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Even the most money-savvy person may have some false beliefs about money. Maybe you were raised with misconceptions about finances, such as investing is only for the very rich, or were given off-target advice from well-intentioned friends (telling you to always aim to buy a house vs. renting), for instance.

Incorrect beliefs about money can have a negative impact on how you manage your finances, potentially hindering your path to achieving your goals.

Why Debunking Money Myths Is Key to Financial Success

Being realistic about money can help you set reasonable financial goals and reach them in the short- and long-term. Whether you are feeling financially secure or are looking to better manage your finances, practicing healthy financial habits will serve you well in the long run.

That’s why debunking money myths is important. If you believe, for instance, that carrying lots of credit card debt is “normal,” you may not eliminate that monthly balance that’s dragging down your budget.

Here are some common misconceptions about money to avoid if you want to be financially fit.

10 Common Misconceptions About Money

Here, learn about popular money misconceptions and why it may be time to bust some financial myths.

1. You Need a Lot of Money to Start Investing

You do not need to be rich in order to invest: You can start investing with just a few dollars. The average stock market return is about 10% a year, as measured by the S&P 500 index. The S&P 500 Index return does not include the reinvestment of dividends or account for investment fees, expenses, or taxes, which would reduce actual returns. Investing has risks, and you’ll want to be comfortable with that notion and find investments that suit your risk tolerance.

Whatever you decide to do, investigate fees before you begin investing so you are prepared for any costs you will need to cover.

2. Budgeting Is Too Restrictive and Complicated

Regardless of how little or how much money you have, a budget is helpful for organizing your finances. If you feel budgeting is too restrictive and/or complicated, you probably just haven’t found the right budgeting method yet.

Making a budget could help you achieve financial stability. You need to budget so you can keep track of your spending, your debt, and your savings for future goals.

There are various techniques and tools (spreadsheets, journals, apps) for budgeting. One strategy is the 50/30/20 budget rule, in which 50% of your post-tax money goes towards necessary expenses (housing, food, utilities, and the like), 30% goes towards wants, and 20% is used for saving.

3. All Debt Is Bad Debt

According to Debt.org, 90% of American households have some kind of consumer debt. But keep in mind, not all debt is created equal. Some debt is considered good debt. Think about a mortgage: Once you’ve saved for a down payment, this financial product is typically a fairly low-interest loan that may help build your credit history (if managed responsibly) and also allows you to accrue equity in the home.

Bad debt, on the other hand, is high-interest debt, such as credit card debt, where interest rates are high and you aren’t building equity. Just because a lot of people may have this kind of debt doesn’t mean you should. It can snowball and keep you spending a chunk of money monthly that could otherwise be saved or invested.

4. A High Salary Automatically Makes You Wealthy

A common money misconception is that earning a high salary makes you wealthy. That is not necessarily true. People who earn a lot of money can spend a lot of it too. The key to building wealth is saving and investing your money so it can potentially grow over time. Even if you simply stash money in a high-yield savings account, compounding interest can help grow your wealth.

To look at it from another angle, say one person earns $50,000 a year, lives within their means, and saves and invests wisely. Then there’s a person who earns $500,000 but they own multiple houses, spend freely on luxuries, and haven’t yet gotten their act together in terms of saving and investing. The person who has the lower salary might actually be the wealthier of the two.

5. Buying a Home Is Always Better Than Renting

Buying a home is the quintessential American dream, but it’s not necessarily the right move for everyone. Whether to rent or buy ultimately depends on your personal situation and your aspirations.

You may have heard that renting is a waste of money, but it can provide flexibility for those who are not ready to buy a home or not interested in doing so. For instance, perhaps your work requires you to relocate often, or you only want to buy a house when your baby is older and you can pick the right school district. Maybe you’d rather pay off debt vs. save for a down payment. Or you just might not want the major expense of a mortgage, taxes, and home maintenance in your life. Whatever your situation may be, it’s important not to feel pressured into buying unless it’s the right move for you.

6. You Should Avoid Credit Cards to Stay Out of Debt

Using credit cards as a form of payment doesn’t mean you’ll go into debt. Spending more than you can afford to pay off what you owe, however, may put you on that path. If you use a credit card wisely and typically pay off the debt every month, this can be a factor that helps you build credit. It also keeps you from paying high credit card interest, which averages 24.35% as of July 2025.

However, if you are a person who tends to spend impulsively and not pay your credit card bill on time, this could negatively affect your credit score. This is why it’s important to manage your purchases and pay your credit card bills on time.

7. Saving for Retirement Can Wait Until You’re Older

This can be a dangerous myth to believe. If you are young and are investing for your retirement, you have time on your side. Your invested money can grow over time thanks to compounding returns. Here’s an example: If a 25-year-old invests $200 a month and earns a 6% return, they’ll have $393,700 by age 65. But if that same person starts saving at age 35, that same money at the same rate nets them $201,100, or about half of what they’d have if they started sooner.

It may feel as if retirement is a long way away, but the sooner you begin funding it, the more you are likely to have. If your employer offers a 401(k) plan, take advantage of contributing to it. If this isn’t offered at your place of work, you can open an individual retirement account (IRA) or a Roth IRA.

8. Talking About Money Is Taboo

Talking about money issues may seem like taboo, but it shouldn’t be. It can be healthy to talk about money troubles to close family and friends, because they may have ideas about how to approach a solution. Perhaps they experienced a similar issue in the past and can offer advice on how they handled it.

If you find it uncomfortable to talk to family or friends about your money concerns, you might want to consider speaking to a professional. For instance, there are non-profit credit counseling organizations, like the National Foundation for Credit Counseling that could help you if you are burdened with debt and feel overwhelmed.

9. More Money Will Solve All Your Problems

Yes, money can help take care of bills, but the old adage, “More money, more problems” may well be true, too. The secret to being financially secure is not about how much money you make, it’s about how well you manage it.

For instance, say you take a new job that pays twice your current salary. If you turn around and buy a pricier home and car and book some luxury vacations, you might be in more debt and experience more stress than before. The way to prevent this is by not living beyond your means.

Healthy budgeting and saving habits (such as automating your savings) are what can help solve problems.

10. Financial Planning Is Only for the Rich

Financial planning isn’t only for those who have hefty savings accounts, net worth, or investment portfolios. Although it may not be taught in school, financial literacy is important for all, and setting money goals can help you achieve your dreams. Too many people just open a checking account and then ignore their money.

You might be more comfortable working with a financial professional, but you don’t need one to manage your money. It’s totally your choice. You might also see what tools and services your bank offers, and investigate third-party options.

Budgeting and Saving Myths Debunked

There are several myths about budgeting and saving that are worth debunking. For instance, many people believe living on a budget is hard, complicated, time-consuming, and all about deprivation.

Not true! The right budget can help you stay on track financially and achieve your goals. What’s important is to experiment with different budgets to find one that suits your needs. You might use technology, such as a savings calculator to help you along.

Also, it’s a financial myth that you need a lot of money to save effectively. Regardless of your income and expenses, budgeting well can allow you to start saving regularly. Small amounts of money can really add up over time.

Recommended: Savings Goal Calculator

Investing and Retirement Myths Debunked

Here’s what is a common misconception about finances: that you need a lot of money to invest. Anyone can invest well, even starting with a small amount, and robo-advisors can help automate the process for you. On the topic of investing, it’s also a misconception that you don’t have to think about retirement until later. You’re actually likely to save more effectively when you start early (again, even with small amounts) than if you put more money in for a shorter period of time.

Another myth is that you don’t need to save for retirement because you can live off Social Security payments. However, many people find that those payments are not enough when they reach retirement age, especially with rising healthcare costs.

Debt and Credit Card Myths Debunked

A debt myth is that all debt is bad. Some kinds of debt, such as mortgages, charge relatively low interest and allow you to build wealth. However, when it comes to credit cards, there are some myths to conquer. For example, some people may believe that they should only pay the minimum amount on their monthly bill. This amount is the bare minimum, and paying just that can wind up locking you into a debt trap, without building up funds in your bank account because you’re struggling to pay off your debt.

Mindset and Lifestyle Myths Debunked

A mindset and lifestyle myth about money to debunk is that making more money means you’re wealthy. It might be true, but if you allow your spending to rise with every raise at work or money windfall, you could wind up less wealthy than you were before.

This is considered lifestyle creep. An example is when you get a new job and earn more, you go out and, say, lease a luxury car rather than putting the extra money into savings or investing. You live more lavishly, but you could be shortchanging your future.

How to Develop a Health Money Mindset

To develop a healthy money mindset, it’s helpful to devote some time and energy to learning how to manage your money well. That could mean reading up on finances, listening to podcasts, or taking an online course.

Goal setting is important, too. By establishing your short-, medium, and long-term goals, you can begin working toward achieving them. Budgeting well and talking with trusted friends and relatives for advice can help you get on the right track. Automating your savings so money seamlessly gets transferred into a savings account can be a smart move, too. You might also work with a financial planner or a financial therapist to help you in your money journey.

The Takeaway

Myths about money can stand in the way of your making the most of your finances. By avoiding these misconceptions, you’ll be better able to take control of your cash, budget, save, and invest wisely. These moves can not only help you achieve your goals, they can enhance your peace of mind, too.

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Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy 3.30% APY on SoFi Checking and Savings with eligible direct deposit.

FAQ

What is the biggest misconception people have about money?

There are many negative beliefs about money. Some include believing only rich people should invest their funds and that a person doesn’t need to think about retirement saving when they are young. These misconceptions can keep people from reaching their financial goals.

Is it true that you need money to make money?

While having money can help you make money, it’s not a requirement. By budgeting well and saving regularly (even small amounts), you can work toward generating wealth. A person who makes $50,000 could be wealthier than one who makes a multiple of that if they manage their money more wisely.

Why is it so hard to talk about personal finances?

It can be hard to talk about personal finances because many people are raised with the belief that one should never discuss money. It’s a myth about money that it’s a taboo topic. Unfortunately, this secrecy leads people not to share information that could help one another manage money better. Also, typically financial management skills aren’t taught in school, so many people clam up about the topic since they feel ignorant about it.

What’s a simple first step to fix my money mindset?

Often, the simple first step to fix your money mindset is to think about and recognize your attitudes. Do online research about money management and talk to friends whose money management you respect. Look at the interest rates on your credit card and student loans, try budgeting apps, and take other small steps that begin to put you in the driver’s seat financially rather than believing prevailing wisdom.

Maybe you think that there’s no point saving for retirement until you’re older or that investing is only for the rich. By being honest about your beliefs and then working to educate yourself and take steps toward financial management, you can fix your money mindset.

Is carrying a small credit card balance good for my score?

If you’ve wondered about what are some common money misconceptions, this is one! Carrying a balance doesn’t build your credit score. Among the habits that help maintain and build your credit score are always paying your card on time and keeping your credit utilization ratio (your balance vs. your credit limit) as low as possible. Under 30%, if not under 10%, is considered a good level.

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If you’re looking for a tool you can use to borrow money when you need it, you may be wondering which is the best choice: a personal line of credit, a personal loan, or a home equity line of credit (HELOC).

In this guide we’ll compare these three types of loans. The two credit lines both function similarly to a credit card but typically have a lower interest rate and a higher credit limit, while a personal loan can provide you with a lump sum of cash that you pay back over a set term. We’ll also cover some of the pros and cons of using a HELOC vs. a personal line of credit vs. a personal loan.

What Is a Personal Loan?

A personal loan is a highly flexible way to borrow a lump sum of money for virtually any reason – from paying medical bills to financing a wedding. You may be able to borrow anywhere from $1,000 to potentially as much as $100,000, typically at a fixed rate, and pay it back in regular monthly installments over a preset period of two to seven or even 10 years. These loans are usually unsecured debt, which means you don’t have to use collateral to qualify. The rate and other terms are determined by the borrower’s credit score, income, debt level, and other factors.

You’ll owe interest from day one on the full amount that you borrow. But if you’re using the loan to make a large purchase, consolidate debt, or pay off one big bill, it may make sense to borrow a specific amount and budget around the predictable monthly payments.

Personal loan rates and fees can vary significantly by lender and borrower. You can use a loan comparison site to check multiple lenders’ rates and terms, or you can go to individual websites to find a match for your goals.

What Is a Personal Line of Credit?

A personal line of credit, sometimes shortened to PLOC, is a revolving credit account that allows you to borrow money as you need it, up to a preset limit.

Instead of borrowing a lump sum and making fixed monthly payments on that amount, as you would with a traditional installment loan, a personal line of credit allows you to draw funds as needed during a predetermined draw period. You’re required to make payments based only on your outstanding balance during the draw period.

In that way, a PLOC works like a credit card. Generally, you can pay as much as you want each month toward your balance, as long as you make at least the minimum payment due. The money you repay is added back to your credit limit, so it’s available for you to use again.

You can use a personal line of credit for just about anything you like as long you stay within your limit, which could range up to $50,000, and possibly more.

Like a personal loan, a PLOC is typically unsecured, so you don’t need collateral. The lender will base decisions about the amount you can borrow and the interest rate you’ll pay on your personal creditworthiness. The interest rates are generally variable.

Can a Personal Loan or a Personal Line of Credit Be Used to Buy a House?

If you could qualify for a high enough credit limit — or if the property you want to buy is being sold at an extremely low price — you might be able to purchase a house with a personal line of credit or a personal loan. But it may not be the best tool available.

A traditional mortgage, secured by the home that’s being purchased, may have lower overall costs than a personal loan or personal line of credit. There are several different types of mortgage loans to choose from.

If you’re looking at a personal loan vs. a personal line of credit or mortgage, it’s also important to realize that a personal loan is usually for a much shorter term than a mortgage, which is typically 30 years, or most PLOCs. And since personal loans, like PLOCs, are unsecured, they typically carry much higher interest rates than traditional mortgages.

A variable rate, which is typical of personal lines of credit, might not be the best option for a large purchase that could take a long time to pay off. Your payments could go lower, but they also could go higher. If interest rates increase, your loan could become unaffordable. With a traditional mortgage, you would have the option of a fixed rate or a variable one.

Another consideration: If you use all or most of your PLOC to make a major purchase like a home, it could have a negative impact on your credit score and future borrowing ability. The amount of revolving credit you’re using vs. how much you have available — your credit utilization ratio — is an important factor that affects your credit score. The rule of thumb is typically to aim for less than 30%.

What Is a HELOC?

A HELOC is a revolving line of credit that is secured by the borrower’s home. It, too, usually has a variable interest rate.

Lenders typically will allow you to use a HELOC to borrow a large percentage of your home’s current value minus the amount you owe. That’s your home equity.

A lender also may review your credit score, credit history, employment history, and debt-to-income ratio (monthly debts / gross monthly income = DTI) when determining your borrowing limit and interest rate.

Recommended: Learn More About How HELOCs Work

Personal Line of Credit vs HELOC Compared

If you’re comparing a personal line of credit with a HELOC, you’ll find many similarities. But there are important differences to keep in mind as well.

Personal Loan vs HELOC Compared

If you’re looking at a HELOC vs. a personal loan, you’ll find many ways in which the two are different, but also some ways they’re alike.

Similarities

Here are some shared aspects of a personal loan vs. a home equity line of credit.

•   The money that you borrow can be used for virtually any purpose you choose.

•   Easy access to your money. A personal loan gives you the money in a lump sum and a HELOC allows you to draw funds at will (up to a set limit) during the draw period.

•   You must pay interest on your loan, and rates are typically lower than they would be for credit cards, for instance.

•   There are defined periods during which your loan and interest must be repaid in regular installments.

•   Lenders may charge a variety of fees, including late or prepayment fees on either. Be sure you know about potential fees before closing.

Differences

There are also many points of difference to take into account when you’re considering a HELOC vs. a personal loan.

•   HELOCs are secured by your house, which serves as collateral. Personal pans are typically unsecured. This means that your interest rate is likely to be higher with a personal loan.

•   HELOCs are revolving lines of credit and work like credit cards – you use what you need when you need it. A personal loan generally comes as a lump sum.

•   Personal loans typically have fixed interest rates, meaning that your monthly payments will always be the same for the length of the loan. HELOCs typically have adjustable rates, meaning that your payments can change with the market as well as with how much you withdraw.

•   Personal loans generally have terms of 10 years at most. HELOCs often have a 10-year draw period followed by a 20-year repayment period, for a total of 30 years.

•   Lender requirements vary, but you’ll generally need a FICO® score of at least 610 for a personal loan, while for a HELOC, it may be 680. Higher scores are likely to result in better interest rates and possibly higher loan limits.

•   Since your home is collateral for a HELOC, you may need to pay for an appraisal to establish how much your home is worth. Depending on your lender, you may also need to pay other closing costs.

Personal Loan vs. Home Equity Line of Credit
	Personal Loan	HELOC
Flexible borrowing and repayment	✓	✓
Convenient access to funds	✓	✓
Annual or monthly maintenance fee	Not typically	Varies by lender
Typically a variable interest rate		✓
Secured with collateral		✓
Approval based on creditworthiness	✓	✓
Favorable interest rates	✓*	✓*
*Rates for secured loans are usually lower than for unsecured loans. Rates for personal loans are generally lower than credit card rates.

Personal Line of Credit vs HELOC Compared

If you’re comparing a personal line of credit with a HELOC, you’ll find many similarities. But there are important differences to keep in mind as well.

Similarities

Here are some ways in which a personal line of credit and a HELOC are alike:

•   Both are revolving credit accounts. Money can be borrowed, repaid, and borrowed again, up to the credit limit.

•   Both have a draw period and a repayment period. The draw period is typically 10 years, with monthly minimum payments required. The repayment period may be up to 20 years after the draw period ends.

•   Access to funds is convenient. Withdrawals can be made by check or debit card, depending on how the lender sets up the loan.

•   Lenders may charge monthly fees, transaction fees, or late or prepayment fees on either. It’s important to understand potential fees before closing.

•   Both typically have variable interest rates, which can affect the overall cost of the line of credit over time. (Each occasionally comes with a fixed rate. The starting rate of a fixed-rate HELOC is usually higher. The draw period of a fixed-rate personal line of credit could be relatively short.)

•   For both, you’ll usually need a FICO® score of 680. Your credit score also affects the interest rate you’re offered and credit limit.

Differences

The biggest difference when you’re looking at a personal line of credit vs. a home equity line of credit is that a HELOC is secured. That can affect the borrower in a few ways, including:

•   In exchange for the risk that HELOC borrowers take (they could lose their home if they were to default on payments), they generally qualify for lower interest rates. HELOC borrowers also may qualify for a higher credit limit.

•   With a HELOC, the lender may require a home appraisal, which might slow down the approval process and be an added expense. HELOCs also typically come with other closing costs, but some lenders will reduce or waive them if you keep the loan open for a certain period — usually three years.

•   A borrower assumes the risk of losing their home if they default on a HELOC. A personal line of credit does not come with a risk of that significance.

Personal Line of Credit vs. Home Equity Line of Credit
	Personal LOC	HELOC
Flexible borrowing and repayment	✓	✓
Convenient access to funds	✓	✓
Annual or monthly maintenance fee	Varies by lender	Varies by lender
Typically a variable interest rate	✓	✓
Secured with collateral		✓
Approval based on creditworthiness	✓	✓
Favorable interest rates	✓*	✓*
*Rates for secured loans are usually lower than for unsecured loans. Rates for personal loans are generally lower than credit card rates.

Recommended: Credit Cards vs. Personal Loans

Pros and Cons of HELOCs

A HELOC and personal line of credit share many of the same pros and cons. An advantage of borrowing with a HELOC, however, is that because it’s secured, the interest rate may be more favorable than that of a personal line of credit or a personal loan.

A HELOC may offer a tax benefit if you itemize, spend the funds on buying, building or significantly improving your home, and can take the mortgage interest deduction. But there are potential downsides, too.

Pros and Cons of Personal Loans

A personal loan can be a good choice when you need a lump sum of money – say, for a major purchase or bathroom remodel – especially if it’s not an extremely large amount. You’re likely to get a better interest rate than you would on a credit card, and a shorter repayment term than you’d have for a PLOC or HELOC. But there’s a lot to consider.

Pros and Cons of Personal Lines of Credit

Because you draw just the amount of money you need at any one time, a personal line of credit can be a good way to pay for home renovations, ongoing medical or dental treatments, or other expenses that might be spread out over time.

You pay interest only on the funds you’ve drawn, not the entire line of credit that’s available, which can keep monthly costs down. As you make payments, the line of credit is replenished, so you can borrow repeatedly during the draw period. And you don’t have to come up with collateral.

But there are other factors to be wary of. Here’s a summary.

Alternatives to Lines of Credit

As you consider the pros and cons of a HELOC vs. a personal LOC or personal loan, you may also wish to evaluate some alternative borrowing strategies, including:

Personal Loan

As you’re thinking about a personal loan vs. a personal line of credit, the big difference is that, with a personal loan, a borrower receives a lump sum and makes fixed monthly payments, with interest, until the loan is repaid.

Most personal loans are unsecured, and most come with a fixed interest rate. The rate and other terms are determined by the borrower’s credit score, income, debt level, and other factors.

You’ll owe interest from day one on the full amount that you borrow. But if you’re using the loan to make a large purchase, consolidate debt, or pay off one big bill, it may make sense to borrow a specific amount and budget around the predictable monthly payments.

Personal loan rates and fees can vary significantly by lender and borrower. You can use a loan comparison site to check multiple lenders’ rates and terms, or you can go to individual websites to find a match for your goals.

Auto Loan

If you’re thinking about buying a car with a personal loan, you may want to consider an auto loan, an installment loan that’s secured by the car being purchased. Qualification may be easier than for an unsecured personal loan or personal line of credit.

Most auto loans have a fixed interest rate that’s based on the applicant’s creditworthiness, the loan amount, and the type of vehicle that’s being purchased.

Down the road, if you think you can get a better interest rate, you can look into car refinancing.

Beware no credit check loans. Car title loans have very short repayment periods and sky-high interest rates.

Mortgage

A mortgage is an installment loan that is secured by the real estate you’re purchasing or refinancing. You’ll likely need a down payment, and borrowers typically pay closing costs of 2% to 5% of the loan amount.

A mortgage may have a fixed or adjustable interest rate. An adjustable-rate mortgage typically starts with a lower interest rate than its fixed-rate counterpart. The most common repayment period, or mortgage term, is 30 years.

Your ability to qualify for the mortgage you want may depend on your creditworthiness, the down payment, and the value of the home.

Credit Cards

A credit card is a revolving line of credit that may be used for day-to-day purchases like groceries, gas, or online shopping. You likely have more than one already. Gen X and baby boomers have an average of about four credit cards per person, Experian® has found, and even Gen Z, the youngest generation, averages two cards per person.

Convenience can be one of the best and worst things about using credit cards. You can use them almost anywhere to pay for almost anything. But it can be easy to accrue debt you can’t repay.

Because most credit cards are unsecured, interest rates can be higher than for other types of borrowing. Making late payments or using a high percentage of your credit limit can hurt your credit score. And making just the minimum payment can cost you in interest and credit score.

If you manage your cards wisely, however, credit card rewards can add up. And you may be able to qualify for a low- or no-interest introductory offer.

Credit card issuers typically base a consumer’s interest rate and credit limit on their credit score, income, and other financial factors.

Student Loans

Federal student loans typically offer lower interest rates and more borrower protections than private student loans or other lending options.

But if your federal financial aid package doesn’t cover all of your education costs, it could be worth comparing what private lenders offer.

Home Equity Loans

If you’re a homeowner with equity in your house and you’re not comfortable with the adjustable payments of a HELOC, you might want to consider a home equity loan. These lump sum loans typically have fixed interest rates, meaning that you’ll know in advance what your payments will be every month and can plan accordingly. And since they’re secured with your home, interest rates are typically lower than they’d be for unsecured loans. Just remember that, as with a HELOC, your home is at risk if you can’t make your payments.

The Takeaway

A HELOC, a personal loan, or a personal line of credit can be useful for a borrower in need of funds. Each kind of loan has different advantages and drawbacks, so it’s important to consider each carefully in light of your financial situation so you can assess what would work best for your needs.

SoFi now partners with Spring EQ to offer flexible HELOCs. Our HELOC options allow you to access up to 90% of your home’s value, or $500,000, at competitively lower rates. And the application process is quick and convenient.

Unlock your home’s value with a home equity line of credit from SoFi, brokered through Spring EQ.

FAQ

What is better, a home equity line of credit or a personal line of credit?

If you qualify for both, a HELOC will almost always come with a lower interest rate. However, it does put your home at risk if you can’t make your payments.

Can I use a HELOC for personal use?

Yes. HELOC withdrawals can be used for almost anything, but the line of credit is best suited for ongoing expenses like home renovations, medical bills, or college expenses. Some people secure a HELOC as a safety net during uncertain times.

How many years do you have to pay off a HELOC?

Most HELOCs have a “draw period” of 10 years, followed by a repayment period, which may be up to 20 years.

What happens if you don’t use your home equity line of credit?

Having a HELOC you don’t use could help your credit score by improving your credit utilization ratio.

How high of a credit score is needed for a line of credit?

Personal lines of credit are usually reserved for borrowers with a credit score of 680 or higher. A credit score of at least 680 is typically needed for HELOC approval, but requirements can vary among lenders. Some may be more lenient if an applicant has a good debt-to-income ratio or accepts a lower loan limit.

Does a HELOC increase your mortgage payments?

The HELOC is a separate loan from your mortgage. The two payments are not made together.

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Photo credit: iStock/KTStock

^²SoFi Bank, N.A. NMLS #696891 (Member FDIC), offers loans directly or we may assist you in obtaining a loan from SpringEQ, a state licensed lender, NMLS #1464945.
All loan terms, fees, and rates may vary based upon your individual financial and personal circumstances and state.
You should consider and discuss with your loan officer whether a Cash Out Refinance, Home Equity Loan or a Home Equity Line of Credit is appropriate. Please note that the SoFi member discount does not apply to Home Equity Loans or Lines of Credit not originated by SoFi Bank. Terms and conditions will apply. Before you apply, please note that not all products are offered in all states, and all loans are subject to eligibility restrictions and limitations, including requirements related to loan applicant’s credit, income, property, and a minimum loan amount. Lowest rates are reserved for the most creditworthy borrowers. Products, rates, benefits, terms, and conditions are subject to change without notice. Learn more at SoFi.com/eligibility-criteria. Information current as of 06/27/24.
In the event SoFi serves as broker to Spring EQ for your loan, SoFi will be paid a fee.

*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.

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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.

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

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.

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.

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

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

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Whether you’re borrowing money from a lender or depositing money in a savings account, interest rates will play into your financial picture. Understanding exactly how they work is crucial to making the best possible decisions for your money and hitting your financial goals.

This guide provides the information you need to understand interest rates and how they work.

Interest Rate Definition

Interest rate is the cost of borrowing or the payoff of saving. Specifically, it refers to the percentage of interest a lender charges for a loan as well as the percentage of interest earned on an interest-bearing account or security.

Interest rates change frequently, but the average personal loan interest rate is dependent on several factors, including the amount borrowed, credit history, and income, among others. A borrower with an excellent credit score and a dependable income, for instance, will likely be considered low risk and may be offered a lower interest rate. On the flip side, some vehicles like payday loans are considered riskier for lenders and tend to have higher interest rates.

Recommended: What Is a No-Interest Loan? A Personal Loan Guide

How Interest Rates Work

Whether you’re borrowing or saving money, the interest rate is applied to the balance during set periods of time called compounding periods.

For borrowers, this extra charge can add to outstanding debt. For savers, savings interest can be one way to earn money without much effort.

Here, some specific examples.

You might take out a personal loan with an APR of 6.99%. That means you’ll pay an additional 6.99% of the loan balance each year in addition to the principal payments, which is paid to the lender for servicing the loan.

Or, if you hold a high-yield savings account that offers a 4.00% APY return, you can expect that account to grow by 4.00% of its balance each year. How often the interest is compounded will also impact the growth you enjoy.

Of course, the interest you might earn in a savings account is usually substantially lower than what you might earn on higher-risk investments.

And when it comes to any of the multiple uses of a personal loan, paying interest means you’re paying substantially more than you would if you were able to cover the expense out of pocket. However, you may be paying considerably less than if you were to use credit cards for a purchase.

Fixed vs Variable Interest Rates

Lenders charge fixed or variable interest rates.

As the name suggests, fixed interest rates remain the same throughout a set period of time or the entire term of the loan. Fixed rates can be higher than variable rates. Borrowers who prefer more predictable payments — or are borrowing when interest rates are low — may decide to go with a fixed-rate loan.

Pros of Fixed Interest Rates	Cons of Fixed Interest Rates
Rates won’t increase	Fixed rates can be higher than variable rates
Predictable monthly payments	Borrowers would need to refinance to get a lower rate, which may involve paying more in fees
Consistent payment schedule can make budgeting easier	Borrowers won’t benefit if interest rates decrease

Variable interest rates change periodically, depending on changes in the market. This means the amount of your payments will vary. Generally speaking, variable-rate loans can be riskier for consumers, so they tend to have lower initial rates than fixed-rate loans. However, it’s important to note that when interest rates rise, so can the cost of borrowing. When borrowers decide to renegotiate from a variable-rate to a fixed-rate loan, they may face additional fees and a new loan length.

A variable-rate loan may be a good move for borrowers who plan to pay off the loan quickly or can take on the risk.

Pros of Variable Interest Rates	Cons of Variable Interest Rates
Monthly payments may go down when interest rates decrease	Interest rates fluctuate depending on changes in the market
Rates can be lower (at first) than fixed-rate loans	Repayment amounts can vary, which can make budgeting difficult
Borrowers may receive better introductory rates when taking out a loan	May face extra fees and extended payoff time if you renegotiate to a fixed-rate loan

Types of Interest

While all interest does one of two things — accrue as a result of saving money or in payment to the bank for a loan — it can be calculated and assessed in different ways. Here are a few common types of interest rates explained.

Simple Interest

Simple interest is interest that is calculated, simply, based on the balance of your account or loan. This is unlike compound interest, which is based on the principal balance (the original money you borrowed) as well as interest accrued over time.

Most mortgages and auto loans are calculated using simple interest. That means you won’t pay additional interest on any interest charged on the loan.

For example, say a driver takes out a simple interest loan to pay for a new car. The loan amount is $31,500, and the annual interest rate on the loan is 4%. The term of the loan is five years. The driver will pay $580.12 per month. After five years, when the loan is satisfied, they will have paid a total of $34,807.23.

Compound Interest

Compound interest, on the other hand, means that interest is charged on not only the principal but also whatever interest accrues over the lifetime of that loan.

Say you take out an unsecured personal loan in the amount of $20,000 to pay for home remodeling. The loan is offered to you at an interest rate of 6.99% compounded monthly, and you must also pay an upfront fee of $500 for the loan. You’ll pay it back over the course of five years.

Over the course of those 60 payments, you’ll pay $3,755.78 in interest, not including the $500 extra you paid in fees. Each month, you’ll pay back some of the principal as well as the interest charged to you.

By the time you’re done with your home remodel, you’ll have paid $24,255.78 altogether, and that’s on a personal loan with a fairly low rate. In other words, you’ll have paid 20% more for the project than you would have if you’d funded it out of pocket.

Recommended: Simple Interest vs. Compound Interest

Amortized Interest

Amortizing loans are common in personal finance. If you have a home loan, auto loan, personal loan, or student loan, you likely have an amortizing loan.

Amortization is when a borrower makes monthly (usually equal) payments toward the loan principal and interest. Early payments largely go toward the calculated interest, while payments closer to the end of the loan term go more toward the principal.

The interest on an amortized loan is calculated based on the balance of the loan every time a payment is made. As you make more payments, the amount of interest you owe will decrease.

To see how payments are spread out over the life of the loan, borrowers can consult an amortization schedule. A mortgage calculator also shows amortization over time for a loan.

But here’s a look at a sample calculation:

Let’s say you take out a $200,000 mortgage over 10 years at a 5% fixed interest rate. Your monthly payments will be $2,121.31. Next, divide the interest rate by 12 equal monthly payments. That equals 0.4166% of interest per month. This means that in the first month of your loan, you’ll pay $833.33 toward interest and the remaining $1,287.98 toward your principal.

Now, how about the second month? To calculate what you’ll owe, deduct your monthly payment from the starting balance. (This will give you the “balance after payment” for the chart.) Be sure to add to the chart the $833.33 you paid in interest and the $1,287.98 you paid toward the principal. Repeat the calculation of monthly interest and principal breakdown for the rest of the chart, which includes 12 months of payments.

Date	Starting Balance	Interest	Principal	Balance after payment
August 2025	$200,000	$833.33	$1,287.98	$198,712.02
September 2025	$198,712.02	$827.97	$1,293.34	$197,418.68
October 2025	$197,418.68	$822.58	$1,298.73	$196,119.95
November 2025	$196,119.95	$817.17	$1,304.14	$194,815.80
December 2025	$194,815.80	$811.73	$1,309.58	$193,506.23
January 2026	$193,506.23	$806.28	$1,315.03	$192,191.19
February 2026	$192,191.19	$800.80	$1,320.51	$190,870.68
March 2026	$190,870.68	$795.29	$1,326.02	$189,544.66
April 2026	$189,544.66	$789.77	$1,331.54	$188,213.12
May 2026	$188,213.12	$784.22	$1,337.09	$186,876.03
June 2026	$186,876.03	$778.65	$1,342.66	$185,533.37
July 2026	$185,533.37	$773.06	$1,348.25	$184,185.12

Precomputed Interest

Loans that calculate interest on a precomputed basis are less common than loans with either simple or compound interest. They’re also controversial and have been banned in some states. Precomputed interest has been banned nationally since 1992 for loans with terms longer than 61 months.

This method of computing interest is also known as the Rule of 78 and was originally based on a 12-month loan. The name is taken from adding up the numbers of the months in a year (or a 12-month loan), the sum of which is 78.

1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10 + 11 + 12 = 78

Interest is calculated ahead — precomputed — for each month and added to each month’s payment, giving more weight to interest in the beginning of the loan and tapering off until the end of the loan term. In the case of a 12-month loan, the first month’s interest would be 12/78 of the total interest, the second month’s interest would be 11/78 of the total interest, and so on.

Here’s an example: Say a borrower takes out a personal loan with a 12-month term that will accrue $5,000 in interest charges. According to the Rule of 78, here’s what the borrower would pay in interest each month:

Month	Fraction of total interest charged	Monthly interest charge
1	12/78	$769
2	11/78	$705
3	10/78	$641
4	9/78	$577
5	8/78	$513
6	7/78	$449
7	6/78	$385
8	5/78	$321
9	4/78	$256
10	3/78	$192
11	2/78	$128
12	1/78	$64

A loan with precomputed interest has a greater effect on someone who plans to pay off their loan early than one who plans to make regular payments over the entire life of the loan.

APR vs APY

Whether compound or simple, interest rates are generally expressed as APR (annual percentage rate) or APY (annual percentage yield). These figures make it easier for borrowers to see what they can expect to pay or earn in interest over the course of an entire year of the loan or interest-bearing account’s lifetime.

However, APY takes compound interest into account, whereas usually APR does not — but on the other hand, APR takes into account various loan fees and other costs, which APY might skip.

APR (Annual Percentage Rate)	APY (Annual Percentage Yield)
Expresses what you pay when you borrow money	Expresses what you earn on an interest-bearing account
Factors in base interest rate over the course of one year	Factors in base interest rate over the course of one year
Factors in fees and other loan costs	Does not factor in fees and other loan costs
Does not factor in compounding	Factors in compounding

Recommended: APY vs. Interest Rate: What’s the Difference?

How Are Interest Rates Determined?

Lenders use several factors to determine the interest rate on a personal loan, including details about your financial background and about the loan itself.

When lenders talk about a borrower’s creditworthiness, they’re usually referring to elements of your financial background. This may include:

•   Your credit history

•   Your income and employment

•   How much debt you already have

•   Whether you have a cosigner

The loan terms can also affect the rate. For example, personal loan rates can be affected by:

•   The size of the loan

•   The duration of the loan

Loan term is something borrowers should be thinking about as well. A longer loan term might sound appealing because it makes each monthly payment lower. But it’s important to understand that a longer-term loan may cost you significantly more over time due to interest charges accumulating.


💡 Quick Tip: In a climate where interest rates are rising, you’re likely better off with a fixed interest rate than a variable rate, even though the variable rate is initially lower. On the flip side, if rates are falling, you may be better off with a variable interest rate.

Interest Rates and Discrimination

Generally speaking, the higher your credit score and income level, the easier it is to qualify for loans with better terms and lower interest rates — which, of course, can make it more difficult for people in lower socioeconomic positions to climb their way out.

Discriminatory lending has had a long history in the U.S. Before federal laws protecting against discrimination in lending practice, lenders would regularly base credit decisions on factors such as applicant’s race, color, religion, sex, and other group identifiers rather than their creditworthiness.

The practice of “redlining” was begun in the 1930s as a way to restrict federal funding for neighborhoods deemed risky by federal mortgage lenders. It persisted for decades, and the detrimental effects can still be felt today by residents of minority neighborhoods.

Since residents of redlined neighborhoods were excluded from approval for regular mortgage loans, they were forced to look for other financing options, which were often exploitive. If they could not find any lender willing to loan to them, they continued renting, unable to gain equity in homeownership.

The Takeaway

The interest rate is the cost of borrowing money — it’s a percentage of the total amount of the loan. It can also refer to the rate at which interest is earned on money in a savings account, certificate of deposit, or certain investments. The amount of interest you’ll pay is usually expressed using percentages, which will be listed as either APR (annual percentage rate) or APY (annual percentage yield), depending on which kind of financial product you’re talking about. When borrowing, it can be wise to access the lowest rates possible to minimize the interest you pay.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.

SoFi’s Personal Loan was named a NerdWallet 2026 winner for Best Personal Loan for Large Loan Amounts.

FAQ

What is the definition of interest rate?

An interest rate is expressed as a percentage and is used to calculate how much interest you would pay on a loan in one year (APR), or how much you would earn on an interest-bearing account in one year (APY).

What is an example of an interest rate?

Simple, compound, or precomputed interest rates are types of interest rates commonly used.

What is the difference between interest and interest rate?

Interest is the money you’re charged when you take out a loan — or earn for leaving your money in a deposit account to grow. Interest rate is the percentage you’re being charged or are earning.

What happens when interest rates are high?

Interest rate increases tend to lead to higher interest rates on personal loans, mortgages, and credit cards. It can also mean costlier financing for borrowers.

Can you adjust the interest rate on a personal loan?

Possibly. One way to lower the interest rate on a personal loan is to refinance it with another lender.

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Photo credit: iStock/Remitski

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.

*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

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

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A no-interest, or 0%, credit card means you won’t be charged any interest on your purchases for a certain period of time. In some cases, these cards also offer 0% interest on balance transfers for a set period of time.

But these cards also have some potential downsides. For one, the 0% annual percentage rate (APR) is only temporary. Once the promotional period ends, a potentially high APR will start accruing on any remaining balance you have on the card. In addition, you typically have to pay a fee to transfer your balance, which might negate any savings on interest.

Here are key things to know before signing up for a no-interest credit card.

Pros of No-Interest Credit Cards

Using a 0% APR credit card can create some breathing room within your budget. Here’s a look at some of the key perks, and how to make the most of them.

No Interest During the Promotional Period

Of course, one of the biggest advantages of a zero-interest card is that you’ll pay just that — zero interest — for a certain period of time, which may be anywhere from six to 18 months or perhaps a bit longer. If you use the card to make a large purchase and are able to pay it off in full before the end of the promotional period, it can be the equivalent of getting an interest-free loan.

Opportunity to Pay Down Debt Faster

In some cases, you also get the 0% APR on any balance you transfer over from another credit card. This can make a no-interest card a good option for consolidating and paying off high-interest credit card debt. If you have a plan in place to pay off the debt within the promotional period, a balance transfer could improve your financial situation.

💡 Quick Tip: A low-interest personal loan from SoFi can help you consolidate your debts, lower your monthly payments, and get you out of debt sooner.

Perks and Bonus Rewards

Some credit cards with 0% APR introductory rates on purchases and/or balance transfers also have additional rewards bonus programs. This might include a welcome offer and/or cash back or rewards points based on each dollar you spend. These extras can lead to even more savings.

For example, say you want to purchase a new chair that costs $500. After some research, you find a credit card offering an introductory 0% APR for 15 months and a $200 rewards bonus after you spend $500 on purchases within the first three months of opening the account. You decide this will work for your financial situation, so you apply and are approved. After buying the chair with the new credit card, you pay the balance in full before the promotional period ends.

With this example, not only would you have paid nothing in interest, you would also have netted $200 in rewards cash.

Cons of No-Interest Credit Cards

Some might look at no-interest credit cards as too good to be true. That’s not necessarily the case, but there can be some drawbacks to them. Here are some potential pitfalls to be aware of.

Temporary Promotional Rate

Alas, that 0% APR doesn’t last forever. If you use the card for a large purchase but are unable to fully pay it off before the end of the promotional period, any balance will start accruing the card’s regular APR.

At that point, the card may not have any advantages over any other card. In fact, the card could have an APR that is higher than the average credit card interest rate. When comparing 0% rate cards, it’s important to look at what the rate will be when the promo period ends and exactly when it will kick in.

Also keep in mind that you could lose the 0% intro APR before the end of the promo period if you are late with a payment. Here again, it pays to read the fine print.

Fees for Balance Transfers

Some — but not all — no-interest credit cards also feature a 0% APR on balance transfers. However, you typically still have to pay a balance transfer fee, often around 3% to 5% of the transferred balance. If you’re transferring a large balance from another card, the balance transfer fee could actually be significant. You’ll want to do the math before making the switch to be sure it will work in your favor.

Interest May Apply Retroactively

Similar to a no-interest credit card, a deferred-interest credit offer is one that’s commonly a feature of retail or store cards. If you’ve been asked if you’d like to apply for a store’s credit card when you’re making a purchase, it might be one that comes with a deferred interest promotion.

Like no-interest credit cards, a deferred-interest card doesn’t charge interest as long as the balance is paid in full within a certain time period. The biggest difference between the two: If the balance is not paid in full before the promotional period ends, interest will be applied to the entire purchase — not just the remaining balance. And APRs on deferred-interest cards can be even higher than APRs charged by regular credit cards.

Recommended: Personal Loan Calculator

Can Credit Scores Be Affected by No-Interest Credit Cards?

Applying for a new credit card results in a hard inquiry on your credit report, which can have a minor, temporary negative impact on your credit scores. This is generally nothing to worry about.

However, repeatedly opening new credit cards and transferring balances to them can cause a long-term negative impact on your credit. That’s because too many hard inquiries too close together can lead lenders to believe you’re applying for more credit than you can pay back.

While no-interest credit cards have their advantages, credit card debt could escalate. If that occurs, it can be wise to seek credit counseling or look into a credit card consolidation loan, which can offer a lower interest rate and streamlined payments.

The Takeaway

A 0% intro APR card can help you avoid paying interest on your purchases for a set period of time. It can also allow you to consolidate and pay down credit card debt faster.

Keep in mind, however, that cards with no interest often come with a balance transfer fee. Also be aware that your interest rate will likely be much higher when the intro APR offer ends if you haven’t paid off your balance by then. Another option could be paying off high-interest credit cards with a personal loan.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.

SoFi’s Personal Loan was named a NerdWallet 2026 winner for Best Personal Loan for Large Loan Amounts.

FAQ

Is it a good idea to get a zero-interest credit card?

If you make on-time payments and pay off your balance before the intro period ends, then it can be a good idea to get a 0% APR credit card. But if you overspend and carry a balance, you may face high interest rates when the introductory period is over.

Does a 0% credit card affect your credit?

Credit bureaus don’t look at your interest rate, but they do look at your credit limit and what percent of that you are utilizing. So in that way, no-interest cards can impact your credit score. Also, when you apply for one of these cards, the issuer likely conducts a hard credit pull, which will usually lower your score by a few points temporarily.

Is 0% interest a trap?

A 0% interest credit card can be a valuable financial tool if used responsibly. However, if you can’t pay off your balance, when the introductory period ends, you may be stuck with your debt growing thanks to the high interest rate that kicks in. In that way, you could find yourself in a debt trap.

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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.

*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

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

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A Roth 401(k) is a type of retirement plan that may be offered by your employer. You contribute money from your paychecks directly to a Roth 401(k) to help save for retirement.

A Roth 401(k) is somewhat similar to a traditional 401(k), but the potential tax benefits are different.

Here’s what you need to know to understand how Roth 401(k)s work and to decide if it may be the right type of retirement account for you.

Roth 401(k) Definition

A Roth 401(k) combines some of the features of a traditional 401(k) plan and a Roth IRA.

Like a traditional 401(k), a Roth 401(k) is an employer-sponsored retirement account. Your employer may offer to match some of your Roth 401(k) contributions.

Like a Roth IRA, contributions to a Roth 401(k) are made using after-tax dollars, which means income tax is paid upfront on the money you contribute.

History and Purpose of the Roth 401(k)

The Roth 401(k) was first offered in 2006 as a provision of the Economic Growth and Tax Relief Reconciliation Act of 2001. Modeled after the Roth IRA, the Roth 401(k) was created to give employees an employer-sponsored investment savings plan that allowed them to save for retirement with after-tax dollars. Employees with a Roth 401(k) pay taxes on their contributions when they make them and withdraw their money tax-free in retirement, as long as the account has been funded for at least five years.

Originally, the Roth 401(k) was due to expire at the end of 2010, but the Pension Protection Act of 2006 made it permanent.

How a Roth 401(k) Works

Contributions to a Roth 401(k) are typically made directly and automatically from your paycheck. As mentioned above, your contributions are taxed at the time you contribute them, and you pay income taxes on them. In general, your money grows in the account tax-free and withdrawals in retirement are also tax-free, as long as the account has been open at least five years.

Differences Between a Roth 401(k) and a Traditional 401(k)

While a Roth 401(k) shares some similarities to a traditional 401(k), there are some differences between the two plans that you should be aware of. When it comes to 401(k) vs Roth 401(k), these are the differences:

•   Contributions to a Roth 401(k) are made with after-tax dollars and you pay taxes on them upfront. With a traditional 401(k), your contributions are made with pre-tax dollars, and you pay taxes on them later.

•   With a Roth 401(k), your take-home pay is a little less because you’re paying taxes on your contributions now. With a traditional 401(k), your contributions are taken before taxes.

•   Your money generally grows tax-free in a Roth 401(k). And in retirement, you withdraw it tax-free, as long as the account is at least five years old and you are at least 59 ½. With a traditional 401(k), you pay taxes on your withdrawals in retirement at your ordinary income tax rate.

•   You can start withdrawing your Roth 401(k) money at age 59 ½ without penalty or taxes. However, you must have had the account for at least five years. With a traditional 401(k), you can withdraw your money at age 59 ½. There is no 5-year rule for a traditional 401(k).

Recommended: IRA vs 401(k)

How Employer Matching Works in a Roth 401(k)

Roth 401(k)s are typically matched by employers at the same rate as traditional 401(k)s plans. Your employer may match your Roth 401(k) contributions up to a certain amount or percentage, depending on the employer and the plan.

Historically, matching contributions for employees with a Roth 401(k) had to be put into a separate traditional 401(k). But because of the SECURE Act 2.0, this changed in 2023. Now employers have the option to make matching contributions directly into an employee’s Roth 401(k).

There are two main methods employers typically use to match employees’ Roth 401(k) contributions:

•   Partial matching: This is when the employer matches part of an employee’s contribution, usually up to a particular percentage of their salary, such as $0.50 for every employee dollar contributed up to 6% of the employee’s salary.

•   Dollar-for-dollar matching: In this case, the employer matches the employee’s contributions 100%, typically up to a certain percentage of the employee’s salary.

It’s important to note that not all employers offer Roth 401(k) matching. Those who do offer it may have certain stipulations. For example, employees may be required to contribute a specific minimum amount to their Roth 401(k) for the employer match to kick in. Check with your Roth 401(k) plan documents or your HR department to find out about your employer’s policy for matching contributions.

Roth 401(k) Contribution Limits

A Roth 401(k) and a traditional 401(k) share the same contribution limits. Both plans allow for the same catch-up contributions for those 50 and older (learn more about catch-up contributions below).

Here are the 2025 contribution limits for each type of plan.

	Roth 401(k)	Traditional 401(k)
2025 contribution limit for those under age 50)	$23,500	$23,500
2025 standard catch-up contribution limit for individuals age 50 and up	$7,500	$7,500
2025 contribution limit for those 50 and older with standard catch-up	$31,000	$31,000
2025 enhanced catch-up contribution limit for those ages 60 to 63 due to SECURE 2.0	$11,250	$11,250
2025 contribution limit for those ages 60 to 63, per SECURE 2.0	$34,750	$34,750
2025 contribution limit for employee and employer contributions combined	$70,000 $77,500 with standard catch-up $81,250 with enhanced Secure 2.0 catch-up	$70,000 $77,500 with standard catch-up $81,250 with enhanced Secure 2.0 catch-up

Catch-Up Contributions for Those 50 and Older

Individuals who are age 50 and up have the opportunity to make catch-up contributions to a Roth 401(k). Catch-up contributions are additional money individuals can contribute to their Roth 401(k) beyond the standard yearly limit.

So, in 2025, if you contribute the standard annual limit of $23,500 to your Roth 401(k), you have the option of contributing an additional $7,500 for the year — for a total of $31,000, as long as you are age 50 or older. And if you are aged 60 to 63, in 2025, you can take advantage of enhanced SECURE 2.0 catch-up contributions of $11,250 instead of $7,500, for a total of $34,750.

Just like the standard contributions you make to a Roth 401(k), when you make catch-up contributions to your account, you also use after-tax dollars. That means you can withdraw the money tax-free in retirement.

Making catch-up contributions is one important factor to consider when you’re thinking about how to manage your 401(k), especially as you get closer to retirement.

Roth 401(k) Withdrawal Rules

A Roth 401(k) has certain withdrawal rules, including the 5-year rule. Under this rule, an individual can start taking tax-free and penalty-free withdrawals from a Roth 401(k) at age 59 ½ only when they’ve had the account for at least five years.

This means that if you open a Roth 401(k) at age 56, you can’t take tax- or penalty-free withdrawals of your earnings at age 59 ½ the way you can with a traditional 401(k). Instead, you’d have to wait until age 61, when your Roth 401(k) is five years old.

Early Withdrawal Rules

There are some exceptions to the withdrawal rules. For example, it’s possible to take early withdrawals — meaning withdrawals taken before age 59 ½ or from an account that’s less than five years old — from a Roth 401(k) without taxes and penalties, if an individual is disabled or passes away.

Other early withdrawals may be taken as well, but they are subject to taxes and a 10% penalty. However, you may not owe taxes and penalties on the entire amount, only on the earnings.

Here’s how it typically works: You can withdraw as much as you’ve contributed to a Roth 401(k) without paying taxes or penalties because your contributions were made with after-tax dollars. In other words, you’ve already paid taxes on them. Any earnings you withdraw, though, are subject to taxes and penalties, and you’ll owe tax proportional to your earnings.

For example, if you have $150,000 in a Roth 401(k) and $130,000 of that amount is contributions and $20,000 is earnings, those $20,0000 in earnings are taxable gains, and they represent 13.3% of the account. Therefore, if you took an early withdrawal of $30,000, you would owe taxes on 13.3% of the amount to account for the gains, which is $3,990.


💡 Quick Tip: How much does it cost to set up an IRA? Often there are no fees to open an IRA online, but you typically pay investment costs for the securities in your portfolio.

Roth 401(k) RMDs

Previously, individuals with a Roth 401(k) had to take required minimum distributions (RMDs) starting at age 73 (the age for RMDs was raised from 72 to 73 in 2023, thanks to SECURE 2.0). However, in 2024, as a stipulation of SECURE 2.0, RMDs were eliminated for Roth accounts in employer retirement plans.

By comparison, traditional 401(k)s still require taking RMDs starting at age 73.

Pros and Cons of a Roth 401(k)

A Roth 401(k) has advantages, but there are drawbacks to the plan as well. Here are some pros and cons to consider:

Pros

You can make tax-free withdrawals in retirement with a Roth 401(k).
This can be an advantage if you expect to be in a higher tax bracket when you retire, since you’ll pay taxes on your Roth 401(k) contributions upfront when you’re in a lower tax bracket. Your money grows tax-free in the account.

There are no longer RMDs for a Roth 401(k).
Because of the SECURE 2.0 Act, required minimum distributions are no longer required for Roth 401(k)s as of 2024. With a traditional 401(k), you must take RMDs starting at age 73.

Early withdrawals of contributions in a Roth 401(k) are not taxed.
Because you’ve already paid taxes on your contributions, you can withdraw those contributions early without paying a penalty or taxes. However, if you withdraw earnings before age 59 ½, you will be subject to taxes on them.

Cons

Your Roth 401(k) account must be open for at least five years for penalty-free withdrawals.
Otherwise you may be subject to taxes and a 10% penalty on any earnings you withdraw if the account is less than five years old. This is something to consider if you are an older investor.

A Roth 401(k) will reduce your paycheck now.
Your take home pay will be smaller because you pay taxes on your contributions to a Roth 401(k) upfront. This could be problematic if you have many financial obligations or you’re struggling to pay your bills.

Recommended: What Happens to Your 401(k) If You Leave Your Job?

Is a Roth 401(k) Right for You?

If you expect to be in a higher tax bracket when you retire, a Roth 401(k) may be right for you. It might make sense to pay taxes on the account now, while you are making less money and in a lower tax bracket.

However, if you expect to be in a lower tax bracket in retirement, a traditional 401(k) might be a better choice since you’ll pay the taxes on withdrawals in retirement.

Your age can play a role as well. A Roth 401(k) might make sense for a younger investor, who is likely to be earning less now than they may be later in their careers. That’s something to keep in mind as you choose a retirement plan to help reach your future financial goals.

The Takeaway

Participating in a Roth 401(k) through your employer can help you save for retirement. Employees make contributions using after-tax dollars, and the money can be withdrawn tax-free in retirement. Your employer may match your contributions, which is essentially free money.

Of course, a Roth or traditional 401(k) isn’t the only way to save for retirement. Along with an employer-sponsored account, you might want to boost your savings with an IRA or a brokerage account, for instance. Whatever type of accounts you choose, the important thing is to have a retirement savings strategy in place to help make your post-working life as comfortable as possible.

Prepare for your retirement with an individual retirement account (IRA). It’s easy to get started when you open a traditional or Roth IRA with SoFi. Whether you prefer a hands-on self-directed IRA through SoFi Securities or an automated robo IRA with SoFi Wealth, you can build a portfolio to help support your long-term goals while gaining access to tax-advantaged savings strategies.

Help build your nest egg with a SoFi IRA.

FAQ

How is a Roth 401(k) taken out of a paycheck?

Contributions to a Roth 401(k) are automatically deducted from your paycheck. Because contributions are made with after-tax dollars, meaning you pay taxes on them upfront, your paycheck will be lower.

What is the 5-year rule for a Roth 401(k)?

According to the 5-year rule for a Roth 401(k), the account must have been open for at least five years in order for an investor to take qualified withdrawals of their Roth 401(k) earnings at age 59 ½ without being subject to taxes and a 10% penalty.

What happens to a Roth 401(k) when you quit?

When you quit a job, you can either keep your Roth 401(k) with your former employer, transfer it to a new Roth 401(k) with your new employer, or roll it over into a Roth IRA.

There are some factors to consider when choosing which option to take. For instance, if you leave the plan with your former employer, you can no longer contribute to it. If you are able to transfer your Roth 401(k) to a plan offered by your new employer, your money will be folded into the new plan and you will choose from the investment options offered by that plan. If you roll over your Roth 401(k) into a Roth IRA, you will be in charge of choosing and making investments with your money.

Do I need to report a Roth 401(k) on my taxes?

Because your contributions to a Roth 401(k) are made with after tax dollars and aren’t considered tax deductible, you generally don’t need to report them on your taxes. And when you take qualified distributions from a Roth 401(k) they are not considered taxable income and do not need to be reported on your taxes. However, it’s best to consult with a tax professional about your particular situation.

Can you roll over a Roth 401(k) into a Roth IRA?

Yes, you can roll over a Roth 401(k) into a Roth IRA. You can do this, for example, if you leave your job. Rolling over your Roth 401(k) typically gives you a wider range of investment options to choose from. Roth IRA rollovers can be complicated, however, so you may want to consult a tax professional to make sure you don’t incur any unexpected tax situations.

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

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

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