Terminology Archives | Page 40 of 76

Oct

2023

Guide to Non-Bank Financial Institutions (NBFI)

By Rebecca Lake | Family Finances, money, Terminology | Comments Off

Non-bank financial institutions provide financial services, but they don’t hold the same license or charter as a bank. Also referred to as non-bank financial companies or NBFCs, these entities can extend credit, provide investment services, cash checks, and exchange currencies. However, they generally can’t accept deposits from customers.

There are different types of non-bank financial institutions, and the way they’re structured can determine what services they provide. An NBFC can serve as a complement to traditional banking services or act as a competitor to licensed banks.

Here, you’ll learn more about these businesses, how they compare to banks, and their pros and cons.

What Are Non-Bank Financial Institutions?

Nonbanking financial institutions (NBFI) are institutions that don’t have a banking license but are able to facilitate certain types of financial services. They’re different from depository institutions, which can offer deposit accounts such as checking accounts, savings accounts, or money market accounts. An NBFI or NBFC is not licensed or equipped to accept deposits.

Non-bank financial institutions can specialize in niche financial services, including:

• Investments

• Financial consulting

• Brokeraging

• Money transfers

• Check cashing

• Risk pooling.

They can target a broad or narrow range of customers, which can include consumers, business owners, and corporate entities. Because they’re not licensed the same way that banks are, NBFCs are not subject to the same degree of government regulation and oversight.

How Do NBFCs Work?

Now that you know NBFCs’ meaning, consider how these institutions work. In general, NBFCs work by providing financial services that are outside the scope of what traditional banking typically entails. There are different types of organizations that can bear the NBFC (or NBFI) label. The type of organization can determine how it works and what services it offers.

Here are some of the most common types of NBFCs:

• Investment companies

• Loan companies

• Companies that offer asset-based financing

• Micro-lending companies

• Risk pooling institutions.

In terms of regulation, NBFCs generally operate within the framework of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. However, the scope of regulation that extends to NBFCs and NBFIs is limited. For that reason, they’re sometimes referred to as “shadow banks” since they operate within the shadows of traditional banking institutions.

Pros and Cons of NBFCs

Non-bank financial institutions have both advantages and disadvantages. On one hand, they can play an important role in providing financial services outside the confines of traditional banking.

However, questions have been raised about the lack of oversight for NBFCs and what implications that might have for the individuals and businesses that use them.

Here are some of the main pros and cons of NBFCs at a glance.

Pros of NBFCs	Cons of NBFCs
NBFCs can provide easier access to credit for individuals and businesses who need to borrow money.	NBFCs cannot provide certain banking services, including offering deposit accounts.
Investors may be able to find higher-yield through an NBFC or NBFI that isn’t offered at a bank.	Financial experts have argued that NBFCs and NBFIs can pose a systemic risk to the financial system as a whole.
NBFCs can offer alternative services to customers, such as check cashing, that may otherwise be inaccessible.	Operations are largely unregulated and there may be less transparency around NBFCs vs. traditional banks.

Accountability is more of a question mark with non-bank financial companies since there’s less oversight overall. The increase in popularity of NBFCs has raised questions about the need for greater regulation of this section of the financial services industry.

Recommended: How to Switch Banks in 3 Easy Steps

NBFCs vs Banks vs Fintech

You may wonder how NBFCs and NBFIs compare to banks and fintech companies. Here are some points to consider:

• Non-bank financial companies are not the same as banks, and they can also be differentiated from fintech. Again, a bank is a financial institution that holds a license or charter which allows it to accept deposits from its customers. Some banks may fall within the category of Community Development Financial Institutions (CDFIs), which help to promote access to capital and financial services in underserved areas.

• Fintech or financial technology is a term that describes the use of innovation to improve financial services and products. Fintech generally encompasses tools, apps, and other tech that can make managing money or borrowing it easier. There can be some overlap between NBFCs and fintech or between fintech and banks.

Which is better, an NBFC vs. a bank vs. fintech? There is no single answer as each one can fulfill different needs. Comparing them side by side can make it easier to distinguish between them.

	NBFCs	Banks	Fintech
What It Is	An NBFC or non-bank financial company provides alternative financial services but does not hold a banking license.	Banks are financial institutions that hold a federal or state license or charter which allows them to accept deposits.	Fintech is a broad term that can refer to technological innovations that are applied within the financial services industry.
How It Works	NBFCs work by offering financial services (other than accepting deposits) to their customers, such as check cashing, investment services, or insurance.	Banks work by accepting deposits, lending money, and facilitating financial transactions. Some of the benefits of local banking include being able to open a checking account, apply for a mortgage, or pay bills online.	How fintech works can depend on its application. For example, budgeting apps can link to your checking account to track spending automatically. Robo-advisors make it easy to invest using an algorithm.
Whom It’s For	NBFCs may be right for individuals or businesses who are seeking services outside of traditional banking.	Banks are suited to people who want to be able to deposit funds, withdraw them on demand, or borrow money.	Fintech may appeal to people who want easier access to their finances online or via mobile apps.

Examples of NBFCs

As mentioned, there are different types of NBFCs and NBFIs. If you’re looking for a specific non-banking financial institution example, the list may include:

• Life insurance companies

• Insurance companies that underwrite disability insurance policies

• Property insurance companies

• Mutual funds

• Pension funds

• Hedge funds

• Financial advisors and investment advisors

• Securities traders

• Broker-dealers

• Mortgage companies

• Peer-to-peer lending companies

• Payday lenders

• Leasing or financing companies

• Companies that provide money transfer services

• Check cashing companies.

If you invest money, send money to friends and family via an app, or own a home, then chances are you’ve encountered an NBFC somewhere along the way. Examples of companies that may be classified as NBFC include LendingClub, Prosper, and Quicken Loans.

At the same time, you may also use traditional banking services if you have a checking account or savings account at a brick-and-mortar bank or an online bank.

NBFCs and the 2008 Financial Crash

The 2008 financial crash was fueled by a number of factors, including risky lending and investment practices. The resulting fallout included bank failures, banking bailouts, and a housing market crisis. Many of the companies that were engaging in these risky behaviors were NBFCs.

In 2010, the Dodd-Frank Act was passed to address some of the conditions that led to the crisis, including the lack of regulation and oversight as it pertained to NBFCs. The legislation made it possible for non-banking financial institutions to flourish, rather than whither away in the wake of the crisis.

Why? Simply because NBFCs continued to lend money at a time when traditional banks were placing greater restrictions on lending. While questions linger about the degree of regulation needed for NBFCs, their popularity has only increased since the financial crisis.

Recommended: Alternatives to Traditional Banking

The Takeaway

Non-bank financial institutions can play a part in how you manage your money. For some people, they may provide financial services that make their lives easier. However, they are not regulated in the same way that licensed or chartered banks are. Also, if you want to be able to deposit money into your checking or savings account, then you can do that through a bank.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.00% APY on SoFi Checking and Savings.

FAQ

How are NBFCs different banks?

NBFCs are different from banks because they do not hold a banking license or charter. While they can provide some of the same financial services as banks, they’re not equipped to accept deposits from customers.

What is the difference between fintech and NBFCs?

Fintech refers to the use of innovation and technology to improve financial products and expand access to financial services. An NBFC can use fintech in order to offer its products and services to its customers. For example, an investment company may offer robo-advisor services that operate on a fintech platform.

What are the disadvantages of NBFCs?

The main disadvantages of NBFCs include lack of government regulation and oversight, as well as their inability to offer deposit accounts. However, NBFCs can offer numerous advantages, including convenient access to credit and the potential to earn higher returns on investments.

Photo credit: iStock/shapecharge
SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2024 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

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.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOBK0423037

Oct

2023

Guide to Consumption Tax

By Timothy Moore | Financial Independence, money, Terminology | Comments Off

A consumption tax is a tax on a specific good or service. When you pay sales taxes on retail purchases, gasoline, and alcohol, you’re paying a consumption tax. Businesses also pay consumption taxes, like when exporting goods to another country (i.e., paying that country’s import taxes).

But that’s just an overview. Here, you can learn more about these taxes and how they impact you, including:

• What is consumption tax?

• How do consumption taxes work?

• What are the different kinds of consumption taxes?

• What are the pros and cons of consumption taxes?

• What’s the difference between consumption taxes vs. income taxes?

What Are Consumption Taxes?

Consumption taxes are a broad range of taxes that are imposed when you spend money on a good or a service. A common example is a sales tax since consumers are used to paying this with most transactions. However, there are other consumption taxes that affect businesses, as well as ones that are in place in other countries.

The key tenet of a consumption tax is that taxpayers are charged based on what they spend, not what they earn, which makes them different from income taxes. In some countries, including the U.S., consumption taxes and income taxes coexist — along with other types of taxes.

Types of Consumption Taxes

Here are some of the most common types of consumption taxes you might encounter:

• Sales tax: When you pay for goods or services at stores, restaurants, and other businesses, you typically pay a sales tax. All but five states have a state-wide sales tax, and individual localities can impose their own sales taxes.

Of those five tax-free states — Alaska, Delaware, Montana, New Hampshire, and Oregon — only one has localities that charge a sales tax: Alaska. States without income taxes often (but not always) have high sales tax rates.

• Excise tax: An excise tax is seemingly similar to a sales tax, except it’s levied on specific purchases. Colloquially called “sin taxes,” excise taxes are often imposed to discourage certain behaviors that society may see as detrimental in some way. For example, there are excise taxes on alcohol, cigarettes, betting, and even tanning salon services.

Excise taxes also refer to specific taxes that support our infrastructure, like taxes on gasoline and air transportation. Depending on the excise tax, it might be levied on the manufacturer, retailer, or consumer. Often the taxes are rolled into the price a consumer pays: For instance, the excise tax on gas could be passed along to you without your even knowing it.

• Value-added tax: Commonly referred to as VAT, value-added taxes are not implemented in place in the United States. Instead, you may encounter these when traveling to Canada or Europe. This flat consumption tax is levied on a product at each stage of production where value is added to it, but the cost of the tax is ultimately passed on to the person who purchases the final product.

The consumption taxes above impact individual taxpayers. Businesses may contend with another type of consumption tax: import duties.

Recommended: How to Reduce Taxable Income

How Do Consumption Taxes Work?

Now that you know what consumption taxes are, take a closer look at how they function. Consumption taxes work a little differently from one another depending on their type. Sales tax, for example, doesn’t appear until the final point of sale, while VAT is applied throughout the production process.

Regardless of the type of consumption tax, however, the fundamental principle remains the same: You pay taxes when you spend money on goods and services, rather than when you earn the money.

Pros and Cons Consumption Taxes

So what are the pros and cons of consumption taxes? Let’s break it down:

• Pro: Consumption taxes can be easier to calculate. A flat sales tax that everybody pays when they make a purchase is quite straightforward. It’s easy to calculate. You are probably accustomed to that sales tax, for instance, that gets added on as you check out in a store.

This is in stark contrast to taxes that can be complex to figure out. For instance, income can be difficult to measure when filing taxes, especially when you consider wages, tips, self-employment income, capital gains, interest, dividends, and so on. (No wonder so many people seek help during tax season.)

• Con: A consumption tax puts a heavier tax burden on low-income earners. The United States has a progressive income tax system. What that means: The more money you earn, the larger the percentage of your income you must pay in taxes. Some believe this is the right thing to do; they argue that high-income earners can afford to pay more in taxes while low-income taxpayers may be living paycheck to paycheck.

However, with consumption taxes, everyone can be taxed at the same rate, which could be problematic for low-wage earners. In other words, the person who earns $20,000 a year pays the same sales tax rate as the person who earns ten times as much.

• Pro: Consumption taxes may encourage saving. For individuals who are struggling to reign in their spending habits, a larger consumption tax — levied every time they swipe their credit card — may encourage them to spend less and save more money.

• Con: Consumption taxes could discourage spending. But if fewer people are encouraged to spend because of higher consumption taxes, the economy could suffer.

Recommended: Tax Benefits of Marriage

Consumption vs Income Tax: What’s the Difference?

So what’s the main difference between consumption taxes and income taxes? Much depends on when the tax is levied.

• A consumption tax is levied when you spend the money (i.e., when you consume a good or service).

• An income tax is levied when you earn the money (usually through tax withholdings from a paycheck and quarterly estimated payments) or when you receive interest, dividends, or capital gains.

The Takeaway

A consumption tax refers to a broad range of taxes, including sales taxes, excise taxes, and value-added taxes. These are charged on goods and services and can be a key sources of revenue for states. Unlike income taxes which are charged on income, consumption taxes are levied when a consumer or business spends money.

Spending money and paying taxes are part of life. But if you want a banking partner that helps you make most of your cash and simplifies financial management, see what SoFi offers. When you open our online Checking and Savings account, you’ll spend and save in one convenient place. You’ll have access to the global Allpoint Network of no-fee ATMs. Ready for more perks? You’ll also enjoy a competitive annual percentage yield (APY) and pay no account fees, which can help your money grow.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.00% APY on SoFi Checking and Savings.

FAQ

Can you deduct consumption tax?

If you itemize your deductions, you can take the SALT (state and local taxes) deduction on your state and local income taxes or your state and local sales taxes, a form of consumption tax. Doing so would require receipts from every purchase or an estimate using the IRS’s optional sales tax tables.

Do you have to put consumption taxes on your yearly taxes?

If you choose to apply the state and local sales tax (SALT) deduction when itemizing deductions on your taxes, you would include your consumption taxes on your tax return. Businesses should also list their consumption taxes as a business expense to reduce their taxable income.

How much do people spend on consumption taxes on average?

How much people spend on what is known as consumption taxes will depend entirely on where they live and how much they spend on purchases each year. Sales tax, for example, varies widely across the United States; in some states, it’s 0% while in others, it’s 7% or more.

Because consumption taxes are levied when consumers make purchases, their total consumption taxes in a given year also depend on the number of purchases they make. Certain items like gas and alcohol have specific excise tax rates, different from regular sales taxes, that can make it even more complicated to estimate.

Photo credit: iStock/sturti

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.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2024 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

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.

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.

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Oct

2023

Guide to Excise Taxes

By Timothy Moore | money, Terminology | Comments Off

Governments levy excise taxes on specific goods and services to generate revenue. In the United States, some of the most common excise taxes are on alcohol, tobacco, and fuel, but even some personal property taxes and penalties on retirement accounts can qualify as excise taxes.

So what is an excise tax precisely? And when do you pay it? Learn more here, including:

• What is excise tax?

• How do excise taxes work?

• What’s the difference between excise and sales taxes?

• What are the different kinds of excise taxes?

What Is an Excise Tax?

An excise is a tax levied on specific goods and services. Unlike sales taxes, which are more broadly applied to everyday purchases, excise taxes are limited in scope to very specific products and services, like gasoline, airfare, tobacco, and alcohol. And unlike income taxes you may pay every tax season, they don’t vary with your earning power.

What Is the Purpose of Excise Taxes?

Excise taxes serve multiple purposes, including discouraging consumption of particular products and services, funding projects related to the item being taxed, and — like all taxes — generating revenue. Here’s a closer look at each one of these goals.

Discouraging Consumption

Many excise taxes are colloquially called “sin taxes” because they are meant to discourage consumption of goods and services that are deemed detrimental in some way. That’s why you’ll find excise taxes on tobacco, alcohol, and even indoor tanning salons.

Similarly, the excise tax on gas and airfare discourages overuse of fuel because it’s bad for the environment, but these specific taxes also fall into the next category (funding projects).

Penalties on retirement accounts — like for early withdrawals or not taking required minimum distributions — are technically considered excise taxes. In a way, the penalties discourage the “wrong actions” related to those retirement accounts.

Funding Projects

Federal, state, and local governments sometimes impose excise taxes to fund projects related to the things being taxed. Infrastructure — including roads, bridges, and airports — is a great example. You pay excise taxes on fuel and airfare tickets, and that revenue is poured back into the infrastructure that enables travel.

Generating Revenue

At the end of the day, governments levy taxes to generate revenue so that they can provide services to citizens. Property taxes, meaning those levied on personal property like motor vehicles or boats vs. real estate taxes, can be quite lucrative for state and local governments.

Recommended: How to Reduce Taxable Income

Types of Excise Taxes

Now that you know what excise taxes are in a general way, here’s more intel on the two main types — ad valorem taxes and fixed-amount taxes. The difference boils down to how they’re calculated.

The difference between these types of taxes is as follows:

• Ad valorem taxes are percentage-based, similar to sales taxes. In Latin, “ad valorem” means “according to value.” In this case, the tax is set according to the value of the item being taxed. Indoor tanning services, for example, carry a 10% excise tax while airfare tickets have a 7.5% excise tax.

• Fixed-rate taxes are a per-unit tax. That means no matter what the cost of the item may be, there is a tax per individual unit. Every gallon of gasoline carries a federal excise tax $0.184, for example, though states can levy their own additional excise taxes. (Diesel fuel has its own excise tax rate as well.)

Cigarettes are another common example. The federal excise tax is $1.01 on a single pack, no matter the brand or cost of the pack, though states can levy additional taxes.

Recommended: IRS Tax Refund Dates and Deadlines

How Do Excise Taxes Work?

Excise taxes work a little differently depending on the specific tax in question. Some excise taxes are levied on the manufacturer or retailer while others are levied on the consumers themselves.

Excise taxes on gasoline, cigarettes, and alcohol, for example, are levied on the merchants, not the consumer. But that doesn’t mean consumers don’t pay them. Most retailers simply add the cost of the excise tax to the price. When you look at the receipt, you wouldn’t even be able to see the excise tax — you’d just see the sale price.

In some cases, consumers do pay excise taxes directly, like penalties on retirement account activity.

Excise Tax vs Sales Tax: What’s the Difference?

Excise taxes and sales taxes share some similarities, but they are two different types of consumption taxes. Here are some ways they’re different:

• Eligibility: With a few exclusions (like prescriptions and food, in many cases), sales taxes are applicable to every transaction. Excise taxes, however, are reserved for specific goods and services, including buying alcohol, gassing up your car, and purchasing tobacco.

• Payment: We pay sales taxes at the point of sale, like when checking out at a register. With excise taxes, manufacturers and retailers often pay the additional amount before consumers ever make the purchase — though consumers typically still foot the bill via higher prices.

• Level of government: Sales taxes are levied at the state and local level. When it comes to excise taxes, the federal government is also involved.

The Takeaway

Excise taxes touch multiple parts of our lives — from gassing up your car to enjoying a glass of wine. While excise taxes operate differently depending on the specific goods or services involved, their main aim is simple: to generate revenue for the government, which needs taxes to provide basic services to citizens.

Whether it’s excise, sales, or income taxes, chances are good that you hand over some of your hard-earned cash to the government — it’s just a part of life. Make the most of the money you keep by opening an online bank account that can help your deposits grow.

When you open a SoFi Checking and Savings account, you’ll enjoy an array of benefits. You’ll spend and save in one convenient place, and you’ll earn a competitive annual percentage yield (APY) while paying no account fees. That can help your money make you more money! Plus, qualifying accounts with direct deposit can get paycheck access up to two days early, which can be a helpful headstart on managing your cash.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.00% APY on SoFi Checking and Savings.

FAQ

How much do people spend on excise taxes on average?

The amount that people spend on excise taxes can vary significantly, depending on what goods and services they buy. People who smoke regularly, for example, pay high excise taxes on cigarettes, while frequent travelers are paying for airline tickets that have excise taxes built in.

Can you deduct excise taxes?

In some cases, businesses can deduct excise taxes as a business expense. However, individuals cannot deduct excise taxes for a personal expense like alcohol or fuel. That said, there are instances where excise taxes on personal property (such as a boat) may be tax-deductible. It’s a good idea to work with a tax professional if you’re not sure.

What happens if excise taxes are removed?

Governments often use excise taxes to fund specific projects related to the goods or services being taxed. Fuel taxes, for example, go toward infrastructure expansion and maintenance. Without the excise tax, the government might not have the money necessary to invest in our roads. In this and other instances, the removal of excise taxes would reduce the government’s revenue and thus limit government spending.

Photo credit: iStock/kate_sept2004

Oct

2023

How to Get the Student Loan Interest Deduction

By Bonnie Gibbs Vengrow | Fresh Out of School, Student Loans, student_loan, Terminology | No Comments

If you’re tackling school debt and looking for ways to maximize your tax refund, one avenue to consider is the student loan interest deduction. This benefit allows you to take a tax deduction for the interest you paid on student loans that you took out for yourself, your spouse, or your dependents. The deduction can lower how much of your income is taxed, which could result in a lower overall tax bill.

However, there’s a limit to how much you can deduct each tax year, and you must meet certain criteria in order to get the deduction. Let’s look at how the student loan interest deduction works and how to qualify for it.

Are Student Loan Payments Deductible?

Typically, when you repay a student loan, your monthly payment goes toward the original amount you borrowed plus origination fees (the loan principal) and the amount a lender charges you to borrow it (interest). With the student loan interest deduction, you are only allowed to deduct the amount you paid in interest, not the full amount of the loan payment.

Is Student Loan Interest Deductible?

The student loan interest deductible allows you to subtract up to $2,500 or the total amount of interest paid on student loans — whichever is lower — from your taxable income. Private and federal loans may qualify for this benefit. The deduction is considered “above the line,” which means you don’t have to itemize your taxes to take advantage of it.

Note that there are income phaseouts based on your modified adjusted gross income (MAGI). A borrower can claim the full credit if their MAGI is $80,000 or less ($160,000 or less if you’re filing jointly). The deduction is gradually reduced if your MAGI falls between $80,000 and $90,000 ($160,000 and $180,000 if you’re filing jointly). The deduction is eliminated for borrowers with a MAGI of more than $90,000 ($180,000 or more if you’re filing jointly).

💡 Quick Tip: Ready to refinance your student loan? With SoFi’s no-fee loans, you could save thousands.

Who Can Deduct Student Loan Interest?

Not everyone is able to claim the student loan interest deduction. In order to be eligible for it, you must meet certain criteria:

• You paid interest on a qualified student loan for you, your spouse, or your dependents in the previous tax year. (A qualified student loan is a loan taken out to pay for qualified education expenses like tuition, housing, books, and supplies. The loan must be used within a “reasonable period” after it’s taken out.)

• You’re legally required to pay interest on a qualified student loan.

• Your MAGI in the 2023 tax year is less than $90,000 (or less than $180,000 if you’re filing jointly).

• Your filing status is anything except married filing separately.

• If you’re filing taxes jointly, neither you nor your spouse can be claimed as a dependent on someone else’s tax return.

Your eligibility may be impacted if your employer made payments on your student loans as part of a work benefit.

What to Know About the Student Loan Interest Deduction Form

If you pay $600 or more in interest on qualified student loans during a tax year, your loan servicer should send you IRS Form 1098-E. This student loan tax form is usually sent out around the end of January.

If you don’t receive a 1098-E form, you should be able to download it from your loan servicer’s website. To find out who your loan servicer is, log on to the Federal Student Aid website, and the information will be listed in your dashboard. You can also call the Federal Student Aid Information Center at 800-433-3243.

Keep in mind that if you didn’t make payments on your federal student loans because of the Covid-related payment pause — or if you didn’t pay $600 in interest during the tax year — you may not get a 1098-E form. However, you can contact your servicer to find out how much interest you paid during the year if you’re planning to report it on your taxes.

Additional Education Tax Breaks

The student loan interest deduction isn’t the only benefit worth knowing about. You may also want to see if you qualify for certain education tax credits, which represent a dollar-for-dollar reduction in your overall tax burden. They can directly lower the tax amount you owe. Here are two to consider.

American Opportunity Tax Credit

The American Opportunity Tax Credit (AOTC) is a credit for tuition and other qualified educational expenses paid during the first four years of a student’s college education. The credit is worth up to $2,500 per eligible student. Once your tax bill hits zero, you could earn 40% of whatever remains (up to $1,000) as a tax refund.

You must meet certain requirements in order to qualify for the AOTC. You must:

• Pursue a degree or other recognized education credential

• Be enrolled at least half time for at least one academic period beginning in the tax year

• Have no felony drug convictions at the end of the tax year

• Haven’t claimed the AOTC for more than four tax years

As with the student loan interest deduction, your income matters. To claim the full credit, your MAGI must be $80,000 or less ($160,000 or less if you’re filing jointly) in the 2023 tax year. The credit amount begins to decrease if your MAGI falls between $80,000 and $90,000 (over $160,000 but less than $180,000 if you’re filing jointly). The credit is eliminated if your MAGI is over $90,000 ($180,000 if you’re filing jointly).

Lifetime Learning Credit

The Lifetime Learning Credit (LLC) works a little differently. The credit is worth 20% of the first $10,000 of qualified educational expenses, or a maximum of $2,000 per year. Unlike the AOTC, which only applies to the first four years of a student’s college education, the LLC includes undergraduate, graduate, and professional schools, and courses needed to acquire job skills. There’s no limit to the number of years you can claim it.

However, the LLC has a lower income limit, which means it could be more difficult to qualify for. For instance, in 2022, the credit amount gradually decreased if your MAGI fell between $80,000 and $90,000 ($160,000 and $180,000 if you filed jointly) in the 2022 tax year. The credit was eliminated if your MAGI is $90,000 or more ($180,000 or more if you filed jointly).

Strategies to Lower Monthly Student Loan Payments

Borrowers looking to save beyond tax time may want to explore ways to lower their monthly student loan payments.

One option to consider is a Direct Consolidation Loan. This loan is offered through the Department of Education and lets you combine different federal student federal loans into a single loan, resulting in one monthly payment. It can also lower your monthly payment amount, allow you to switch from a variable to a fixed interest rate, and help set up loans that are eligible for forgiveness.

Another strategy to think about is refinancing your student loans with a private lender, resulting in one new loan, hopefully with a lower interest rate. Just realize that if you refinance a federal student loan, you will lose access to federal protections and programs, such as the Covid-related payment pause, the Public Service Loan Forgiveness program, and income-driven repayment plans. And if you’re refinancing to get a lower monthly payment, know that you may pay more interest over the life of the loan if you refinance with an extended term.

The Takeaway

The student loan interest deduction can lower how much of your income is taxed, which could result in a lower overall tax bill. Depending on your income, you can deduct up to $2,500 of the interest paid on your loans. If you earn more than $90,000 a year (or $180,000 if you’re filing jointly), you are not eligible. Education tax credits, like the American Opportunity Tax Credit and the Lifetime Learning Credit, could also help lower your tax bill. Like the student loan interest deduction, you must meet certain criteria to be eligible.

There are different strategies that may help you lower your monthly payments so you can save outside of tax time. A Direct Consolidation Loan, for example, lets you combine multiple federal loans into a single loan and switch from a variable to a fixed interest rate.

Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.

With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.

SoFi Student Loan Refinance
SoFi Student Loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891. (www.nmlsconsumeraccess.org). SoFi Student Loan Refinance Loans are private loans and do not have the same repayment options that the federal loan program offers, or may become available, such as Public Service Loan Forgiveness, Income-Based Repayment, Income-Contingent Repayment, PAYE or SAVE. Additional terms and conditions apply. Lowest rates reserved for the most creditworthy borrowers. For additional product-specific legal and licensing information, see SoFi.com/legal.

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

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.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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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Oct

2023

What Is a Personal Loan? How Do Personal Loans Work?

By Janet Schaaf | personal_loan, Terminology | No Comments

A personal loan is a flexible type of loan issued by a bank, credit union, or online lender that you pay back in regular, fixed payments over a set term.

Personal loans work a little differently than other types of loans. Consumer loans typically specify what the money should be spent on: Mortgages are used to purchase or refinance homes, and student loans are used to pay for an education. But there aren’t as many restrictions on how you can or can’t spend personal loan funds, which allows for more flexibility than other types of loans.

Read on to learn more about how personal loans work, including how much you can borrow, how to apply, and the different types of personal loans.

Table of Contents

What Is a Personal Loan?
How Do Personal Loans Work?
Personal Loan Uses
The Personal Loan Application Process
Types of Personal Loans
What Personal Loan Lenders Look at in Your Application
Deciding If a Personal Loan Is Right for You
Alternatives to Personal Loans

What Is a Personal Loan?

As mentioned before, a personal loan is a one-time lump sum you borrow from a bank or other financial institution and repay over time, usually with interest. The funds can be used for almost anything.

Loan amounts generally range from $1,000 to $50,000, though some lenders offer personal loans up to $100,000. Repayment terms are usually anywhere from two to seven years.

💡 Quick Tip: Before choosing a personal loan, ask about the lender’s fees: origination, prepayment, late fees, etc. SoFi personal loans come with no-fee options, and no surprises.

Key Points

• A personal loan is a flexible type of loan issued by a bank, credit union, or online lender that you pay back in regular, fixed payments over a set term.

• Personal loans can be used for almost anything. Loan amounts generally range from $1,000 to $50,000, though some lenders offer personal loans up to $100,000. Repayment terms are usually anywhere from two to seven years.

• The interest rate on a personal loan is determined by the lender and is based on a number of factors, including the applicant’s financial history, income, debt, and credit score.

• Personal loans can be used for various purposes, including debt consolidation, home improvement expenses, wedding costs, unexpected medical expenses, moving expenses, funeral expenses, family planning, car repairs, and vacation

• Before you apply for a personal loan, you’ll want to consider how much money you want to borrow, how much you can afford to pay each month, how long you want to make payments, and whether or not you want to put up collateral.

How Do Personal Loans Work?

Personal loans are typically unsecured loans (meaning you don’t have to pledge an asset to secure the loan) that provide you with money you then pay back in regular installments over the term of the loan.

How Do You Get the Money?

The first step is applying for a personal loan (more on that below). After loan approval, the lender typically deposits the loan proceeds directly into the borrower’s bank account.

Repaying a Personal Loan

You repay a personal loan in monthly installments that go toward both principal and interest.

Typically, personal loans are amortized. This means the total amount you owe is divided into equal monthly payments over the term of the loan. Even though the total monthly payment remains the same, the amounts being directed to principal and interest will change each month. An amortization schedule can show you exactly how much of your payment is going towards paying down the principal and how much is being paid in interest.

Personal loans with longer terms may offer lower monthly payments, but cost more in interest over the life of the loan. A shorter-term personal loan can have higher monthly payments, but cost less overall in interest.

How Personal Loan Interest Rates Work

The interest rate on a personal loan is determined by the lender and is based on a number of factors, including the applicant’s financial history, income, debt, and credit score. Generally speaking, the better an applicant’s credit score, the better the chance they have to receive a lower interest rate on the loan. The higher the interest rate, the more money the loan will cost over its term.

Reasons To Take Out Personal Loans

Personal Loan Uses

Personal loans can be used for just about anything. That said, there are some common reasons people take out different types of personal loans, including:

• Debt management and consolidation

• Home improvement expenses

• Wedding costs

• Unexpected medical expenses

• Moving expenses

• Funeral expenses

• Family planning

• Car repairs

• Vacation

What not to use personal loans for

The Personal Loan Application Process

While it’s not as simple as walking into a bank, asking for a loan, and walking out with a check, the application process for personal loans is relatively easy.

Before you apply for a personal loan, you’ll want to consider how much money you want to borrow, how much you can afford to pay each month, how long you want to make payments, and whether or not you want to put up collateral (though less common, some lenders offer secured personal loans). There may be other considerations for specific financial circumstances, which can vary from person to person.

Checking Your Own Credit

Because lenders will be looking closely at your creditworthiness, it’s a good idea to give your financial health a check-up before you begin the application process. You can get a free copy of your credit reports from the three main consumer credit bureaus — Equifax, Experian, and TransUnion — for free at AnnualCreditReport.com.

Once you get your reports, it’s a good idea to review them carefully and report for any errors. Correcting anything that isn’t accurate means your credit report will look as good as possible to lenders.

Comparing Loans

Just like shopping around for the best prices before making a large purchase, comparing lenders’ rates and terms is a smart move before the application process actually begins.

Here are some things to look for when researching lenders:

• How much do they lend on personal loans? If the amount you need to borrow doesn’t fall within the range offered by the lender, you may need to look elsewhere.

• Do they charge any fees or penalties? Some lenders charge an origination fee equal to a percentage of the loan amount to process your application. Some personal loans also have a prepayment penalty if you pay off your loan ahead of schedule.

• How are fees and penalties charged? Some lenders may roll any fees into the loan amount, which increases the total amount you’ll owe. Other lenders may deduct the fee amounts from the loan proceeds, so the amount you receive will be lower than the actual amount of the loan.

• Can I get prequalified so I’ll know what interest rate they might offer me? Prequalification involves the lender doing a soft pull on your credit report, which will not affect your credit score. This step will give the lender a sneak peek at your financial history so they can give you an estimated interest rate. Going through this process with multiple lenders is one way to compare rates and terms you may qualify for.

• What if I can’t make my loan payments due to financial hardship? Missed or late payments could result in late fees, affect your credit score, or lead to your account being sent to collections. Some lenders may offer protections for borrowers who have lost their job or are having difficulty making their payments for other reasons.

Applying for a Loan

When you’ve selected a lender, it’s time to submit the actual application. For an unsecured personal loan, lenders typically require:

• A photo ID

• Proof of address

• Proof of income or employment

Each lender has different requirements, though, so it’s important to carefully read and follow the lender’s application instructions. At this stage, the lender will usually do a hard credit check, which can have a small and temporary negative affect on your credit score.

Waiting for Approval

Once you’ve submitted the application and all required documents, it’s time to play the waiting game. Rest easy, though, because some personal loan approvals happen quickly — sometimes in just a day. More complicated applications could take a week or more.

Personal loans can range anywhere from $1,000 to $100,000, depending on the lender. Once you apply and are approved for the loan, you’ll receive the amount of money you were approved for in a lump sum, minus any origination fees that some lenders may charge. You then start paying back that money in installments which are set by the specific terms of your loan.

Types of Personal Loans

There are a variety of different types of personal loans. Factors like how much money you plan to borrow, your credit and financial history, and how much debt you already have will influence which type of personal loan is right for you. Here’s a look at some common personal loan options.

Unsecured vs Secured Personal Loans

An unsecured personal loan is the most common type of personal loan. Unsecured means the loan is not backed by collateral, like a house or car. The approval and interest rate you receive on an unsecured personal loan is mostly based on your creditworthiness.

Secured personal loans require an asset to be pledged to “secure” the loan. Think of a house when it comes to a mortgage loan, or a car when it comes to a car loan. If you fail to repay your loan, the lender can then seize the collateral.

Some banks offer secured personal loans that allow you to borrow against the equity of your car, personal savings, or other assets. Since secured loans are backed by an asset that the lender can seize if you default on the loan, they generally have a lower interest rate than an unsecured personal loan.

Here’s a look at some pros and cons of unsecured and secured personal loans:

	Unsecured Personal Loans	Secured Personal Loans
Advantages	Funds may be disbursed the same day or within a week Interest rates are typically lower compared to credit cards No collateral required	Interest rates are typically lower compared to unsecured personal loans Can be a good way to improve credit if payments are regular and on time Tend to have a longer repayment period
Disadvantages	May need to meet minimum credit score requirements for approval Interest rates may be higher compared to secured personal loans Credit score may be negatively affected if borrower defaults	Collateral is required Lender can seize the collateral if borrower defaults Application and approval process may involves more steps

Unsecured Personal Loans

Secured Personal Loans

Advantages

Funds may be disbursed the same day or within a week

Interest rates are typically lower compared to credit cards

No collateral required

Interest rates are typically lower compared to unsecured personal loans

Can be a good way to improve credit if payments are regular and on time

Tend to have a longer repayment period

Disadvantages

May need to meet minimum credit score requirements for approval

Interest rates may be higher compared to secured personal loans

Credit score may be negatively affected if borrower defaults

Collateral is required

Lender can seize the collateral if borrower defaults

Application and approval process may involves more steps

Fixed-Rate vs Variable-Rate Personal Loans

Most personal loans are typically fixed-rate loans, meaning your rate and monthly payment stay the same (or are fixed) for the life of the loan. Fixed-rate loans can make sense if you’re looking for something with consistent payments each month. A fixed-rate loan is also worth considering if you are concerned about rising interest rates on longer-term personal loans.

As the name suggests, the interest rate on a variable-rate loan can fluctuate over the life of the loan. Interest rates on this type of loan are tied to benchmark rates or indexes. Based on how the benchmark rate or index changes, the interest rate on a variable-rate loan will also change, directly affecting your monthly payment.

Generally, variable-rate loans carry lower annual percentage rates (APRs) and some have limits on how much the interest rate can rise or lower over a specific period, or even over the life of the loan. A variable-rate loan could be a good choice if you are taking out a small amount of money with a short repayment term.

Here are some pros and cons of variable-rate personal loans and fixed-rate personal loans. Choosing between variable vs. fixed rates will come down to personal preference and what you are approved for.

	Variable-Rate Personal Loans	Fixed-Rate Personal Loans
Advantages	Loans often start out with a lower interest rate compared to fixed-rate loans If benchmark rate goes down, interest rate on the loan also goes down Flexible	Monthly payments are consistent Can avoid rising interest rates Easy to understand
Disadvantages	If benchmark rises, the cost of the loan also rises Borrowers have a greater risk of defaulting on loan if the interest rate increases significantly As interest rates change, so will the monthly payment	Won’t be able to take advantage of changes in interest rates Interest rates tend to be higher compared to variable-rate loans May pay more over time if you took out your loan when interest rates were high

Variable-Rate Personal Loans

Fixed-Rate Personal Loans

Advantages

Loans often start out with a lower interest rate compared to fixed-rate loans

If benchmark rate goes down, interest rate on the loan also goes down

Flexible

Monthly payments are consistent

Can avoid rising interest rates

Easy to understand

Disadvantages

If benchmark rises, the cost of the loan also rises

Borrowers have a greater risk of defaulting on loan if the interest rate increases significantly

As interest rates change, so will the monthly payment

Won’t be able to take advantage of changes in interest rates

Interest rates tend to be higher compared to variable-rate loans

May pay more over time if you took out your loan when interest rates were high

Small vs Large Personal Loans

Just as personal loans are taken out for a variety of reasons, the dollar amount borrowed can vary, too.

A small personal loan, which is generally for $3,000 or less, typically has a lower APR than other types of short-term debt, such as payday loans. Many banks and other financial institutions have limits on the minimum amount they’ll lend. Some credit unions may offer alternatives to payday loans in an effort to help their members save money and avoid being stuck in a cycle of debt.

A large personal loan might be used to pay for major expenses such as home repair or remodeling, medical expenses, or an expensive life event, such as a wedding. Some lenders offer personal loans up to $100,000.

It’s important to keep in mind your ability to repay the loan when deciding how much to borrow. Here’s how small and large loans compare:

	Small Personal Loan	Large Personal Loans
Advantages	Can use the money for a wide variety of purposes Interest rates are typically lower compared to credit cards Usually has better terms than payday loans	Can use the money for a wide variety of purposes Greater ability to combine multiple credit card balances into one balance Can be a good way to improve credit if payments are regular and on time
Disadvantages	Can often get a better interest rate with a larger loan No grace period Lenders may limit how much you can borrow	The larger the loan, the more debt you’re taking on Increases your debt-to-income ratio Lenders may limit how much you can borrow

Small Personal Loan

Large Personal Loans

Advantages

Can use the money for a wide variety of purposes

Interest rates are typically lower compared to credit cards

Usually has better terms than payday loans

Can use the money for a wide variety of purposes

Greater ability to combine multiple credit card balances into one balance

Can be a good way to improve credit if payments are regular and on time

Disadvantages

Can often get a better interest rate with a larger loan

No grace period

Lenders may limit how much you can borrow

The larger the loan, the more debt you’re taking on

Increases your debt-to-income ratio

Lenders may limit how much you can borrow

What Personal Loan Lenders Look at in Your Application

When you apply for a loan, the lender typically considers your credit score, debt-to-income (DTI) ratio, and other factors.

Credit Score

A person’s credit score shows lenders what the theoretical likelihood of that person paying back a loan would be. Generally, the lower a person’s credit score, the more of a risk they are assumed to be. Conversely, the higher a person’s credit score, the lower a risk they are assumed to be — and the more likely they are to be approved for lower interest rates and higher loan amounts.

Debt-to-Income Ratio

Your DTI is a percentage that tells lenders how much money you spend on monthly debt payments versus how much money you have coming into your household. You can calculate your DTI by adding up your monthly minimum debt payments and dividing it by your monthly pretax income.

Lenders generally want to see a DTI of 35% to 40% or less but may make exceptions if you have good credit.

Credit History

Lenders will review your credit report for anything that might stand out as a risk for them. If there are a high number of inquiries on your credit report or if there were multiple debt accounts opened in a short time period, that might indicate high risk to a lender. Borrowers who are considered high risk may find it more difficult to get a loan and could pay higher interest rates.

Deciding If a Personal Loan Is Right for You

Not sure whether a personal loan makes sense for your situation? Here are some questions to ask yourself:

• Do I need the money quickly? If you do, then a personal loan might be a smart move.

• Can I afford the monthly payments? Before you take on any debt, it’s important to set a realistic plan on how you’ll repay what you owe.

• Do I already have a high amount of debt? Taking out a personal loan when you have significant debt can put a serious dent in your budget and savings goals. It can also increase your DTI, which lenders look at when reviewing your loan application.

• Do I have a “bad” credit score? If your credit score isn’t so great — FICO defines “bad” as 579 or below — then you may want to wait on taking out a loan and instead work on your credit.

• Does a personal loan offer the lowest interest rate of all the options available? It’s a good idea to shop around for the rate and terms that best fit your needs before you apply with a lender.

Recommended: Personal Loan Calculator

Alternatives to Personal Loans

There may be times when you need help covering a big expense, but taking out a personal loan isn’t the best choice. Fortunately, there are alternative funding options. Here are a few you may want to explore:

Credit Cards

Like personal loans, credit cards offer a line of credit that can be used for a wide range of purposes. You may want to consider using a credit card if you have a smaller expense that you can pay off quickly.

Home Equity Line of Credit

If you own your home and have at least 20% equity, you may be able to get a home equity line of credit (HELOC). This option could be a smart move if you need to borrow a large amount of money or plan on having ongoing expenses, like those with a remodeling project.

401(k) Loan

If you have a financial emergency or want to pay off high-interest debt — and no other option is available — then you may want to consider borrowing from your 401(k). Keep in mind that you may face taxes and penalties when you withdraw the money, so be sure you understand how your plan works and what it allows.

💡 Quick Tip: While HELOCs may require an appraisal before you get approved, a SoFi home improvement loan does not. That means you can get approved and funded the same day.^*

The Takeaway

Personal loans can offer flexibility when you’re looking for funds for a variety of uses, and typically have lower interest rates than credit cards. Depending on your financial needs and financial circumstances, there may be a personal loan that fits. Comparing multiple lenders is a good way to make sure you’re getting a personal loan that works for you.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

SoFi’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.

FAQ

How do personal loan payments work?

Personal loans are typically repaid in monthly installments. When you take out a personal loan, you agree to repay the borrowed amount plus interest over a set period, usually through equal monthly payments. Each payment consists of a portion that goes towards reducing the principal balance and another portion that covers the interest charges. The loan agreement will specify the amount of each payment, the duration of the loan, and the interest rate.

What are the risks of a personal loan?

Personal loans come with certain risks that borrowers should be aware of. One risk is defaulting on the loan, which can lead to late fees, damage to your credit score, and even legal action from the lender. Another risk is needing to take on additional debt if you borrow more than you can afford to repay. In addition, personal loans may have higher interest rates compared to secured loans like mortgages or auto loans. It’s important to carefully consider your financial situation and ability to repay before taking on a personal loan.

What are the disadvantages of a personal loan?

Personal loans have a few potential disadvantages to consider. One is that they tend to have higher interest rates compared to loans secured by collateral. Personal loans may also have origination fees or other associated costs. Another potential disadvantage is that, should you miss payments or default on the loan, it could have a negative impact on your credit score.

Is a personal loan bad for your credit score?

A personal loan itself is not inherently bad for your credit score. In fact, when managed responsibly, a personal loan can have a positive impact on your credit. Making timely payments and paying off the loan as agreed can demonstrate your ability to handle debt responsibly, which can improve your credit profile. However, if you miss payments or default on the loan, it can have a negative affect on your credit. It’s important to borrow within your means, make payments on time, and consider the impact on your credit score before taking on a personal loan.

Does personal loan money go to your bank account?

Yes, when you are approved for a personal loan, the funds are typically deposited directly into your bank account. This allows you to have immediate access to the loan amount. The specific timeline for receiving the money may vary depending on the lender and the loan application process.

Do you get money right away from a personal loan?

The timing of receiving money from a personal loan can vary depending on the lender and their processes. Typically, you receive the money within five to seven business days of approval, and some lenders even offer same-day funding.

^* Same-Day Personal Loan Funding: 82% of typical SoFi Personal Loan applications, excluding Direct Pay Personal Loans and Personal Loan refinance, from January 1, 2022 to January 1, 2023 that were signed before 7pm ET on a business day were funded the same day.

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Guide to Non-Bank Financial Institutions (NBFI)

What Are Non-Bank Financial Institutions?

Get up to $300 when you bank with SoFi.

How Do NBFCs Work?

Pros and Cons of NBFCs

NBFCs vs Banks vs Fintech

Examples of NBFCs

NBFCs and the 2008 Financial Crash

The Takeaway

FAQ

How are NBFCs different banks?

What is the difference between fintech and NBFCs?

What are the disadvantages of NBFCs?

Guide to Consumption Tax

What Are Consumption Taxes?

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Types of Consumption Taxes

How Do Consumption Taxes Work?

Pros and Cons Consumption Taxes

Consumption vs Income Tax: What’s the Difference?

The Takeaway

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Can you deduct consumption tax?

Do you have to put consumption taxes on your yearly taxes?

How much do people spend on consumption taxes on average?

Guide to Excise Taxes

What Is an Excise Tax?

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What Is the Purpose of Excise Taxes?

Discouraging Consumption

Funding Projects

Generating Revenue

Types of Excise Taxes

How Do Excise Taxes Work?

Excise Tax vs Sales Tax: What’s the Difference?

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How much do people spend on excise taxes on average?

Can you deduct excise taxes?

What happens if excise taxes are removed?

How to Get the Student Loan Interest Deduction

Are Student Loan Payments Deductible?

Is Student Loan Interest Deductible?

Who Can Deduct Student Loan Interest?

What to Know About the Student Loan Interest Deduction Form

Additional Education Tax Breaks

American Opportunity Tax Credit

Lifetime Learning Credit

Strategies to Lower Monthly Student Loan Payments

The Takeaway

What Is a Personal Loan? How Do Personal Loans Work?

What Is a Personal Loan?

How Do Personal Loans Work?

How Do You Get the Money?

Repaying a Personal Loan

How Personal Loan Interest Rates Work

Personal Loan Uses

The Personal Loan Application Process

Checking Your Own Credit

Comparing Loans

Applying for a Loan

Waiting for Approval

Types of Personal Loans

Unsecured vs Secured Personal Loans

Fixed-Rate vs Variable-Rate Personal Loans

Small vs Large Personal Loans

What Personal Loan Lenders Look at in Your Application

Credit Score

Debt-to-Income Ratio

Credit History

Deciding If a Personal Loan Is Right for You

Alternatives to Personal Loans

Credit Cards

Home Equity Line of Credit

401(k) Loan

The Takeaway

FAQ

How do personal loan payments work?

What are the risks of a personal loan?

What are the disadvantages of a personal loan?

Student Loan
Refinancing

Personal
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