year, up to the annual limit.

Young adults should also think about their financial goals, at what age they plan to retire, and what their tolerance is for risk. Each of these factors can affect how they invest and what kinds of assets they invest in.

The Takeaway

An IRA can be a way for young adults to start saving for retirement. The earlier they begin, the longer their money may have to grow, which can make a big difference over time.

In order to choose the best IRA for young people, weigh the different tax benefits of Roth and traditional IRAs. If you’re leaning toward a Roth IRA, make sure you meet the income limit requirements, and if you’re considering a traditional IRA, check to see if you can deduct your contributions.

Once you’ve chosen the right IRA for you, start contributing to it regularly if you can. And no matter how much you’re able to contribute, remember this: Getting started with retirement savings is one of the most important steps you can take to build a nest egg and help secure your financial future.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

FAQ

What are the different types of IRAs?

There are several types of IRAs. Two of the most popular are traditional and Roth IRAs, which individuals with earned income can open and contribute to. Contributions to traditional IRAs are made with pre-tax dollars and the contributions are generally tax deductible; the money is taxed on withdrawal in retirement. Contributions to Roth IRAs are made with after tax dollars, and the money is withdrawn tax-free in retirement.

Other types of IRAs include SEP IRAs for self-employed individuals and small business owners, and SIMPLE IRAs for small businesses with 100 employees or fewer.

Which IRA is suitable for young adults?

It depends on an individual’s specific situation, but for young adults choosing between a traditional or Roth IRA, a Roth may be a suitable choice for those in a low tax bracket now and who expect to be in a higher tax bracket in retirement. That’s because with a Roth, contributions are made with after tax dollars and distributions are withdrawn tax-free in retirement. With traditional IRAs, contributions are deducted upfront and you pay taxes on distributions when you retire.

Still, it’s important to weigh the different options and benefits to choose the IRA that’s best for you.

Can I have a 401(k) and an IRA at the same time?

Yes, you can have a 401(k) and an IRA at the same time. In fact, this could potentially be a way to increase retirement savings. You may be able to save more for retirement by having both a 401(k) — and contributing enough to get the employer match — and an IRA. Plus, with an IRA, you typically have a wider range of investment options than with a 401(k), and there may be tax advantages. For example, having a traditional 401(k) and a Roth IRA might provide flexibility when it comes to managing taxes now and in retirement.

What is the maximum I can contribute to my IRA in 2025?

The maximum you can contribute to a traditional or Roth IRA in 2025 is $7,000 if you are under age 50. Those ages 50 and up can contribute up to $8,000, including $1,000 in catch-up contributions.

Photo credit: iStock/andresr

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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.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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

CalculatorThis retirement calculator is provided for educational purposes only and is based on mathematical principles that do not reflect actual performance of any particular investment, portfolio, or index. It does not guarantee results and should not be considered investment, tax, or legal advice. Investing involves risks, including the loss of principal, and results vary based on a number of factors including market conditions and individual circumstances. Past performance is not indicative of future results.

Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®

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Oct
16
2025
Tiny wooden toy houses of different sizes sit next to a graph showing how the rate on an adjustable-rate mortgage might rise over time.

How Does an Adjustable-Rate Mortgage Work?

By | Home Ownership, mortgage, Real Estate | Comments Off on How Does an Adjustable-Rate Mortgage Work?

An adjustable-rate mortgage (also called an ARM) is a mortgage where the interest rate changes. Monthly payments may go up or down, following the larger interest-rate market. Borrowers may be looking to save money with this type of mortgage because there’s usually an introductory period where the interest rate is lower than what they could get with a fixed-rate loan. The monthly payment is lower as a result.

Adjustable-rate mortgages can make sense in certain situations, such as when buyers only plan to own a home for a few years or for those looking to buy a home in a high-interest-rate environment. However, they’re not your only option if you’re looking at getting a mortgage in a high-interest-rate environment.

Before you commit to an ARM, it’s important to understand what exactly it is and how it works. Keep reading to discover the pros and cons of an ARM and how the variable rate on an ARM is determined. You’ll come away understanding when it does (and doesn’t) make sense to get an ARM.

Key Points

•  Adjustable-rate mortgages (ARMs) offer low initial rates and monthly payments, but payments can increase over time.

•  The variable interest rate is based on a market index plus a fixed margin.

•  ARMs come in various types, including 5/1, 5/6, 7/1, 7/6, 10/1, and 10/6 ARMs.

•  ARMs are suitable for short-term homeowners or in high-interest-rate environments.

•  Effective ARM management includes understanding rate caps and early payoff penalties.

What Is an Adjustable-Rate Mortgage (ARM)?

An adjustable-rate mortgage is a type of mortgage loan where the interest rate can change periodically throughout the life of the loan. This means your monthly payment might increase or decrease over time.

They typically come in shorter terms, such as five, seven, or ten years. The adjustment period (how often the interest rate is evaluated and changed) is usually six months or one year. They may be useful as a financing tool for short-term situations, but there are some things to consider before taking on a mortgage like this.

How Adjustable-Rate Mortgages Work

The terms of an adjustable-rate mortgage are determined at the outset of the loan. You’ll decide on a type of ARM, apply with the lender of your choice, and start making payments once the loan closes.

What’s different about an ARM from other home mortgage loans is the interest rate will adjust periodically and your monthly payment will change. It’s typical to see an introductory period (a number of years) where your interest rate doesn’t change, however.

Types of Adjustable-Rate Mortgages

If you’ve started to look into financing a home purchase, then you’ve probably seen loans labeled with different numerals. Maybe you’re wondering, what is a 5/1 ARM? When you’re choosing mortgage terms, the different types of ARMs you can get correspond to the different terms (with 5-, 7-, and 10-year ARMs being the most common) and adjustment periods (typically 1 year or six months). An ARM is labeled with two numbers, first with the number of years in the introductory period, followed by the period when the interest rate will reset. A 5/1 ARM, for example, has a 5-year introductory period followed by one adjustment per year to the interest rate.

Here are some other examples:

•  5/6: A five-year term with an adjustment period of six months.

•  7/1: A seven-year term with an adjustment period of one year.

•  7/6: A seven-year term with an adjustment period of six months.

•  10/1: A 10-year term with an adjustment period of one year.

•  10/6: A 10-year term with an adjustment period of six months.

Recommended: Is a 10-Year Mortgage A Good Option?

Pros and Cons of Adjustable-Rate Mortgages

If you’re considering an ARM, you’re probably weighing the lower payment against future financial positions you’ll need to take. There are some other pros and cons to consider.

Pros of an ARM

•  Many different term lengths to choose from

•  Low annual percentage rate

•  May start with a lower monthly payment than a fixed-rate mortgage

•  May be slightly easier to qualify for

Cons of an ARM

•  Interest rate can change

•  You could end up with a higher monthly payment

•  If you’re unable to afford the higher monthly payment, your home could be in danger of foreclosure

Recommended: Cost of Living by State

How the Variable Rate on ARMs Is Determined

To fully understand how does an adjustable-rate mortgage work, it helps to see what’s going on behind the scenes of an ARM and how the rate is determined. You’ll be looking at these four components:

1.   Index

2.   Margin

3.   Interest rate cap structure

4.   Initial interest rate period

Index

The cost of an ARM is tied to a market index, generally the secured overnight financing rate (SOFR). These can increase when the federal funds rate rises.

Margin

The margin is the percentage points added to the cost of the index. It is disclosed when you apply for the loan and can vary from lender to lender, so be sure to shop around!

The interest rate on your ARM is equal to the index plus the margin.

Interest rate cap structure

There are three types of rate caps: initial, periodic, and lifetime. For the initial period, the cap is on how much interest you’ll be charged in the first period of your loan. For example, in a 5/1 ARM, you’ll have an interest rate that stays the same for the initial period of 5 years.

When your initial period is over, you’ll have periodic adjustments. These will have a separate cap for how much your interest rate can increase over the defined period (usually six months or a year).

You’ll also have a cap on how much your interest rate can increase over the life of the loan.

Initial interest rate period

The cost of an ARM is also determined by how long the interest remains constant for the initial period. ARMs with longer initial periods generally have higher rates. A 7/1 ARM will have a higher APR than a 5/1 ARM, for example.

💡 Quick Tip: Generally, the lower your debt-to-income ratio, the better loan terms you’ll be offered. One way to improve your ratio is to increase your income (hello, side hustle!). Another way is to consolidate your debt and lower your monthly debt payments.

Adjustable-Rate Mortgage vs. Fixed-Interest Mortgage

When it comes to fixed-rate vs. adjustable-rate mortgages, the mortgages are structured very differently. Here’s a quick breakdown of the major differences:

Adjustable-Rate Mortgage Fixed-Rate Mortgage
Interest rate adjusts after introductory fixed-rate period Interest rate stays the same
Terms are usually shorter, such as 5 to 7 years Terms are usually longer, such as 15 or 30 years
Loans are often refinanced at a later date Loan can be paid off or refinanced
May have lower interest rate initially Interest rate does not change
Monthly payment changes Predictable monthly payment
Interest rate you pay is tied to economic conditions Interest rate determined at the origination of the mortgage

The main difference between fixed-rate and adjustable mortgages is in how you pay interest on the loan. With a fixed loan, the interest is paid with regular monthly payments, which are fairly set (except for fluctuations with escrow items). With an adjustable-rate mortgage, the interest you pay can change.

The other major difference between the two types of mortgages is the term length. Fixed mortgages are often financed at 15- or 30-year terms. ARMs are usually held for shorter periods of time.

💡 Quick Tip: A major home purchase may mean a jumbo loan, but it doesn’t have to mean a jumbo down payment. Apply for a jumbo mortgage with SoFi, and you could put as little as 10% down.

Example of When Adjustable-Rate Mortgages Makes Sense

There are a few scenarios where an ARM makes sense.

•  If you’re only planning to keep the home (or keep the mortgage) for a few years.

•  Interest rates are very high.

In each of these situations, borrowers — including first-time homebuyers — don’t plan to hold onto the mortgage long-term. They’re looking to sell the property or refinance at a future date.

However, there are times where an ARM doesn’t make a lot of sense.

Example of When Adjustable-Rate Mortgages Doesn’t Make Sense

An ARM may not make sense when the interest rate for a fixed-rate mortgage is low. This was common just a few years ago, and buyers who have these low-interest, fixed-rate mortgages don’t need to worry about getting another mortgage.

If you’re considering purchasing a home with an ARM, you may also want to look at buying down the interest rate on a fixed-rate mortgage with points, especially if you plan on staying in the home long-term.

Can You Refinance an ARM?

Many borrowers get an ARM with the expectation that they will be able to refinance into a different mortgage at a later date. Refinancing any mortgage, including an ARM, will depend on your ability to qualify for the new loan. If your credit score or income take a serious hit, for example, you may not be able to refinance an ARM to get a more attractive rate. It’s also possible market conditions may change and the property could decline in value to the point that it isn’t a good candidate for a refinance. Remember, too, that when you refinance there are typically closing costs to pay on the new loan. That said, it’s a good idea to explore whether you can lower your monthly payment.

Adjustable-Rate Mortgage Tips

To keep your ARM manageable, you may want to consider some of the following tips:

•  Look at the rate cap structure. Make sure you can handle the monthly payment all the way to the cap rate, which is the limit on how much your interest rate will increase.

•  Watch for fees or penalties. If you pay off the ARM early, you may be subject to several thousand dollars in penalties or fees. Be aware of what you could be on the hook for.

•  Shop around for mortgage rates. The interest rate caps and margins will be different from lender to lender. Get a loan estimate to ensure you’re comparing apples to apples.

•  Work with someone you trust. It’s incredibly valuable to work with a lender you trust to give you good advice.

The Takeaway

Many borrowers may be considering an ARM at the moment, but you still need to make sure it’s the right financial tool for you. Adjustable-rate mortgage costs can increase when interest rates increase and, for some borrowers, monthly mortgage payments might become unmanageable. However, it is possible that an ARM could be the right solution for buyers who don’t plan on keeping the home long-term, or for those who believe they’ll be able to refinance into a less expensive mortgage in a few years.

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


SoFi Mortgages: simple, smart, and so affordable.

FAQ

Is it ever a good idea to get an adjustable-rate mortgage?

You should get in contact with a lender if you’re wondering about whether or not an adjustable-rate mortgage is right for you. Some borrowers find it makes sense if they’re looking for financing that’s geared toward short-term situations.

What is the main downside of an adjustable-rate mortgage?

Adjustable-rate mortgages have interest rates that can rise periodically, at intervals of every 6 months or a year. You could end up with a higher mortgage payment.

What is the major risk of an ARM mortgage?

The major risk of an ARM is when it becomes unaffordable after an adjustment period. If a payment can’t be made, the risk is going down the path to foreclosure. This can happen after the introductory period ends or if an adjustment significantly raises the monthly payment.

Photo credit: iStock/Andrii Yalanskyi

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*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

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.

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

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Oct
16
2025
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Understanding Your Mortgage APR

By | Home Ownership, mortgage | No Comments

Key Points

•  APR, or annual percentage rate, includes the interest rate and additional loan fees, providing a comprehensive view of costs.

•  Examining different loans’ APR can help in making comparisons between loans.

•  When comparing APRs, it’s important to consider your financial plans and the duration of intended home occupancy.

•  APR differences highlight total costs but may not accurately compare fixed-rate and adjustable-rate mortgages.

What Is APR?

APR stands for annual percentage rate, and it’s used to measure the cost of borrowing money from lenders for various reasons, such as with a home loan. While it’s often presented at the same time as your interest rate, it isn’t the same thing.

APR is expressed as a percentage and takes into account not only the interest rate but also many of the costs that are associated with the loan. When it comes to borrowing using a mortgage, these costs can include such items as these:

•  Origination fees

•  Application fees

•  Processing fees

•  Mortgage points, also called discount points

APR provides a more comprehensive picture of the total cost of the mortgage loan. It gives you an overall view of the fees and costs you would have to pay that are included in the finance charge. If you compare just the interest rate, the additional fees and costs aren’t represented, which could give you an incomplete picture when it comes to determining the actual cost of the loan. That could negatively impact your ability to budget accurately for your home loan costs.

Since not all lenders charge the same fees or interest rates, comparing APRs is usually a better way to compare the total cost of your loan from one lender to another.

Why Is APR Important When Taking Out a Mortgage?

Knowing the APR can help consumers be more informed while comparison shopping for loan products. Thanks to the Truth in Lending Act, lenders are required to disclose the APR of their loans, as well as all fees and charges associated with a loan.

The APR should include all finance charge fees, which can make it easier for borrowers to sort through loan comparisons to find the right mortgage.

How Are Interest Rates Calculated?

As we’ve discussed, APR and interest rate aren’t the same, but your interest rate does impact your APR. So, how exactly are interest rates calculated?

Your interest rate is a percentage of your mortgage rate. What that percentage will be depends on what type of mortgage loan you have.

•  With a fixed-rate mortgage, you’ll pay the same interest rate for the entire time you have the loan.

•  With an adjustable-rate mortgage, on the other hand, your rate will fluctuate throughout the life of the loan.Also, keep in mind that any unpaid interest gets added to the mortgage principal. This means you’ll have to pay interest on that interest.

Your lender will determine your specific interest rate based on your financial details, such as your credit score, as well as the current economic conditions and market interest rates. “Working to build your credit score before applying for a home loan could save a borrower a lot of money in interest over time. Lower interest rates can keep monthly payments down or help you pay back the loan faster,” says Brian Walsh, CFP® and Head of Advice & Planning at SoFi. Lenders usually use their own unique formula to calculate interest rates, which is why your rate can vary from lender to lender — and why it’s important to shop around for rates.

Recommended: APR vs. Interest Rate: What’s The Difference?

How to Calculate Your APR

When you’re getting a mortgage, you may want to be extra thorough and calculate the APR yourself. There’s a way to make that happen. Be warned, it’s not necessarily a super fun math project, but hey, where there’s a formula, there’s a way, right?

•  To get started, you’ll have to know the approximate monthly Principal and Interest (P&I) payment on your loan. Maybe your lender has already told you what it would be, but if not, you could calculate it with an online mortgage calculator or by hand.

•  You’ll need to have a loan amount, interest rate, and a term in years.

•  Once you have the monthly P&I payment calculated, you’ll then be able to calculate the APR, which you can do with an online calculator. Keep in mind that because you don’t know what your applicable APR loan fees will be, it can be wise to use a ballpark estimate. If the loan costs that will impact your APR are 2% of your loan amount and your loan amount is $200,000, your loan costs for calculating the APR will be $4,000.

The formula for calculating APR looks like this:

[({Fees + Total Interest} ∕ Loan Principal) ∕ Total Days in Loan Term] ✕ 365 ✕ 100

💡 Quick Tip: Lowering your monthly payments with a mortgage refinance from SoFi can help you find money to pay down other debt, build your rainy-day fund, or put more into your 401(k).

Why You Need to be Careful When Using APR to Compare Mortgages

When you’re getting a mortgage, you will likely have the APRs for all the mortgage offers you’re considering. Your APR is important to consider because it factors in the expense of additional fees over the life of your mortgage. If you’re applying for a 30-year mortgage, those fees are spread over 30 years.

But do you plan to live in your home for the full 30 years of your mortgage and never refinance your mortgage? If you sell your home after five years, rather than staying for the duration of your 30-year loan, you’ll still have to pay for the loan fees (such as origination fees).

That’s why it’s important to consider and compare APRs when choosing a mortgage. If you plan on living in the home for a limited time, a lender that offers fewer fees might be a better choice than a lender with a low interest rate but lots of fees. You may want to consult with your financial advisor before making this decision.

When you’re mortgage shopping, especially if you are a first-time homebuyer, you also may want to proceed with caution when comparing the APRs of fixed-rate and adjustable-rate mortgages if you are using an online calculator. The APR on adjustable-rate loans may not be an accurate representation of the cost of the loan since calculators cannot anticipate the frequency or amounts of the interest rate changes.

Recommended: Tips When Shopping for a Mortgage

The Takeaway

When getting a home loan, your interest rate and APR, or annual percentage rate, are not the same thing. The APR reflects the overall cost of the loan, including various fees, for instance.

If you’re ready to take the next step in your home-buying journey, you’ll want to take stock of your mortgage options. Comparing each loan’s APR is a quick and easy way to see how your offers stack up, although it isn’t the only factor to take into account.

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


SoFi Mortgages: simple, smart, and so affordable.

FAQ

What is a good mortgage APR?

A good APR is one that falls below the current average for the type of loan you have chosen. Simply search online for “national average APR” and your loan type (such as “30-year fixed-rate mortgage”) and you’ll see the current rates.

Is it better to have a low interest rate or low APR?

Whether it is better to have a low interest rate or a low APR depends in part on how long you plan to stay in the home. If you have high upfront costs for a loan and then sell the home in just a few years, the APR won’t reflect your overall cost as well as it would if you stayed for the full term of your loan. If you don’t plan to own the home for very long, you might be better off focusing on choosing the loan that gets you the lowest interest rate.

Can I negotiate a mortgage interest rate?

You can negotiate a mortgage interest rate by shopping around and comparing offers from multiple lenders, examining both the interest rate and APR on the loans. Once you narrow the field, you might be able to purchase mortgage points, also known as discount points, to reduce the rate further. But the best way to help ensure a low mortgage rate is to cultivate a strong credit score before you apply for a loan.

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


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



*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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