Jul
07
2023
How to Use a Trailing Stop Loss Properly

How to Use a Trailing Stop-Loss Properly

By | Growing Wealth, invest, Investing, Terminology | Comments Off on How to Use a Trailing Stop-Loss Properly

A trailing stop loss allows investors to create a built-in safety mechanism to insulate themselves against downward pricing trends. It’s an important exit strategy that day traders can use to manage their risk.

Understanding how a trailing stop order works and how to use it properly can help cap potential losses when day trading investments.

What Is a Trailing Stop-Loss?

A trailing stop-loss offers a flexible approach to minimizing investment losses. A trailing stop order trails the price of the underlying investment by a percentage or a specific dollar amount. So, if an investor buys shares at $50 each, they might impose a trailing stop limit of 10%. If the stock’s share price dipped by 10% they’d be sold automatically.

To understand trailing stop-loss, it helps to have a basic understanding of how limit orders and stop orders work.

A limit order is an order to buy or sell a security once it reaches a specific price. If the order is to buy, it only gets triggered at or below the limit price. If the order is to sell, the order can only get executed at or above the limit price. Limit orders are typically filled on a first-come, first-served basis in the market.

A stop order, also referred to as a stop-loss order (yet another of the stock order types), is also an order to buy or sell a particular investment. The difference is that the transaction occurs once a security’s market price reaches a certain point. For example, if you buy shares of stock for $50 each, you might create a stop order to sell those shares if the price dips to $40. Once a stop or limit order is executed, it becomes a market order.

Stop orders help you either lock in a set purchase price for an investment or cap the amount of losses you incur when you sell if the security’s price drops. While you can use them to manage investment risk, stop orders are fixed at a certain share price.

💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

How a Trailing Stop Order Works

Using a trailing stop to manage investments can help you capitalize on stock market movements and momentum. You determine a preset price at which you want to sell a stock, based on how a particular investment is trending, rather than pinpointing an exact dollar amount.

You can decide where to set a trailing stop limit, based on your risk tolerance and what you expect an investment to do over time. What remains consistent is the percentage by which you can control losses as the investment’s price changes.

Example

So, assume that you purchase 100 shares of stock at $50 each. You set a trailing stop order at 10%. If the share price dips to $45, which reflects a 10% loss, those shares would be sold automatically capping your total loss on the investment at $500.

Now, assume that the stock takes off instead and the share price doubles to $100 with the same 10% trailing stop in place. Your stop order would only be triggered if the stock’s price falls to $90. If you had set a regular stop order at $40 instead, there’d be a much wider margin for losses since the stock’s price has further to fall before shares would be sold. Thus, trailing stops enhanced downside protection compared to a regular stop order.

3 Advantages of Using a Trailing Stop Order

There are several benefits that come with using a trailing stop limit to manage your investments.

1. Tandem Movements

First, trailing stops move in tandem with stock pricing. As a stock’s per share price increases, the trailing stop follows. In the previous example, when the stock’s price doubled from $50 to $90, the trailing stop price moved from $45 to $90. In effect, it’s a hands-off tool — which can be great for some investors.

2. Confidence

Implementing a trailing stop limit strategy can offer reassurance since you know shares will be sold automatically if the stop order is triggered. That can offer investors some confidence in what may be a chaotic market environment. That, for many, can be very valuable.

3. Take Emotion Out of the Equation

Trailing stop limits rely on math rather than emotions when making decisions. That can also help you avoid the temptation to try to time the market and either sell too quickly or hold on to a stock too long, impacting your profit potential.


💡 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.

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How Do You Set up a Trailing Stop Order?

If you’re day trading online, it’s relatively simple to set up a trailing stop loss order for individual securities. Because the orders are flexible, you can choose where you want to set the baseline percentage at which stocks should be sold. For example, if you’re less comfortable with risk you might set a trailing stop at 5% or less. But if you’re a more aggressive portfolio, you may bump the order up to 20% or 30%.

You can also control whether you want buy or sell actions to happen automatically or whether you want to place trades manually. Automating ensures that the trades happen as quickly as possible, but performing them manually may be preferable if you’re more of a hands-on trader.

Example of a Trailing Stop-Loss Order

Though we’ve already given some quick examples of how a trailing stop-loss order might work in a practical sense, let’s run through it again.

Say that you buy 100 shares of Company A stock for $10. You set up a trailing stop-loss order at 10%, meaning that if Company A stock falls to $9 or below, a sell order will automatically be executed. The next week, Company A stock’s value rises to $12 — the trailing stop loss order follows. The week after, Company A’s stock loses 15% of its value, falling from $12 to $10.20.

The stop-loss order kicked in when the stock lost 10%, so your shares were sold at $10.80, saving you $0.60 per share, for a total of $60.

Again, this can be helpful if investors want to “lock in” their gains and cash out stocks with a positive return.

Are There Any Downsides of Using a Trailing Stop?

Investing is risky by nature, and no strategy is foolproof. While trailing stops can help minimize losses without placing a cap on profits, there are some downsides to consider.

Accessibility

Depending on which brokerage account you’re using, you may face limits on which investments you can use trailing stop loss strategy with. Some online brokerages don’t allow any type of stop loss trading at all.

Potential to Lock-in Losses

If a stock you own experiences a two-day slide in price, your stop loss order might require your shares be sold. If on the third day, the stock rebounds with a 20% price increase, you’ve missed out on those gains and locked in your losses. If you want to repurchase the stock you’ll now have to do so at a higher price point, and you’ve missed your chance to buy the dip.

Velocity Challenges

If share prices drop too quickly there may be some lag time before your trailing stop order can be fulfilled. In that scenario, you might end up incurring bigger losses than expected, regardless of where you placed your stop price limit.

No Market for the Security

It’s possible an investor finds themselves holding a stock that nobody wants — meaning that it has no liquidity, and can’t be traded. This is unlikely, but in this case, a stop-loss order couldn’t execute as there’s no one to trade with.

Market Closure

If you’ve set up trailing stop-loss orders, they can’t and won’t execute when the market is closed. Security prices can go up and down after-hours, but market orders can only be executed during normal operating hours for stock exchanges.

Using a market-on-open order may be another tool to consider if investors are concerned about this scenario.

Gaps

On the same note as market closures, pricing gaps — which may occur due to after-hours pricing movements, for instance — can and do occur. A stop-loss order may not help in those cases, and investors may lose more than anticipated as a result.

How to Use a Trailing Stop-Loss Strategy

Using trailing stops is better suited as part of a short-term trading strategy, rather than long-term investing. Buy-and-hold investors focused on value don’t need to worry as much about day-to-day price movements.

With that in mind, there are a few things to consider before putting trailing stop orders to work. A good starting point is your personal risk tolerance and the level of loss you’d be comfortable accepting in your portfolio. This can help determine where to set your trailing stop loss limit.

Again, if you’re a more conservative investor then it might make sense to set the percentage threshold lower. But if you have a larger appetite for risk, you could go higher. You can also tailor thresholds to individual investments to balance out your overall risk exposure.

Technical Indicators

Becoming familiar with technical indicators could help you become more adept at reading the market so you can better gauge where to set trailing limits. Unlike fundamental analysis, technical analysis primarily focuses on decoding market signals regarding trends, momentum, volatility and trading volume.

This means taking a closer look at a security’s price movements and understanding how it’s trending. One indicator you might rely on is the Average True Range (ATR). The ATR measures how much a security moves up or down in price on any given day. This number can tell you where to set your trailing loss limit based on whether price momentum is moving in your favor.

In addition to ATR you might also study moving averages and standard deviation to understand where a stock’s price may be headed. Moving averages reflect the average price of a security over time while standard deviation measures volatility. Considering these variables, along with your risk tolerance and overall investment goals, can help you use trailing losses in your portfolio correctly.

Applying Your Stock Trading Knowledge With SoFi

Whether you plan to use trailing stop strategies in your portfolio or not, making sure you’re working with the right brokerage matters. Ideally, you’re using an online brokerage that offers access to the type of securities you want to invest in with minimal fees so you can keep more of your portfolio gains.

Keep in mind, though, that utilizing stop-loss orders isn’t foolproof, and that there can be pros and cons to doing so. It’s also a somewhat advanced tool to incorporate into your strategy — if you don’t feel like you fully understand it, it may be worth discussing with a financial 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).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

How does a trailing stop-loss work?

A trailing stop-loss is a built-in mechanism that automatically sells an investor’s holdings when certain market conditions are met — specifically, when a stock loses a predetermined amount of value.

What is a disadvantage of a trailing stop-loss?

There are several potential disadvantages to using trailing stop-losses, including the fact that they won’t execute during market closures. Securities may lose value during that time, and traders could experience a pricing gap as a result.

What is a good trailing stop-loss percentage?

A good stop-loss percentage will depend on the individual investor’s risk tolerances, but many investors would likely be comfortable with a 5% or 10% trailing stop-loss.

Photo credit: iStock/akinbostanci

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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.

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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07
2023
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What Is the Spot Market & How Does It Work?

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Is the Spot Market & How Does It Work?

The spot market of a commodity is a market where buyers meet sellers and make an immediate exchange. In other words, delivery takes place at the same time payment is made. This is the simplest spot market definition available.

Commodity markets are somewhat different from the markets for stocks, bonds, mutual funds, and ETFs, all of which trade exclusively through brokerages. Because they represent a physical good, commodities have an additional market — the spot market. This market represents a place where the actual commodity gets bought and sold right away.

Spot Markets Definition

If you’re trying to define the spot markets, it may be helpful to think of it as a public financial market, and one on which commodities are bought and sold. They’re also bought and sold for immediate, or quick, delivery. That is, the asset being traded changes hands on the spot.

Prices quoted on spot markets are called the spot price, naturally.

One example of a spot market is a coin shop where an individual investor goes to buy a gold or silver coin. The prices would be determined by supply and demand. The goods would be delivered upon receipt of payment.

Understanding Spot Markets

Spot markets aren’t all that difficult to understand from a theoretical standpoint. There can be a spot market for just about anything, though they’re often discussed in relation to commodities (perhaps coffee, corn, or construction materials), and specific things like precious metals.

But again, an important part of spot market transactions is that trades take place on the spot — immediately.

Which Types of Assets Can Be Found on Spot Markets

As noted, all sorts of assets can be found on spot markets. That ranges from food items or other consumables, construction materials, precious metals, and more. If you were, for instance, interested in investing in agriculture from the sense you wanted to trade contracts for oranges or bananas, you could likely do so on the spot market.

Some financial instruments may also be traded on spot markets, such as Treasurys or bonds.

How Spot Market Trades Are Made

In a broad sense, spot market trades occur like trades in any other market. Buyers and sellers come together, a price is determined by supply and demand, and trades are executed — usually digitally, like most things these days. In fact, a spot market may and often does operate like the stock market.

You may be surprised to learn that stock markets are, in fact, spot markets, with financial securities trading hands instantly (in most cases).

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

What Does the Spot Price Mean?

As mentioned, the spot price simply refers to the price at which a commodity can be bought or sold in real time, or “on the spot.” This is the price an individual investor will pay for something if they want it right now without having to wait until some future date.

Because of this dynamic, spot markets are thought to reflect genuine supply and demand to a high degree.

The interplay of real supply and demand leads to constantly fluctuating spot prices. When supply tightens or demand rises, prices tend to go up, and when supply increases or demand falls, prices tend to go down.

The Significance of a Spot Market

The spot market of any asset holds special significance in terms of price discovery. It’s thought to be a more honest assessment of economic reality.

The reason is that spot markets tend to be more reliant on real buyers and sellers, and therefore should more accurately reflect current supply and demand than futures markets (which are based on speculation and can be manipulated, as recent legal cases have shown. More on this later.)

Types of Spot Markets

There’s only one type of spot market — the type where delivery of an asset takes place right away. There are two ways this can happen, however. The delivery can take place through a centralized exchange, or the trade can happen over the counter.

Over-the-counter

OTC trades are negotiated between two parties, like the example of buying coins at a coin shop.

Market Exchanges

There are different spot markets for different commodities, and some of them work slightly differently than others.

The spot market for oil, for example, also has buyers and sellers, but a barrel of oil can’t be bought at a local shop. The same goes for some industrial metals like steel and aluminum, which are bought and sold in much higher quantities than silver and gold.

Agricultural commodities like soy, wheat, and corn also have spot markets as well as futures markets.

Spot Market vs Futures Market

One instance that makes clear the difference between a spot market and a futures market is the price of precious metals.

Gold, silver, platinum, and palladium all have their own spot markets and futures markets. When investors check the price of gold on a mainstream financial news network, they are likely going to see the COMEX futures price.

COMEX is short for the Commodity Exchange Inc., a division of the New York Mercantile Exchange. As the largest metals futures market in the world, COMEX handles most related futures contracts.

These contracts are speculatory in nature — traders are making bets on what the price of a commodity will be at some point. Contracts can be bought and sold for specific prices on specific dates.

Most of the contracts are never delivered upon, meaning they don’t involve delivery of the actual underlying commodity, such as gold or silver. Instead, what gets exchanged is a contract or agreement allowing for the potential delivery of a certain amount of metal for a certain price on a certain date.

For the most part, futures trading only has two purposes: hedging bets and speculating for profits. Sophisticated traders sometimes use futures to hedge their bets, meaning they purchase futures that will wind up minimizing their losses in another bet if it doesn’t go their way. And investors of all experience levels can use futures to try to profit from future price action of an asset. Predicting the exact price of something in the future can be difficult and carries high risk.

The spot market works in a different manner entirely. There are no contracts to buy or sell and no future prices to consider. The market is simply determined by what one party is willing to purchase something for.

Spot Market vs Futures Market
Spot Market

 Futures Market
No contracts to buy or sell Contracts are bought and sold outlining future prices
Trades occur instantly Trades may never actually occur at all
Non-speculative Speculative by nature

Another important concept to understand is contango and backwardation, which are ways to characterize the state of futures markets based on the relationship between spot and future prices. Some background knowledge on those concepts can help guide your investing strategy.

Note, too, that some investors may be confused by the concepts of margin trading and futures contracts. Margin and futures are two different concepts, and don’t necessarily overlap.

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

Example of a Spot Market

Consider the spot and futures markets for precious metals.

Precious-metal prices that investors see on financial news networks will most often be the current futures price as determined by COMEX. This market price is easy to quote. It’s the sum of all futures trading happening on one central exchange or just a few central exchanges.

The spot market is more difficult to pin down. In this case, the spot market could be generally referred to as the average price that a person would be willing to pay for a single ounce of gold or silver, not including any premiums charged by sellers.

Sometimes there is a difference between prices in the futures market and spot market. The difference is referred to as the “spread.” Under ordinary circumstances, the difference will be modest. During times of uncertainty, though, the spread can become extreme.

Futures Market Manipulation

To fully answer the question “What does the spot price mean?” it’s important to include one final note on futures markets. This will illustrate a key difference between the two markets.

Recent high-profile cases brought by government enforcement agencies like the Securities and Exchange Commision and Commodities and Futures Trading Commission highlight the susceptibility of futures markets to manipulation.

Some large financial institutions have been convicted of engaging in practices that artificially influence the price of futures contracts. Again, we can turn to the precious-metals markets for an example.

During the third quarter of 2020, JP Morgan was fined $920 million for “spoofing” trades in the gold and silver futures markets and lying about it to COMEX.

Spoofing involves creating large numbers of buy or sell orders with no intention of fulfilling the orders.

Because order book information is publicly available, traders can see these orders, and may act on the perception that big buying or selling pressure is coming down the pike. If many sell orders are on the books, traders may sell, hoping to get ahead of the trade before prices fall. If many buy orders are on the books, traders may buy, thinking the price is going to rise soon.

Cases like this show that futures markets can be heavily influenced by market participants with the means to do so.

Spot markets, on the other hand, are much more organic and more difficult to manipulate.

3 Tips for Spot Market Investing

For those interested in trying their hand in the spot market, here are a few things to keep in mind.

1. Know What’s Going On

Often, prices in the spot market can change or be volatile in relation to the news or other current events. For that reason, it’s important that investors know what’s happening in the world, and use that to assess what’s happening with prices for a given asset or commodity.

2. Keep Your Emotions in Check

Emotional investing or trading is a good way to get yourself into financial trouble, be it in the spot market, or any other type of trading or investing. You’d likely do well to keep your emotions in check when trading or investing on the spot market, as a result.

3. Understand the Market

It’s also a good idea to do some homework and make a solid attempt at trying to understand the market you’re trading in. There may be jargon to learn, terms to understand, price discovery mechanisms that could otherwise be foreign to even a seasoned investor — do your best to do your due diligence.

Spot-on Investing

Spot markets are where commodities are traded, instantly. There are numerous types of spot markets, and there are numerous types of commodities that might be traded on them. Investors would be wise to know the basics of how they work, and come armed with a bit of background knowledge about the given commodity they’re trading, in order to reach their goals.

Spot market trading can be a part of an overall trading strategy, but again, investors should know the ropes a bit before getting in over their heads. It may be a good idea to speak with a financial professional before investing.

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).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

What is spot market vs a futures market

Trades on a spot market occur instantly, on the spot. Trades in the futures market involve contracts for commodities with prices outlined for some time in the future — if they occur at all.

What does spot market mean?

The term spot market refers to a financial market where commodities are bought and sold by traders. The trades occur on the spot, or instantly, for immediate delivery.

What is the difference between spot market and forward market?

Forward markets involve trading of futures contracts, or transactions that take place at some point in the future, whereas spot market trades occur instantly, often for cash.

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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.

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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Jul
06
2023
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LTV 101: Why Your Loan-to-Value Ratio Matters

By | Home Ownership, mortgage, Terminology | No Comments

If you are planning on applying for a home loan or for a mortgage refinance, you are likely going to want to know your loan-to-value (LTV) ratio. This is calculated by dividing the loan principal by the value of the property. It’s an important metric when getting a mortgage approved because it reflects how much of the property’s value you are borrowing. A higher number may be seen as a riskier proposition by prospective lenders.

Here, you’ll learn the ins and outs of calculating LTV, why it matters, and how it can have a financial impact over the life of a loan.

LTV, a Pertinent Percentage

The relationship between the loan amount and the value of the asset securing that loan constitutes LTV.

To find the loan-to-value ratio, divide the loan amount (aka the loan principal) by the value of the property.

LTV = (Loan Value / Property Value) x 100

Here’s an example: Say you want to buy a $200,000 home. You have $20,000 set aside as a down payment and need to take out a $180,000 mortgage. So here’s what your LTV calculation looks like:

180,000 / 200,000 = 0.9 or 90%

Here’s another example: You want to refinance your mortgage (which means getting a new home loan, hopefully at a lower interest rate). Your home is valued at $350,000, and your mortgage balance is $220,000.

220,000 / 350,000 = 0.628 or 63%

As the LTV percentage increases, the risk to the lender increases.

Why Does LTV Matter?

Two major components of a mortgage loan can be affected by LTV: the interest rate and private mortgage insurance (PMI).

Interest Rate

LTV, in conjunction with your income, financial history, and credit score, is a major factor in determining how much a loan will cost.

When a lender writes a loan that is close to the value of the property, the perceived risk of default is higher because the borrower has little equity built up and therefore little to lose.

Should the property go into foreclosure, the lender may be unable to recoup the money it lent. Because of this, lenders prefer borrowers with lower LTVs and will often reward them with better interest rates.

Though a 20% down payment is not essential for loan approval, someone with an 80% LTV or lower is likely to get a more competitive rate than a similar borrower with a 90% LTV.

The same goes for a refinance or home equity line of credit: If you have 20% equity in your home, or at least 80% LTV, you’re more likely to get a better rate.

If you’ve ever run the numbers on mortgage loans, you know that a rate difference of 1% could amount to thousands of dollars paid in interest over the life of the loan.

Let’s look at an example, where two people are applying for loans on identical $300,000 properties.

Person One, Barb:

•  Puts 20%, or $60,000, down, so their LTV is 80%. (240,000 / 300,000 = 80%)

•  Gets approved for a 4.5% interest rate on a 30-year fixed-rate mortgage

•  Will pay $197,778 in interest over the life of the loan

Person Two, Bill:

•  Puts 10%, or $30,000, down, so their LTV is 90%. (270,000 / 300,000 = 90%)

•  Gets approved for a 5.5% interest rate on a 30-year fixed-rate mortgage

•  Will pay $281,891 in interest over the life of the loan

Bill will pay $84,113 more in interest than Barb, though it is true that Bill also has a larger loan and pays more in interest because of that.

So let’s compare apples to apples: Let’s assume that Bill is also putting $60,000 down and taking out a $240,000 loan, but that loan interest rate remains at 5.5%. Now, Bill pays $250,571 in interest;

The 1% difference in interest rates means Bill will pay nearly $53,000 more over the life of the loan than Barb will. (It’s worth noting that there are costs when you refinance a mortgage; it’s a new loan, with closing expenses.)

Mortgage CalculatorMortgage Calculator



💡 Quick Tip: You deserve a more zen mortgage loan. When you buy a home, SoFi offers a guarantee that your loan will close on time. Backed by a $5,000 credit.‡

PMI or Private Mortgage Insurance

Your LTV ratio also determines whether you’ll be required to pay for private mortgage insurance, or PMI. PMI helps protect your lender in the event that your house is foreclosed on and the lender assumes a loss in the process.

Your lender will charge you for PMI until your LTV reaches 78% (by law, if payments are current) or 80% (by request).

PMI can be a substantial added cost, typically ranging anywhere from 0.1% to 2% of the value of the loan per year. Using our example from above, a $270,000 loan at 5.5% with a 1% PMI rate translates to $225 per month for PMI, or about $18,800 in PMI paid until 20% equity is reached.

Recommended: Understanding the Different Types of Mortgage Loans

How Does LTV Change?

LTV changes when either the value of the property or the value of the loan changes.

If you’re a homeowner, the value of your property fluctuates with evolving market pressures. If you thought the value of your property increased significantly since your last home appraisal, you could have another appraisal done to document this. You could also potentially increase your home value through remodels or additions.

The balance of your loan should decrease over time as you make monthly mortgage payments, and this will lower your LTV. If you made a large payment toward your mortgage, that would significantly lower your LTV.

Whether through an increase in your property value or by reducing the loan, decreasing your LTV provides you with at least two possible money-saving options: the removal of PMI and/or refinancing to a lower rate.

💡 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.

The Takeaway

The loan-to-value ratio affects two big components of a mortgage loan: the interest rate and private mortgage insurance. A lower LTV percentage typically translates into more borrower benefits and less money spent over the life of the loan.

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.

*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.

‡SoFi On-Time Close Guarantee: If all conditions of the Guarantee are met, and your loan does not close on or before the closing date on your purchase contract accepted by SoFi, and the delay is due to SoFi, SoFi will give you a credit toward closing costs or additional expenses caused by the delay in closing of up to $10,000.^ The following terms and conditions apply. This Guarantee is available only for loan applications submitted after 04/01/2024. Please discuss terms of this Guarantee with your loan officer. The mortgage must be a purchase transaction that is approved and funded by SoFi. This Guarantee does not apply to loans to purchase bank-owned properties or short-sale transactions. To qualify for the Guarantee, you must: (1) Sign up for access to SoFi’s online portal and upload all requested documents, (2) Submit documents requested by SoFi within 5 business days of the initial request and all additional doc requests within 2 business days (3) Submit an executed purchase contract on an eligible property with the closing date at least 25 calendar days from the receipt of executed Intent to Proceed and receipt of credit card deposit for an appraisal (30 days for VA loans; 40 days for Jumbo loans), (4) Lock your loan rate and satisfy all loan requirements and conditions at least 5 business days prior to your closing date as confirmed with your loan officer, and (5) Pay for and schedule an appraisal within 48 hours of the appraiser first contacting you by phone or email. This Guarantee will not be paid if any delays to closing are attributable to: a) the borrower(s), a third party, the seller or any other factors outside of SoFi control; b) if the information provided by the borrower(s) on the loan application could not be verified or was inaccurate or insufficient; c) attempting to fulfill federal/state regulatory requirements and/or agency guidelines; d) or the closing date is missed due to acts of God outside the control of SoFi. SoFi may change or terminate this offer at any time without notice to you. *To redeem the Guarantee if conditions met, see documentation provided by loan officer.
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.

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

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.

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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05
2023
What is mortgage amortization?

What Is Mortgage Amortization?

By | Home Ownership, mortgage, Terminology | No Comments

If you’re looking into getting a mortgage for the first time, congratulations! You’re about to embark on a brave new adventure, full of highs and lows with (hopefully) a wonderful reward, aka your new home, at the finish line.

But before you get there, you’ll need to navigate some challenges. For instance: the somewhat intimidating home-buying terminology: prequalification vs. preapproval, for instance. And what on earth is escrow? And what does amortized mean?

Here, you’ll learn the answer to that last question, quickly and painlessly. Basically, mortgage amortization means that your mortgage loan payments will be spaced out over a period of time (typically 30 years) and will be calculated so that you always pay the same amount per month (if you have a fixed-rate mortgage, not a variable rate mortgage, that is).

That means that if you get a fixed-rate mortgage and your first payment in your first month is $1,500, you know that you’ll pay $1,500 in the last month of your mortgage, years later. If you take out a variable rate mortgage, the amount you pay each month will change periodically as the market rate fluctuates.

Also, as you pay your mortgage at first, most of the money paid goes toward interest and a little to the principal, but that shifts over time to the opposite scenario.

Learn more about mortgage amortization here.

Why Do People Choose Amortized Mortgages?

Mortgage amortization helps ensure that your obligations are predictable, which can make it easier for you to plan. If you take out a 30-year mortgage, then the amortization helps guarantee that in 30 years, you will have finished paying it off. For a fixed-rate mortgage, amortization also keeps all your payments consistently the same amount, rather than different amounts that depend on how much your principal is.

Recommended: The Different Kinds of Mortgages

How to Calculate Amortization Using Tables

In real life, even if you choose an amortized mortgage, you may never need to figure out your 30 years or so of payments yourself. But it’s useful to see what goes into the table or payments (they’re not arbitrary!) and understand how it’s populated. Calculating your amortized mortgage really puts you on the front lines of homebuying.

Let’s say you take out a $100,000 mortgage over 10 years at a 5% fixed interest rate. That means your monthly payment will be $1,061. You can then divide your interest rate by 12 equal monthly payments. That works out to 0.4166% of interest per month. And that, in turn, means that in the first month of your loan, you’ll pay around $417 toward interest and the remaining $644 toward your principal.

Next, to calculate the second month, you’ll need to deduct your monthly payment from the starting balance to get the ‘balance after payment’ for the chart. You’ll also need to put the $417 you paid in interest and $644 you paid toward the principal in the chart. Then you can repeat the calculation of your monthly interest and principal breakdown, and continue inputting until you finish completing the chart.


Date Starting Balance Interest Principal Balance after payment
Jan, 2023 $100,000 $417 $644 $99,356
Feb, 2023 $99,356 $414 $647 $98,709
Mar, 2023 $98,709 $411 $649 $98,060
Apr, 2023 $98,060 $409 $652 $97,408
May, 2023 $97,408 $406 $655 $96,753
Jun, 2023 $96,753 $403 $658 $96,096
Jul, 2023 $96,096 $400 $660 $95,435
Aug, 2023 $95,435 $398 $663 $94,772
Sep, 2023 $94,772 $395 $666 $94,107
Oct, 2023 $94,107 $392 $669 $93,438
Nov, 2023 $93,438 $389 $671 $92,767
Dec, 2023 $92,767 $387 $674 $92,093


💡 Quick Tip: SoFi’s new Lock and Look* feature allows you to lock in a low mortgage financing rate for up to 90 days while you search for the perfect place to call home.

How to Calculate Amortization Using a Calculator

So you can see that it’s not so difficult to calculate your amortized payments as it is time-consuming. Fortunately, you can save yourself the trouble by using an online amortization calculator . All you have to do is input info about your mortgage, including the amount you’re borrowing, your term length, and the interest you’re paying, and the calculator will do the math for you.

Recommended: First-Time Home-Buyer Guide

What Are the Pros of an Amortized Mortgage?

Here are some of the benefits to consider:

•   You’ll slowly but surely pay off the mortgage principal of your home loan. With every month, you’ll get closer to owning your home outright!

•   It ensures that you pay a set amount for each payment over the life of your loan. With some loans you may end up paying more at the beginning or the end. A balloon mortgage, for example, requires you to pay interest charges monthly during the regular term. You then pay off large parts of the principal at the end of the loan period. (Thus, your payment literally balloons.)

•   You can often get better terms with an amortized loan. And you’ll save money in the long run by paying less interest over the life of your mortgage.

Recommended: What Is PMI and How to Avoid It

What Are the Cons of an Amortized Mortgage?

Next, consider the downsides:

•   Amortized mortgages may favor borrowers who are putting down a larger down payment. To qualify for a competitive interest rate, you’ll probably need to put down 10% (if not 20%).

•   You might not be able to qualify to borrow as much money via an amortized mortgage as you would through an alternative mortgage, such as an interest-only mortgage or a balloon mortgage.


💡 Quick Tip: Your parents or grandparents probably got mortgages for 30 years. But these days, you can get them for 20, 15, or 10 years — and pay less interest over the life of the loan.

The Takeaway

An amortized mortgage can be a good option for many homebuyers. It provides a steady way to pay down the principal of your home loan.

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.

*Terms and conditions apply. Applies to conventional purchase loans only. Rate will lock for 90 calendar days at the time of pre-approval subject to payment on 60th day of the fee below. If you submit a fully executed purchase contract within 30 days of the initial rate lock, SoFi will reduce the interest rate by an additional 0.125% at no cost. If current market pricing has improved by .75 percentage points or more from the original locked rate, you may qualify for an additional rate reduction. If you have not submitted a fully executed purchase contract within 60 days of your initial rate lock, you will be charged $250 to maintain the rate lock through the 90-day period. The $250 fee will be credited back to you at the time of closing. SoFi reserves the right to change or terminate this offer at any time with or without notice to you.
*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.

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

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.

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.

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.

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Jul
03
2023

What Is a Reverse Mortgage?

By | Home Ownership, mortgage, Terminology | No Comments

A reverse mortgage is a loan that allows homeowners to turn part of their home equity into cash. Available to people 62 and older, a reverse mortgage can be set up and paid out as a lump sum, a monthly payment, or a line of credit, which can then be used to fund home renovations, consolidate debt, pay off medical expenses, or simply improve one’s lifestyle.

While older Americans, particularly retiring baby boomers, have increasingly drawn on this financial tool, reverse mortgages aren’t for everyone. Find out how they work, their advantages and disadvantages, and alternatives you might consider instead.

How Does a Reverse Mortgage Work?

Usually when people refer to a reverse mortgage, they mean a federally insured home equity conversion mortgage (HECM). That being said, there are two other types of reverse mortgages (more on those below).

Note: SoFi does not offer home equity conversion mortgages (HECM) at this time.

To qualify for an HECM, all owners of the home must be 62 or older and have paid off their home loan or have a considerable amount of equity. Borrowers must use the home as their primary residence or live in one of the units if the property is a two- to four-unit home. Certain condominium units and manufactured homes are also allowed. The borrower cannot have any delinquent federal debt. Plus, the following will be verified before approval:

•   Income, assets, monthly living expenses, and credit history

•   On-time payment of real estate taxes, plus hazard and flood insurance premiums, as applicable

The reverse mortgage amount you qualify for is determined based on the lesser of the appraised value or the HECM mortgage loan limit (the sales price for HECM to purchase), the age of the youngest borrower or the age of an eligible non-borrowing spouse, and current interest rates. Generally, the older you are and the more your home is worth, the higher your reverse mortgage amount could be, depending on other eligibility criteria.

The reverse mortgage loan and interest do not have to be repaid until the last surviving borrower dies, sells the house, or moves out permanently. In some cases, a non-borrowing spouse may be able to remain in the home.

Loan Costs

An HECM loan may include several charges and fees, such as:

•   Mortgage insurance premiums

◦   Upfront fee (2% of the home’s appraised value or the Federal Housing Administration (FHA) lending limit, whichever is less)

◦   Annual fee (0.5% of the outstanding loan balance)

•   Third-party charges (an appraisal fee, surveys, inspections, title search, title insurance, recording fees, and credit checks)

•   Origination fee (the greater of $2,500 or 2% of the first $200,000 of the home value, plus 1% of the amount over $200,000; the origination fee cap is $6,000)

•   Servicing fee (up to $30 per month if the loan interest rate is fixed or adjusted; if the interest rate can adjust monthly, up to $35 per month)

•   Interest

Your lender can let you know which of the above fees are mandatory. Many of the costs can be paid out of the loan proceeds, meaning you wouldn’t have to pay them out of pocket. However, financing the loan costs reduces how much money will be available for your needs.

The servicing fee noted above is a cost you could incur from the lender or agent who services the loan and verifies that real estate taxes and hazard insurance premiums are kept current, sends you account statements, and disburses loan proceeds to you.


💡 Quick Tip: With SoFi, it takes just minutes to view your rate for a home loan online.

What Is the Most Common Kind of Reverse Mortgage?

The most common type of reverse mortgage is the HECM, or home equity conversion mortgage, which can also be used later in life to help fund long-term care. HECM reverse mortgages are made by private lenders but are governed by rules set by the Department of Housing and Urban Development (HUD). The current loan limit is $1,089,300.

To qualify for this kind of reverse mortgage loan, you must meet with an HECM counselor, which you can find through the HUD site. When you meet with the counselor, they may cover eligibility requirements, potential financial ramifications of the loan and when the loan would need to be paid back, including circumstances under which the outstanding amount would become immediately due and payable. The counselor may also share alternatives.

The reverse mortgage loan generally needs to be paid back if the borrower moves to another home for a majority of the year or to a long-term care facility for more than 12 consecutive months, and if no other borrower is listed on the loan.

However, a new HUD policy offers protections to a non-borrowing spouse when a partner moves into long-term care. The non-borrowing spouse may remain in the home as long as they continue to occupy the home as a principal residence, are still married, and were married at the time the reverse mortgage was issued to the spouse listed on the reverse mortgage.

In 2021, HUD also removed the major remaining impediment to a non-borrowing spouse who wanted to stay in the home after the borrower’s death. Now they will no longer have to provide proof of “good and marketable title or a legal right to remain in the home,” which often meant a probate filing and had forced many spouses into foreclosure.

Two Other Types of Reverse Mortgages

The information provided so far answers the questions “What is a reverse mortgage?” and “How do reverse mortgages work?” for HECMs, but there are also two other kinds: the single-purpose reverse mortgage and the proprietary reverse mortgage.

Here’s more information about each of them.

Single-Purpose Reverse Mortgage

This loan is offered by state and local governments and nonprofit agencies. It’s the least expensive option, but the lender determines how the funds can be used. For example, the loan might be approved to catch up on property taxes or to make necessary home repairs.

Check with the organization giving the loan for specifics about costs, as they can vary.

Proprietary Reverse Mortgage

If a home is appraised at a value that exceeds the maximum for an HECM ($1,089,300), a homeowner could pursue a proprietary reverse mortgage.

Counseling may be required before obtaining one of these loans, and a counselor can help a homeowner decide between an HECM and a proprietary loan.

Typically, proprietary reverse mortgages can only be cashed out in a lump sum. The costs can be substantial and interest rates higher. This type of reverse mortgage, unlike an HECM, is not federally insured, so lenders tend to approve a lower percentage of the home’s value than they would with an HECM.

One cost a borrower wouldn’t have to pay with a proprietary mortgage: upfront mortgage insurance or the monthly premiums. In some cases, the costs associated with this type of mortgage may cause a homeowner to decide to sell the home and buy a new one.



💡 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.

Pros and Cons of Reverse Mortgages

Reverse Mortgages: Pros and Cons

Pros Cons

•   No monthly payments

•   Flexibility on how you get money

•   Can pay back the loan whenever you want

•   The money counts as a loan, not as income

•   An HECM can be used to buy a new primary residence

•   Rates can be higher than traditional mortgage rates

•   Generally requires reducing your home equity

•   Must keep up with property taxes, insurance, repairs and any association dues

•   Interest accrued isn’t deductible until it’s actually paid

If you’re nearing retirement, it’s easy to see why reverse mortgages are appealing. Here are some of their pros:

•   Unlike most loans, you don’t have to make any monthly payments. The HECM loan can be used for anything, whether that’s debt, health care, daily expenses, or buying a vacation home (although this is not true for the single-purpose variety).

•   How you get the money from an HECM is flexible. You can choose whether to get a lump sum, monthly disbursement, line of credit or some combination of the three.

•   You can pay back the loan whenever you want, even if that means waiting until you’re ready to sell the house. If the home is sold for less than the amount owed on the mortgage, borrowers may not have to pay back more than 95% of the home’s appraised value because the mortgage insurance paid on the loan covers the remainder.

•   The money from a reverse mortgage counts as a loan, not as income. As a result, payments are not subject to income tax. Social Security and Medicare also are not affected.

•   An HECM can be used to buy a new primary residence. You’d make a down payment and then finance the rest of the purchase with the reverse mortgage.

Then again, here are some cons of reverse mortgages to consider:

•   Reverse mortgage interest rates can be higher than traditional mortgage rates. The added cost of mortgage insurance also applies, and, like most mortgage loans, there are origination and third-party fees you will be responsible for paying, as described above.

•   Taking out a reverse mortgage generally means reducing the equity in your home. That can mean leaving less for those who might inherit your house.

•   You’ll need to keep up property taxes and insurance, repairs, and any association dues. If you don’t pay insurance or taxes, or if you let your home go into disrepair, you risk defaulting on the reverse mortgage, which means the outstanding balance could be called as immediately “due and payable.”

•   Interest accrued on a reverse mortgage isn’t deductible until it’s actually paid (usually when the loan is paid off). And a deduction of mortgage interest may be limited.

Alternatives to Reverse Mortgages

A reverse mortgage payout depends on the borrower’s age, the value of their home, the mortgage interest rate and loan fees, as well as whether they choose a lump sum, line of credit, monthly payment, or a combination of those options.

If the payout will not provide financial stability that allows an individual to age in place, there are other ways to tap into cash, including:

Cash-out refi: If you meet credit and income requirements, you may be able to borrow up to 80% of your home’s value with a cash-out refinance of an existing mortgage. Closing costs are involved, but this product lets you turn home equity into cash and possibly lock in a lower interest rate.

Personal loan: A personal loan could provide a lump sum without diminishing the equity in your home. This kind of loan does not use your home as collateral. It’s generally a loan for shorter-term purposes.

Home equity line of credit (HELOC): A HELOC, based in part on your home equity, provides access to cash in case you need it but requires interest payments only on the money you actually borrow. Sometimes a lender will waive or reduce closing costs if you keep the line open for at least three years. HELOCs usually have a variable interest rate.

💡 Recommended: What Are Home Equity Lines of Credit (HELOC)?

Home equity loan: A fixed-rate home equity loan allows you to borrow a lump sum based on your home’s market value, minus any existing mortgages. You make a monthly principal and interest payment each month. Again, lenders may reduce or waive closing costs if you keep the loan for, usually, at least three years.

The Takeaway

A reverse mortgage may make sense for some older people who need to supplement their cash flow. But many factors must be considered, including the youngest homeowner’s age, home value, equity, loan rate and costs, heirs, and payout type. As homeowners are weighing the pros and cons, remember there are other options.

*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.

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

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.

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Terms and conditions apply. SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or other eligible status, be residing in the U.S., and meet SoFi's underwriting requirements. Not all borrowers receive the lowest rate. Lowest rates reserved for the most creditworthy borrowers. If approved, your actual rate will be within the range of rates at the time of application and will depend on a variety of factors, including term of loan, evaluation of your creditworthiness, income, and other factors. If SoFi is unable to offer you a loan but matches you for a loan with a participating bank, then your rate may be outside the range of rates listed above. Rates and Terms are subject to change at any time without notice. SoFi Personal Loans can be used for any lawful personal, family, or household purposes and may not be used for post-secondary education expenses. Minimum loan amount is $5,000. The average of SoFi Personal Loans funded in 2023 was around $33K. Information current as of 2/26/24. SoFi Personal Loans originated by SoFi Bank, N.A. Member FDIC. NMLS #696891 (www.nmlsconsumeraccess.org). See SoFi.com/legal for state-specific license details. See SoFi.com/eligibility for details and state restrictions.

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