In a rising interest rate climate, especially after historic lows, you may be more aware of purchase interest charges on your credit card statement. These charges are a wordy way of saying interest, which you owe when you don’t pay your credit card statement balance in full.
Americans pay about $120 billion per year in credit card interest and fees — about $1,000 per year for each household. Read on for more about credit card interest, including how it works and how to find your card’s interest rate.
Key Points
• Purchase interest charges on credit cards arise when users fail to pay their full statement balance by the due date, leading to accrued interest on purchases.
• Different types of balances, such as purchases, cash advances, and balance transfers, may incur varying annual percentage rates (APRs), which are detailed in the cardmember agreement.
• Interest is typically calculated daily, using a method that compounds interest charges, making it crucial to pay off balances promptly to avoid accumulating debt.
• To mitigate interest charges, consumers can seek credit cards offering introductory 0% APR promotions, allowing them to pay down balances without incurring interest during the promotional period.
• Awareness of various fees, including late payment and cash advance fees, is essential in managing credit card costs and maintaining financial health.
What Is Credit Card Interest?
Credit card interest is what you’re charged by a credit card issuer when you don’t pay off your statement balance in full each month. Card issuers may charge different annual percentage rates (APRs) for different types of balances such as purchases, balance transfers, cash advances, and others. You may also be charged a penalty APR if you’re more than 60 days late with your payment.
An interest charge on purchases is the interest you are paying on the purchases you make with the credit card but don’t pay in full by the end of the billing cycle in which those purchases were made. The purchase interest charge is based on your credit card’s annual percentage rate (APR) and the total balance on that card — both of which can fluctuate.
Taking a closer look at your credit card balance and interest rate can help you figure out the best way to pay it off. Here’s some information about how purchase interest charges work and, in general, how interest works on a credit card.
Credit cards charge different APRs on purchases, cash advances, and balance transfers. The cardmember agreement that was included when you first received your credit card outlines the different APRs and how they’re charged. This information is also included in brief on each monthly billing statement, or you can contact your credit card issuer’s customer service department for this information. Another place to find how interest works on various credit cards is through the Consumer Financial Protection Bureau, which maintains a database of credit card agreements from hundreds of card issuers.
Some credit cards offer an introductory 0% interest rate. But once that promotional period ends, paying your balance in full each month is how you can avoid interest charges.
For example, you get a new credit card with a $5,000 available credit limit and 0% interest for three months. You use the credit card to buy a new computer that costs $3,000 and a designer dog house for your poodle that costs $1,000.
For each of the three interest-free months you pay only the minimum balance due. But since the full balance hasn’t been paid, your fourth statement will include a purchase interest charge. That is the interest you now owe because you did not pay off your credit card statement balance in full.
Credit card interest is variable, based on the prime rate, and banks typically calculate interest daily. A typical interest calculation method used is the daily balance method.
• The bank will calculate the daily periodic rate, which is the APR divided by 365.
• To each day’s balance, the bank will add any interest charge from the previous day (compounded interest) and any new transactions and fees, then subtract any payments or credits. This is the new daily balance.
• The daily periodic rate is multiplied by the daily balance each day.
• At the end of the billing cycle, each day’s balance is added together, resulting in the amount of interest owed.
• If the amount owed is less than the minimum interest charge shown on the credit card’s fee schedule, the bank will charge the minimum.
You can make a payment toward your balance due at any time — you don’t have to wait until the due date. Since interest is commonly calculated daily, making multiple smaller payments rather than one large payment on the due date is one way to decrease the amount of interest you might owe at the end of the billing cycle. This can be a good strategy to use if you don’t pay your credit card bill in full each month. You’ll still owe some interest, but it may be less.
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What is a Purchase Interest Charge?
Sometimes also known as a finance charge, an interest charge on purchases is simply interest you pay on your credit card balance for purchases you made but didn’t pay in full. If you don’t pay off your balance each billing cycle, a purchase interest charge for the unpaid amount then becomes part of the total balance you owe.
For example, let’s say you owe $1,000 on a credit card, and because you did not pay that $1,000 in full you were charged a purchase interest charge of $90. You now owe $1,090, and then the next month’s purchase interest charge will be calculated based on a balance of $1,090.
This is called compound interest and can lead to a cycle of credit card debt. The interest charges continue to accrue if you’re not paying your balance in full every month.
How Do You Get Rid of a Purchase Interest Charge?
For a temporary reprieve from paying an interest charge on purchases, you might look for a credit card that has an introductory 0% APR. Some credit card issuers offer introductory rates for anywhere from 12 to 18 months for qualified applicants. If you make a plan for paying off the balance before the promotional period ends and you’re diligent about sticking to it, you could forgo paying interest on purchases made during that period.
Some people might choose this strategy rather than taking out a personal loan for a specific purchase. If you’re sure you can pay the balance in full while the APR remains at 0%, it could be a good strategy.
The only sure way not to pay a purchase interest charge is to pay your credit card balance in full each month.
Interest charges on purchases are just one type of interest charged on a credit card. Other transactions and fees may apply and must be disclosed to credit card applicants. The information can be found in a credit card’s rates and fees table often referred to as the “Schumer Box” after legislation introduced by Sen. Chuck Schumer as part of the Truth in Lending Act. The APR for purchases is typically at the top of the list, with others below.
• Balance transfer APR: If you transfer a balance from one credit card to another, this is the rate you’ll pay on the amount of the transfer. You’ll also be charged interest at this APR on any balance transfer fee your card issuer might charge you.
• Cash Advance APR and fee:Cash advance APRs tend to be much higher than purchase APRs, and there’s typically no grace period — interest starts accruing immediately. Like a balance transfer fee, you’ll be charged interest on a cash advance fee, too.
• Penalty APR: If your credit card payment is more than 60 days late, your credit card issuer may increase your APR. If you make the next six consecutive payments on time, the card issuer must reinstate your original APR on the outstanding balance. But they are allowed to keep the higher penalty APR on any new purchases.
In addition to interest charges, there may also be fees charged. All of these fees could potentially accrue interest at their respective rates if the credit card’s balance is not paid in full by the payment due date.
• Annual fee: Some credit cards charge an annual fee to the card holder.
• Balance transfer fee: A fee of 3% to 5%, typically, on the amount transferred.
• Cash advance fee: The greater of a flat dollar amount or a percentage of the cash advance.
• Foreign transaction fee: A percentage of each transaction amount, in U.S. dollars.
• Returned payment fee: Having insufficient funds in the bank account used to pay your credit card bill could result in a returned payment fee.
• Late payment fee: Payments made after the statement due date will incur a late fee of at least $29 and not more than $40.
Where Can I Find My Credit Card’s Interest Rates?
There are several places you can locate your credit card’s interests rates and fees.
Anytime you receive a solicitation for a credit card, which is basically an advertisement, the credit card issuer is required by law to disclose the card’s possible interest rates and fees, as well as how interest is calculated. Since the recipient of this advertisement hasn’t been approved for the credit at this point, these numbers are estimations.
If you are going through a prequalification process for a credit card, the issuer should be able to provide you with more specific APRs so you can decide if that card is a good financial tool for you.
After you’ve been approved, the credit card issuer will mail you a packet containing your physical credit card and detailed information in a cardmember agreement. It’s a good idea to read this document thoroughly so you’re aware of all possible APRs and fees you could be charged.
If you access your credit card account online, you can also find this same detailed information on the card issuer’s website. You can call the card’s customer service telephone number for the information.
The Takeaway
If you’re one of the many people who carry a credit card balance, knowing how much interest you’re paying on different types of charges is important. Interest charges on purchases are likely the most common interest charges, and the amount of interest you may pay can add up quickly.
To keep from paying interest on purchases at all, it’s important to pay your credit card balance in full each month. If you don’t, you’ll accrue interest, which compounds and can create a debt cycle.
3 Personal Loan Tips
Before agreeing to take out a personal loan from a lender, you should know if there are origination, prepayment, or other kinds of fees. If you get a personal loans from SoFi, there are no-fee options.
If you’ve got high-interest credit card debt, a personal loan is one way to get control of it. But you’ll want to make sure the loan’s interest rate is much lower than the credit cards’ rates — and that you can make the monthly payments.
Just as there are no free lunches, there are no guaranteed loans. So beware lenders who advertise them. If they are legitimate, they need to know your creditworthiness before offering you a loan.
Learn more about how a personal loan from SoFi can help you get out of credit card debt.
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There are millions of credit card accounts in the United States alone, and it’s estimated that 84% of adults in the U.S. have at least one credit card. Yet, many people don’t have a firm grasp on the basics of what a credit card is and how credit cards work.
If you have a credit card account, or plan on ever using one, it’s important to understand the fundamentals of credit cards. This ranges from what a credit card is to how credit card interest works to how credit cards relate to credit scores.
A credit card is a type of payment card that is used to access a revolving line of credit.
Credit cards differ from other types of loans in that they offer a physical payment card that is used to make purchases. Traditionally, credit cards are made of plastic, but an increasing number of credit card issuers now offer metal cards, usually for their premium accounts that offer travel rewards.
But a credit card account is much more than a plastic or metal payment card. A credit card account is a powerful financial tool that can serve many purposes. For starters, it can be a secure and convenient method of payment anywhere that accepts credit card payments. It also can be used to borrow money in a cash advance or to complete a balance transfer.
Additionally, credit cards can offer valuable rewards, such as cash back and travel rewards like points or miles. Cardholder benefits can also include purchase protection and travel insurance policies.
If used responsibly, a credit card can help you to build your credit score and history, which can open up new borrowing opportunities. Of course, credit cards can also damage your credit when used irresponsibly. If you rack up debt on your credit card, it can be hard to get it paid off and back in the clear (here, for instance, is what happens to credit card debt when you die).
Credit cards offer a line of credit that you can use for a variety of purposes, including making purchases, completing balance transfers, and taking out cash advances. You can borrow up to your credit limit, and you’ll owe at least the minimum payment each month.
You can apply for a credit card from any one of hundreds of credit card issuers in the U.S. Card issuers include national, regional, and local banks, as well as credit unions of all sizes. Card issuers will approve an application based on the credit history and credit score of the applicant, among other factors.
There are credit cards designed for people with nearly every credit profile, from those who have excellent credit to those with no credit history or serious credit problems. As with any loan, those with the highest credit score will receive the most competitive terms and benefits.
Once approved, you’ll likely receive a credit limit that represents the most you can borrow using the card. Whether your limit is above or below average credit card limit depends on a variety of factors, including your payment history and income.
The credit card is then mailed to the account holder and must be activated before use. You can activate a credit card online or over the phone. So long as your account remains in good standing, it will be valid until the credit card expiration date.
Once activated, the card can be used to make purchases from any one of the millions of merchants that accept credit cards. Each card is part of a payment network, with the most popular payment networks being Visa, Mastercard, American Express, and Discover. When you make a payment, the payment network authenticates the transaction using your card’s account number and other security features, such as the CVV number on a credit card.
Every month, you’ll receive a statement from the card issuer at the end of each billing cycle. The statement will show the charges and credits that have been made to your account, along with any fees and interest changes being assessed.
Your credit card statement will also show your balance, minimum payment due, and payment due date. It’s your choice whether to pay your minimum balance, your entire statement balance, or any amount in between. Keep in mind that you will owe interest on any balance that’s not paid back.
If you don’t make a payment of at least the minimum balance on or before the due date, then you’ll usually incur a late fee. And if you pay more than your balance, you’ll have a negative balance on your credit card.
Credit Card Fees
There are a number of potential fees that credit card holders may run into. For example, some credit cards charge an annual fee, and there are other fees that some card issuers can impose, such as foreign transaction fees, balance transfer fees, and cash advance fees. Cardholders may also incur a late fee if they don’t pay at least the minimum due by their statement due date.
Often, however, you can take steps to curb credit card fees, such as not taking out a cash advance or making your payments on-time. For a charge like an annual fee, cardholders will need to assess whether a card’s benefits outweigh that cost.
3 Common Types of Credit Cards
There are a number of different kinds of credit cards out there to choose from. Here’s a look at some of the more popular types.
Rewards Credit Cards
As the name suggests, rewards credit cards offer rewards for spending in the form of miles, cash back, or points — a rewards guide for credit cards can give you the full rundown of options. Cardholders may earn a flat amount of cash back across all purchases, or they may earn varying amounts in different categories like gas or groceries.
The downside of these perks is that rewards credit cards tend to have higher annual percentage rates (APRs), so you’ll want to make sure to pay off your full balance each month.
Balance Transfer Credit Cards
Balance transfer cards allow you to move over your existing debt to the card. Ideally, this new card will have a lower interest rate, and often they’ll offer a lower promotional rate that can be as low as 0% APR. However, keep in mind that this promo rate only lasts for a certain period of time — after that, the card’s standard APR will kick back in.
Secured Credit Cards
If you’re new to credit or trying to rebuild, a secured credit card can be a good option. Generally, when we talk about credit cards, the default is an unsecured credit card, meaning no collateral is involved. With a secured credit card, you’ll need to make a deposit. This amount will generally serve as the card’s credit limit.
This deposit gives the credit card issuer something to fall back on if the cardholder fails to pay the amount they owe. But if you’re responsible and get upgraded to a secured credit card, or if you simply close your account in good standing, you’ll get the deposit back.
How Does Credit Card Interest Work?
The charges you make to your credit card are a loan, and just like a car loan or a home loan, you can expect to pay interest on your outstanding credit card balance.
That being said, nearly all credit cards offer an interest-free grace period. This is the time between the end of your billing period and the credit card payment due date, typically 21 or 25 days after the statement closing date. If you pay your entire statement balance before the payment due date, then the credit card company or issuer will waive your interest charges for that billing period.
If you choose not to pay your entire statement balance in full, then you’ll be charged interest based on your account’s average daily balance. The amount of interest you’re charged depends on your APR, or annual percentage rate. The card issuer will divide this number by 365 (the number of days in the year) to come to a daily percentage rate that’s then applied to your account each day.
As an example, if you had an APR of 15.99%, your daily interest rate that the card issuer would apply to your account each day would be around 0.04%.
Although they look almost identical, much differs between debit cards vs. credit cards. Really, the only thing that debit cards and credit cards truly have in common is that they’re both payment cards. They both belong to a payment network, and you can use them to make purchases.
With a debit card, however, you can only spend the funds you’ve already deposited in the checking account associated with the card. Any spending done using your debit card is drawn directly from the linked account. Because debit cards aren’t a loan, your use of a debit card won’t have any effect on your credit, positive or negative.
But since it isn’t a loan, you also won’t be charged interest with a debit card, nor will you need to make a minimum monthly payment. You will, however, need to make sure you have sufficient funds in your linked account before using your debit card.
Another key difference between credit cards vs. debit cards is that credit card users are protected by the Fair Credit Billing Act of 1974. This offers robust protections to prevent cardholders from being held responsible for fraud or billing errors. Debit card transactions are subject to less powerful government protections.
Lastly, debit cards rarely offer rewards for spending. They also don’t usually feature any of the travel insurance or purchase protection policies often found on credit cards. You likely won’t be on the hook for an annual fee with a debit card, which is a fee that some credit card issuers do charge, though you could face overdraft fees if you spend more than what’s in your account.
To recap, here’s an overview of the differences between credit cards and debit cards:
Credit cards
Debit cards
Can be used to make purchases
Yes
Yes
Can be used to borrow money
Yes
No
Must deposit money before you can make a purchase
No
Yes
Must make a minimum monthly payment
Yes
No
Can provide purchase protection and travel insurance benefits
Often
Rarely
Can offer rewards for purchases
Often
Rarely
Can help or hurt your credit
Yes
No
Can use to withdraw money
Yes, with a cash advance
Yes
Pros and Cons of Using Credit Cards
Beyond knowing what a credit card is, it’s important to familiarize yourself with the pros and cons of credit cards. That way, you can better determine if using one is right for your financial situation.
To start, notable upsides of using credit cards include:
• Easy and convenient to use
• Robust consumer protections
• Possible access to rewards and other benefits
• Ability to avoid interest by paying off monthly balance in full
• Potential to build credit through responsible usage
However, also keep these drawbacks of using credit cards in mind:
• Higher interest rates than other types of debt
• Temptation to overspend
• Easy to rack up debt
• Various fees may apply
• Possible to harm credit through irresponsible usage
How to Compare Credit Cards
Since there are hundreds of credit card issuers, and each issuer can offer numerous individual credit card products, it can be a challenge to compare credit cards and choose the one that’s right for your needs. But just like purchasing a car or a pair of shoes, you can quickly narrow down your choices by excluding the options that you aren’t eligible for or that clearly aren’t right for you.
Start by considering your credit history and score, and focus only on the cards that seem like they align with your credit profile. You can then narrow it down to cards that have the features and benefits you value the most. This can include having a low interest rate, offering rewards, or providing valuable cardholder benefits. You may also value a card that has low fees or that’s offered by a bank or credit union that you already have a relationship with.
Once you’ve narrowed down your options to a few cards, compare their interest rates and fees, as well as their rewards and benefits. You can find credit card reviews online in addition to user feedback that can help you make your final decision.
Important Credit Card Terms
One of the challenges to understanding how credit cards and credit card payments work is understanding all of the jargon. Here’s a small glossary of important credit card terms to help you to get started:
• Annual fee: Some credit cards charge an annual fee that users must pay to have an account. However, there are many credit cards that don’t have an annual fee, though these cards typically offer fewer rewards and benefits than those that do.
• APR: This stands for annual percentage rate. The APR on a credit card measures its interest rate and fees calculated on an annualized basis. A lower rate is better for credit card users than a higher rate.
• Balance transfer: Most credit cards offer the option to transfer a balance from another credit card. The card issuer pays off the existing balance and creates a new balance on your account, nearly always imposing a balance transfer fee.
• Card issuer: This is the bank or credit union that issues the card to the cardholder. The card issuer the company that issues statements and that you make payments to.
• Cash advance: When you use your credit card to receive cash from an ATM, it’s considered a cash advance. Credit card cash advances are usually subject to a much higher interest rate and additional fees.
• Chargeback: When you’ve been billed for goods or services you never received or that weren’t delivered as described, you have the right to dispute a credit card charge, which is called a credit card chargeback. When you do so, you’ll receive a temporary credit that will become permanent if the card issuer decides the dispute in your favor.
• Due date: This is the date you must make at least the credit card minimum payment. By law, the due date must be on the same day of the month, every month. Most credit cards have a due date that’s 21 or 25 days after the statement closing date.
• Payment network: Every credit card participates in a payment network that facilitates each transaction between the merchant and the card issuer. The most common payment networks are Visa, Mastercard, American Express, and Discover. Some store charge cards don’t belong to a payment network, so they can only be used to make purchases from that store.
• Penalty interest rate: This is a separate, higher interest that can apply to a credit card account when the account holder fails to make their minimum payment on time.
• Statement closing date: This is the last day of a credit card account’s monthly billing cycle. At the end of this day, the statement is generated either on paper or electronically, or both. This is the day on which all the purchases, payments, fees, and interest are calculated.
Credit Cards and Credit Scores
There’s a lot of interplay between credit cards and your credit score.
For starters, when you apply for a new credit card, that will affect your score. This is because the application results in a hard inquiry to your credit file. This will temporarily ding your score, and it will remain on your credit report for two years, though the effects on your credit don’t last as long.
Further, how you use your credit card can impact your credit score — either positively or negatively. Having a credit card could increase your credit mix, for instance. Or, closing a longstanding credit card account may shorten the age of your accounts, resulting in a negative impact to your score.
Making timely payments is key to maintaining a healthy credit score, as is keeping a low credit utilization rate (the amount of your overall available credit you’re currently using). If you max out your credit card or miss payments, that won’t bode well for your credit score. Conversely, staying on top of payments can be a great step toward building your credit.
The Takeaway
Credit cards work by giving the account holder access to a line of credit. You can borrow against it up to your credit limit, whether for purchases and cash advances. You’ll then need to pay back the amount you borrowed, plus interest, which is typically considered to be a high rate vs. other forms of credit. For this reason, it’s important to spend responsibly with a credit card.
Whether you're looking to build credit, apply for a new credit card, or save money with the cards you have, it's important to understand the options that are best for you. Learn more about credit cards by exploring this credit card guide.
FAQ
How does a person shop for a credit card?
To shop for a credit card, start by looking at your credit score to determine what cards you may be able to qualify for. Then, decide what kind of card is best for your needs, such as a card that has a low interest rate, one that will allow you to build credit, or a card that offers rewards. Finally, compare similar products from competing card issuers to assess which is the most competitive offer available to you.
Can I use my credit card abroad?
Yes, most credit card payment networks are available in most countries. As long as you visit a merchant that accepts cards from the same payment network that your card belongs to, then you’ll be able to make a purchase.
How do you use a credit card as a beginner?
If you’re new to credit and working to build your score, you’ll want to make sure you’re as responsible with your card as possible. Pay your bill on time, and aim to pay in full if you can to avoid interest charges. Use very little of your credit limit — ideally no more than 30%. And make sure to regularly review your credit card statements and your credit report. But don’t let any of that scare you away from using your card either — it’s important to regularly use your card for small purchases to get your credit profile built up.
How do credit cards work in simple terms?
Credit cards offer access to a line of credit. You can borrow against that, up to your credit limit, for a variety of purposes, including purchases and cash advances. You’ll then need to pay back the amount you borrowed.
How do payments on a credit card work?
At the end of each billing cycle, you’ll receive a credit card statement letting you know your credit card balance, minimum payment due, and the statement due date. You’ll then need to make at least the minimum payment by the statement due date to avoid late fees and other consequences. If you pay off your full balance, however, you’ll avoid incurring interest charges. Otherwise, interest will start to accrue on the balance you carry over.
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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.
A budget can be a terrific tool to help you understand how much money you have flowing in and out every month. It provides the guidelines and guardrails you may need to avoid overspending and hit your savings goals.
No one likes to feel broke or in debt, and setting up a simple line item budget is a time-tested way to take control of your money. If you’re sick of running out of money before the end of the month or watching your credit card debt climb, this guide to line item budgeting can help.
Read on to learn:
• What is a line item budget?
• What are the pros and cons of a line item budget?
• What are examples of a line item budget?
• How do you set up a line item budget?
What Is a Line Item Budget?
Depending on where you look, you’ll find a variety of budgeting insight and advice. Some tout the benefits of the 50/30/20 rule and others swear by the envelope method. These different budgets can offer flexibility and provide a solid structure for your budget.
However, if you’re looking for specific insights, it could be worth starting with a different approach that offers more granular detail into your expenses and spending habits — a line item budget.
Essentially, line item budgets function by grouping related costs together and creating a clearly organized flow of funds. They also track both income and expenses, giving a more complete and accurate financial picture.
What Is Considered a Line Item?
A line item budget at its core is a list of expected income streams and pre-planned expenses expected over a specific period of time. A line item is simply one of the items on that list.
For example, a line item budget that calculates income from a salaried job and a rental property, plus expenses for a cell phone, car insurance, and a music subscription, would have a total of five line items. A line item budget can have as few or as many line items as needed, and they’re often categorized by type to help keep the budget organized.
It may be helpful to know a bit about how these budgets can work in business, as background for creating your own line item budget. Say a business is creating a new advertising campaign. They might consider:
• Projected expenses: How much they think the cost of creating and executing their advertising materials will cost in the future.
• Previous actual expenses: This will show how much in the past their costs actually were for such endeavors.
• Present-year expenses: This would track the actual expenses being incurred as they create their ads. This could be done week by week or month by month.
In this way, one can track expenses over time and see how spending is trending.
In personal line item budgeting, you will be able to use this technique in a similar way. In addition to focusing on day-to-day spending, saving, and keeping expenses in line, you can also use this sort of household budget to plan for the future and to save.
What Are the Advantages of Using a Line Item Budget?
If you are considering implementing a line item budget, consider these upsides.
Allocating Expenses Is Simple
One of the biggest pros of using this kind of budget is the ease with which they can be created. With just a few clicks on a spreadsheet, you can establish a basic structure and begin to fill in the data that needs to be recorded. And as priorities change, the budget can be changed just as easily to meet those new needs.
Interpreting the Budget Is Easy
Another major advantage of the line item approach: Making a budget this way isn’t only easy to do, it’s also easy to understand. Creating a basic list of categorized income and expenses doesn’t require any specialized accounting degree to decipher. With your phone’s calculator function, you’re good to go.
Planning Your Future Finances
It provides an easy to read, at-a-glance view of what to expect from your expenses in a week’s, month’s or year’s time. And specific amounts are clearly displayed on each individual line. Those looking for budgeting for beginners tips may want to consider a line item budget for these two benefits.
What Are Some Downsides to Line Item Budgets?
Next, it’s worthwhile to recognize the possible drawbacks of line item budgets.
Best for Steady Earners
Line item budgeting usually relies on fixed and steady income and expenses for accuracy. It can work well for managing predictable finances, but if a budget contains line items that fluctuate significantly, it may not balance properly. This can lead to inaccurate calculations.
For instance, a business budget with a line item for income from a candle company may be accurate if the same number of candles is sold each month. However, if the candles are sold during the holiday at a discount, the income would not match the preset number on the line budget, and the final calculations would be incorrect.
Typically Rigid
Another disadvantage of line item budgets is that they are rigid. It’s not uncommon to change spending habits throughout the year to fit changing needs, but those changes aren’t automatically reflected in a line item budget.
Spending adjustments may require extensive budget rewrites in order to accurately capture a new spending plan. With a line budget, any time financial goals change, it requires reviewing and adjusting everything line-by-line in order to stay current.
Requiring Detail
Unlike a budget such as the 50/30/20 rule, in which a person wrangles three big financial buckets (or spending categories), a line item budget does require rigorous accounting of specific expenses. This can be challenging for some people.
Now, in chart form, here are the pros and cons of line item budgets:
Pros of Line Item Budgets
Cons of Line Item Budgets
Simple to manage
Requires detailed record-keeping
Easy to create
Rigid
Good for future planning
Best for steady earners
Budgeting: Is It Worth It?
Budgeting can seem tedious. After a long day (or week) at work, the last thing you may want to do is spend time in front of a screen, plugging in data and recording how much you’ve spent.
But tracking your money can be a powerful exercise. Here are some reasons why budgeting can be worthwhile:
• Tracking your spending can give you direct visibility into your habits and when you understand where your money is going, you can feel empowered to make adjustments.
• Budgeting can be part of a good money mindset. Instead of thinking of budgeting as a series of spending restrictions, you could think of it as a tool you can use. It’s a technique that can give you the freedom to spend money on what is most important to you.
• Setting money goals can provide a structure to help you build out your budget and plan for the future. So, whether you’re saving for retirement, planning a wedding, or jetting off on a trip overseas, having and sticking to a well-crafted budget can help you get there.
• It’s also worth noting that your budget is a living document. It’s okay to make changes. As you adjust your goals or experience or experience changes in your income or lifestyle, you can (and should) make adjustments and changes to fit your new needs. Your life isn’t stagnant, and your budget shouldn’t be either.
Typically, line item budgets are used by small businesses to track their earnings and expenses and compare them from year to year. They lend well to financial analysis, allowing business owners to easily target areas of their business where they may potentially reduce costs — and where there might be room to grow the company.
While businesses typically have different needs than households, creating a line item budget can be helpful in personal finances, too.
Just as they give small businesses insight into opportunities to grow the business or reduce expenses, line item budgets can help manage your personal expenses. Outlining each source of income and expense can reveal personal spending habits and opportunities to reduce one’s cash outflow.
The specific insights you gather from a line item budget, as well as the changes you make, will ultimately depend on your personal goals and overall financial situation.
Deciding What to Include in a Line Item Budget
Deciding to create a line item budget is just the first step. Next, consider which categories are most important for you to include. A personal budget is just that — personal.
Everyone’s financial situation is different, so this list is not the end-all-be-all solution, but here are a few high-level categories you may want to consider.
Bills and Utilities
This category is fairly self explanatory — after all, everyone’s got bills to pay, right? Things worth listing in this category might include water and electricity bills; cable, internet, or phone bills; or any other monthly bill you have on your expense list.
Debt
If you have student loan payments, credit card bills, or other recurring debt payments, include them in your budget. That’s an important area to track.
Education
If you are currently attending school or have kids, you’ll likely want to consider including things like tuition and fees, the cost of books and other supplies, and any other expenses directly related to education costs.
Entertainment
This one is a little broader and can be highly customized depending on personal spending habits. Do you have subscriptions to streaming services? Do you buy lots of books?
Tickets to the movies, museums, or a concert could also be included in this category. Depending on your hobbies and interests, you may find you can expand this with additional detail.
Fees
Think of all the fees charged to your accounts. Late fee on a delayed credit card payment? ATM fees? Add ՚em here. You could add HOA fees and others to this category as well. If you pay an annual fee to your credit card issuer, that goes here as well.
Food
Depending on your eating habits, you could split this up even further in a line item budget into categories like groceries, snacks, and dining out.
Home
Think of things like your rent or mortgage as well as expenses for maintenance and upkeep of your home.
Income
You’ll probably want to include all sources of income, not just your regular 9 to 5. If you’re budgeting as a couple, you can include income for both partners.
Add income earned from having a side hustle or from passive income opportunities, too.
Investments
Add your contributions to all investment accounts including a 401(k), IRA, 529 accounts, or other brokerage accounts.
Medical
Expenses for medications, health, dental, or vision insurance, and co-pays can all be included under this category.
Personal Care
Things like toiletries, vitamins, and beauty supplies would fit into this category. Hair cuts, trips to the nail salon, and massages could be included as well. If desired, you could also include the cost of other self-care practices, like a subscription to a meditation app, gym membership, or exercise classes.
Savings
Money that you put into an emergency fund, vacation fund, or other form of savings should be accounted for in your line item budget, too.
Services
Do you pay for any regular services? You could include things like dry cleaning services, the cost of having a housekeeper, or the fee you pay your babysitter for a night out.
Shopping
Heading to the mall? Shopping expenses like clothing, toys, and even gifts for others, could be added here.
Taxes
If you’re a full-time employee, be sure to note the taxes being taken out of your paycheck. If you are a freelancer or independent contractor, note quarterly taxes in your line item budget.
Transportation and Auto
This is a catch-all category for things like your monthly metro pass, gas, car insurance, auto loan payment, and general maintenance of your vehicle (if you own one).
Travel
Add all costs associated with trips you take here. Things like hotels or lodging, air travel, taxis, travel insurance, and tickets and admission for excursions and seeing the sights.
If you’re road-tripping, you could include the cost of gas, tolls, and other car-related expenses for the trip here too. Also worth including is the cost of food while on the road.
Get up to $300 when you bank with SoFi.
No account or overdraft fees. No minimum balance.
Up to 4.00% APY on savings balances.
Up to 2-day-early paycheck.
Up to $2M of additional FDIC insurance.
Putting Your Line-Item Budget Together
A list this long can seem overwhelming. Take it one step at a time, and, if needed, break the work up over a few days. For instance:
• On day one, gather all of the relevant documents (tax returns, paychecks, credit card statements, etc) and create the skeleton of your line item budget.
• On day two you could aim to make it through recording your income and investments, and maybe half of your expenses.
• On day three you could finish adding data and add any finishing touches or edits.
After creating this line-item budget, you should have a bird’s-eye view of your spending habits. Take a close look at the information, and decide if you are happy with what you see. Now is the time to be honest with yourself and make the changes you feel are necessary. Do you want more money to put towards savings or paying down debt? See how you might alter the numbers as they currently exist for the months ahead.
Want to make cuts to your monthly expenses? Now you know exactly how much money is being spent in each category and where you could stand to hold back. Some ideas to mull over:
• Can you negotiate a less expensive car insurance fee? Experiment with meal planning to see if you can be intentional about your food spending and potentially cut your grocery bill.
• Try adjusting the thermostat setting while you’re asleep or away from your home to cut your energy bill.
• Getting hit with fees on late payments? You might want to add an alert to your calendar or a monthly notification to your phone to remind you when payments are due. Another possible option is to enroll in autopay so you never miss a payment.
Payment history accounts for 35% of your credit score. So making payments on-time consistently could not only eliminate those pesky late fees from your budget but it could also potentially help improve your credit score in the long-term.
A line item budget example can be as simple as using an Excel or Google Sheets spreadsheet. You could even make your own basic line item budget template, if you prefer.
At the top rows, income can be added, say, for a given month. Then, moving down the page, you can list out the various expenses you have.
That will allow you to see your income and cash that is flowing out. To the right of that column of numbers, you can have last month’s expenses, if you like. Some people find it helpful to put their projected income and spending vs. actual income and spending in the other vertical columns. Then they can assess if they are in debt or have excess funds.
You can customize the organization to best suit your needs.
Alternatives to a Line Item Budget
Though simple and intuitive in nature, line item budgets aren’t a perfect fit for everyone. However, there are many different budgeting methods to choose from to fit unique lifestyle needs. A few popular methods are:
50/30/20 Budget
Also known as a proportional budget, the 50/30/20 budget rule focuses on splitting income into three buckets — “needs,” “wants,” and savings. Instead of creating lists of expenditures, you instead commit to spending 50% of your income on things you need to spend on (housing, food, debt, and similar “musts”), 30% on things you want (dining out, travel, and so forth), and the remaining 20% is set aside for savings.
Because spending isn’t tracked on a granular level, spend tracking apps and services can be used to help avoid overspending in any one category.
The envelope method focuses on using physical envelopes and labeling each with a spending category such as food, bills, or entertainment. The envelopes are then filled with the maximum amount of money desired to be spent in each category, and spending throughout the month happens directly from those envelopes.
Once an envelope is empty, no more spending can be done in that category, unless taken from another. This method can be adapted to use a debit card vs. cash.
Zero-Based Budget
Similar to the line item budget, this approach takes account of all income and expenses. The difference is that with this budget, the goal is to make sure that every incoming dollar is allocated to either a saving or a spending purpose, and to leave nothing left over. Automating finances with services like automatic bill-pay and pre-scheduled bank transfers can help with managing this style of budgeting.
The Takeaway
Creating a line item budget can be useful when determining your spending habits. It’s a fairly simple, detailed, and well-organized way to track your earnings and spending, but it’s not always flexible. Also, if you don’t have your budget spreadsheet on hand, it could be more difficult to make changes or check-in while you’re busy living.
Enter SoFi’s Checking and Savings, an account that allows you to review your weekly spending in your dashboard within the SoFi app. With it, you can save, spend, and earn all in one convenient place, which can make staying on budget easier. What’s more, this online account pays a competitive annual percentage yield (APY) while charging no account fees, which can help your money grow faster.
Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.00% APY on SoFi Checking and Savings.
FAQ
What is an example of a line item budget?
A line item budget is a simple, organized way of listing income and spending in detail so you can keep things in balance and see how you are tracking over time. It can be easily made with a basic spreadsheet template.
What is the difference between a line item budget and a program budget?
Line item budgets and program budgets are frequently used in business. Typically, a line item budget will list out individual budget expenses, item by item. In a program budget, however, the spending tends to be grouped into smaller budgets for specific activities or programs. For instance, in a program budget, all the costs related to advertising a new service could be kept together, to show the expenses required to meet that goal.
How do I create a line item budget in Excel?
One simple way to make a line item budget in Excel is to create vertical columns for each month. Starting at the top of each month, you could list various sources of income. Then below that, you could break out, line by line, all of your expenses, such as food, housing, utilities, entertainment, clothing, dining out, travel, transportation, and so on, going down the page.
This can allow you to tally your earning, spending, and saving. As time passes, each vertical column can represent a month of the year. Some people like to enter and compare projected earning, spending, and saving vs. actual; it’s up to you if that suits your needs.
SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.
As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.
SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.
SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.
Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.
Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Can a person on disability buy a house? Yes, if that aspiring homeowner’s income, debt, and credit qualify them for the house they want to buy. Lenders look at those factors for all applicants.
Income can come from Social Security Disability Insurance (SSDI), Supplemental Security Income (SSI), long-term disability from an employer or insurer, or veterans disability compensation.
Let’s take a look at housing rights, how to qualify to buy a house on disability, and home loans that make sense.
Legal Protections for People With Disabilities
The Fair Housing Act prohibits housing discrimination when people are buying or renting a home, applying for a mortgage, or finding housing assistance. That shields people with disabilities, among many others.
Mortgage lenders are not to:
• Approve or deny loans based on an applicant’s disability
• Refuse to provide a mortgage or information about a mortgage to a person with a disability
• Create different terms, rates, or fees for a disabled person
• Appraise a property differently for a disabled person
• Modify homeowners insurance for a person with a disability
• Discriminate in a home loan modification
Section 504 of the Rehabilitation Act of 1973 and the Americans with Disabilities Act (ADA) also stipulate that people with disabilities should not be excluded from federal housing programs offering financial assistance and do require accommodation in the construction and modification of public and commercial spaces.
First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.
How to Buy a Home on Disability
If you receive disability pay and want to buy a house, you might start by seeking prequalification and preapproval for a mortgage.
Preapproval begins with a mortgage loan application, which can be made for many different types of mortgage loans. A lender will look at your credit scores, income, debt, and assets.
If you’re preapproved for a mortgage, the lender will issue a letter with a maximum amount you can likely borrow. Buying a home under this amount gives your loan a good chance of closing because it’s based on hard credit inquiries and documentation you provided.
You may have a chance to buy a house from a family member. If so, a gift of equity is a wonderful one: The relative sells the home to you for less than full market value.
Credit Scores
Your credit scores and history are a big part of qualifying for a mortgage. Your median credit score of three represents your risk to the lender. A higher credit score means you pay your bills on time and are less likely to default.
Lenders often offer the most favorable interest rates to borrowers with credit scores above 740, but a government home loan like an FHA loan is available to people with credit scores as low as 500.
If you have past medical bills or an imperfect credit history as a result of your disability, you can focus on factors that affect your credit score and make improvements as needed. Making on-time payments and paying down debt can go a long way toward helping your credit.
Your disability income counts as long as there is no expiration date on your benefits in the next three years (or you have a guaranteed job waiting with the same pay once you’ve recovered, as can be the case with a maternity leave).
General guidelines suggest looking for a home with a monthly payment that is around 28% of your gross monthly income, or three to five times your yearly income.
Your debt also plays a large factor when your lender determines how much you’re able to borrow.
Lenders will look at your debt-to-income ratio, which is your debt payments each month relative to your monthly income. This number is recommended by lenders to be 43% or less, though the exact ratio will depend on the mortgage loan you’re applying for.
Generally, the lower the number, the better your chances of being approved for the mortgage you want.
To find your DTI ratio, add up your monthly bills (not including groceries, utilities, cellphone bill, car insurance, or health insurance) and divide that sum by your monthly gross income. Then turn it into a percentage.
Sometimes qualifying for a mortgage with your own income isn’t enough. There are assistance programs worth looking into.
Financial Assistance in Your State
One of the first places you can look for homeownership assistance is your individual state. Once you click on your state, you’ll see a link for “homeownership assistance” or “homebuying programs.” From there, you’ll be directed to programs in your area that offer down payment assistance and other help.
Are you a first-time homebuyer, meaning you haven’t owned a principal residence in the past three years? If so, you may qualify for more housing perks than others.
Another reference is the National Council of State Housing Agencies, which has a state-by-state list of housing finance agencies, which cater to low- and middle-income households.
There may be a specialized program to fit your needs. Take a look at some of these options.
Section 8 Housing Choice Voucher Homeownership Program
Most know the Section 8 housing program as providing rental assistance for the elderly, very low-income families, and people with disabilities. But did you know that low-income families may be able to use the vouchers to buy a home and assist with mortgage payments?
The conditions are up to the public housing agencies in your area. Contact information for each state can be found on HUD’s website.
General qualifications may include:
• Be eligible for the Housing Choice Voucher program
• Be a first-time homebuyer
• Family cannot pay more than 40% of monthly income for housing expenses and utilities
• Must meet minimum income standard
• Full-time employment
• Applicant cannot have defaulted on a previous mortgage
• Complete homeownership counseling sessions
VA Loans
Whether you receive Veterans Affairs disability compensation or not, if you’re a veteran, VA home loans make a lot of sense. There’s no down payment and no minimum credit score requirement (although many lenders require a FICO® score of at least 580 to 620). Most borrowers pay a one-time funding fee.
Disabled Veteran Housing Assistance
Veterans who have service-related or aging-related disabilities may be able to qualify for grants through the VA. Three types of grants can be used to modify a home for your needs.
• Specially Adapted Housing or a Special Housing Adaptation grant. This grant allows disabled veterans to buy, build, or modify a home to help them live independently.
• Temporary Residence Adaptation grant. If you’re living with a family member or in another temporary living situation, you may be able to qualify for grant money to modify the home to meet your needs.
• Home Improvements and Structural Alterations grant. This grant allows you to make structural or medically necessary improvements to your home. Veterans may not need to have a service-connected disability to qualify.
FHA Loans
Credit scores of at least 500 are required for an FHA loan. If your credit score is between 500 and 579, you’ll need a 10% down payment. A score above 580 earns the privilege of putting as little as 3.5% down.
Conventional Loans
If you have good credit and a decent down payment, a conventional loan may be a more inexpensive option than an FHA loan.
A Fannie Mae “family opportunity mortgage” can also make sense for a parent who wants to buy a home for an adult disabled child and retain owner-occupant status, even if the parent won’t be living in the home.
A Fannie Mae HomeReady® Mortgage is ideal for low-income borrowers who may need down payment assistance. It allows for a down payment as low as 3% to come from various sources, such as grants, gifts, and “Community Seconds” second mortgages. Borrowers must have a FICO score of at least 620, but a credit score above 680 gets the best pricing.
USDA Loans
The U.S. Department of Agriculture (USDA) has nothing-down options to buy a home through its Rural Development office. Low- and moderate-income buyers in rural areas may apply for a USDA loan through approved lenders. Low- and very-low-income buyers may apply directly to the USDA for a subsidy to lower mortgage payments for a period of time.
The Takeaway
A person who receives disability benefits may be able to buy a house if they qualify based on income, debts, and credit score. There are also programs to help buyers qualify for a mortgage.
If you need a reliable partner in your home-buying journey, give SoFi a look. SoFi offers low-fixed-rate mortgages, and qualifying first-time buyers may put just 3% down.
Can you get preapproved for a mortgage while on disability?
Yes, it is possible to get preapproved for a mortgage while on disability. You’ll submit an application to one or more lenders, which will look at your income, debt, assets, and credit history.
Is it possible to buy a house on disability?
Yes. You will need to show that your disability income will continue for at least three years or that you have a comparable job waiting once you’ve recovered.
Can I buy a house on SSI?
Yes, you can use Supplemental Security Income to qualify for a home as long as there’s no documented expiration date in the next three years. SSI payments alone usually aren’t enough to pay mortgage payments, but it might be possible to buy a house with help from family members.
Photo credit: iStock/baona
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.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Buying a house with bad credit can be challenging, but it’s doable with planning and preparation. Subprime borrowers — homebuyers with lower credit scores — may be eligible for both federally backed loans and conventional mortgages.
If your credit score is less than stellar but you’re ready to buy a home, it’s important to pause and take stock of your finances. This guide will review strategies and steps to secure a mortgage and buy a house with bad credit.
How to Buy a House With Bad Credit
Lenders will consider a number of factors — not just your credit score — when determining if you’ll be approved for a mortgage. Your debt-to-income ratio and proof of income represent a couple of things you need to buy a house.
Figuring out how to buy a house with a so-called bad credit score can vary on a case-by-case basis. These eight tips will help you assess your financial situation and plan accordingly to buy a house with bad credit.
First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.
As the saying goes, knowledge is power. Assessing your credit is a valuable first step to understand where you stand in qualifying for a mortgage.
A credit report can provide a detailed overview of your creditworthiness, including your total debt, payment history, and age of your credit accounts. You can request free credit reports from this site or once a year directly from each of the three major credit reporting companies: Equifax, Experian, and TransUnion.
Upon receipt of your credit reports, it’s important to review any derogatory marks (e.g., late payments) and check for errors. Addressing mistakes could give a quick boost to your credit score.
Many lenders use the FICO® score model to calculate credit scores, from 300 to 850, and categorize them like this.
Exceptional
800-850
Very Good
740-799
Good
670-739
Fair
580-669
Poor
300-579
It’s not uncommon for your FICO score to differ slightly among the three credit reporting companies, so mortgage lenders take the average or use the middle score.
According to the June 2021 Origination Insight Report by Ellie Mae, the average FICO score ranged from 743 to 753 for mortgages that closed in the first half of 2021. Borrowers with credit scores in this range or higher generally receive the most competitive mortgage rates.
Meanwhile, borrowers with credit scores below 650 represented only 6.2% of mortgages in June 2021.
An estimated 30% of U.S. consumers had credit scores in the subprime range, or less than 670, in Q1 of 2021, Experian found. (There is no universal definition of “subprime.” And Experian sometimes uses the term “nonprime,” for the category of borrowers with scores between 601 and 660.)
2. Plan to Pay a Higher Mortgage Interest Rate
Lenders may consider borrowers with poor credit more likely to default on a mortgage loan. To account for this risk, borrowers with lower credit scores usually face higher interest rates.
A modest increase in the mortgage interest rate can bump up your monthly payment and translate to much more interest paid over the life of the loan. For example, a borrower with a 30-year fixed-rate loan of $250,000 at 5% interest would pay $53,468 more in interest than a borrower with a 4% interest rate.
Paying a higher interest rate may be an unavoidable part of buying a house with bad credit. An option is to refinance your mortgage later to secure a lower rate and save on interest, especially if you make timely payments and improve your credit over time.
3. Pay Your Other Debts
How much debt you have and your ability to pay it is another factor lenders weigh when approving mortgage loans. This is captured through your debt-to-income ratio. Your DTI ratio is your monthly debt obligations divided by your gross monthly income and multiplied by 100.
Higher DTI ratios suggest that borrowers have less ability to make monthly payments. A 43% DTI ratio is usually the highest a borrower can have to obtain a qualified mortgage.
Paying off other debts, like credit cards and student loans, can improve your DTI ratio and signal to lenders that you can afford mortgage payments. Reducing your debt can boost your credit score too by lowering your credit utilization ratio, which is a measure of the amount of available revolving credit you use.
4. Draw Up a Budget
Buying a home is exciting, and it’s easy to lose sight of the true cost of homeownership when shopping for your dream home. But this puts you at risk of becoming “house poor,” meaning you have to spend a disproportionately high share of your monthly income on housing.
Although buying a home is a way to build wealth, having little left over from your paycheck makes it hard to save for retirement and realize other financial goals.
The dreaded B-word, budgeting, is a useful way to ensure that you can afford a home before you walk away with the keys.
An effective budget accounts for both the upfront costs of buying a home (down payment and closing costs) and the long-term expenditures. Besides the loan principal and interest, it’s important to consider property taxes, homeowners insurance, and maintenance, as well as private mortgage insurance (PMI) if you plan to put less than 20% down on a conventional loan, or mortgage insurance premiums (MIP) for an FHA loan, no matter the down payment. They add up, but PMI and MIP allow many people to buy homes who otherwise wouldn’t be able to.
You can get a sense of how much your monthly mortgage payment might be with SoFi’s mortgage calculator tool.
If you’re a buyer with subpar credit, putting more money down on a home can be advantageous. A larger down payment means borrowing less money, making the loan less risky to lenders and improving the chances of qualifying with bad credit. A smaller loan amount also accrues less interest.
But of course, saving up for a down payment can be challenging. If you meet first-time homebuyer qualifications, you may be eligible to receive down payment assistance.
Buyers with lower credit scores or less money tucked away for a down payment could benefit from an FHA loan. FHA loans are issued by private lenders but are insured and regulated by the Federal Housing Administration.
Borrowers with credit scores of at least 580 may put just 3.5% down. If your credit score is 500 to 579, you might still qualify, but need to make a 10% down payment. Borrowers who have declared bankruptcy in the past may still qualify for an FHA loan.
Keep in mind that borrowers with higher credit scores who qualify for a conventional (nongovernment) mortgage may put just 3% down.
7. See if You Are Eligible for a VA or USDA Loan
The federal government backs other loan types that can help buyers with fair credit.
Active-duty service members, veterans, or certain surviving spouses may use a VA loan to purchase a primary residence. VA loans usually don’t require a down payment, and the U.S. Department of Veterans Affairs does not set a minimum credit score for eligibility. Lenders have their own requirements, though, so it’s important to compare options.
The U.S. Department of Agriculture guarantees mortgages issued to low- and moderate-income homebuyers in eligible rural areas. No down payment is needed, and the USDA does not specify a credit score requirement. But lenders will still evaluate a borrower’s credit history and ability to pay back the loan.
VA loans typically come with a one-time funding fee that varies; USDA loans, an upfront and annual guarantee fee.
8. Build Up Your Credit Scores
Raising your credit scores can increase your chances of qualifying and securing better loan terms, but it takes time. Negative marks usually stay on your credit reports for seven years.
Paying bills on time, every time, can gradually build up your credit scores. And if possible, it’s a good idea to stay below your credit limits and avoid applying for several credit cards within a short amount of time.
Soft credit inquiries do not affect credit scores, no matter how often they take place. Multiple hard inquiries if you’re rate shopping for an auto loan, mortgage, or private student loan within a short period of time are typically treated as a single inquiry.
But outside of rate shopping, many hard pulls for new credit can lower your credit scores and indicate distress in a lender’s eyes.
The Takeaway
Can you buy a house with bad credit? Yes, but you may have to put more money down or accept a higher interest rate to qualify. If taking steps to improve your credit aren’t enough, you might consider using a cosigner or exploring federal loan programs.
Knowing how to buy a house with bad credit is a good first step to making it happen. You can check out this home loan help center to continue your homebuyer education.
If your financial foundation is feeling pretty firm, consider a home loan with SoFi. Qualifying first-time buyers can put as little as 3% down.
View your rate with just a few clicks.
FAQ
Is a 500 credit score enough to buy a house?
Yes, but the options are limited. Borrowers with a credit score of 500 might be able to qualify for an FHA loan.
How can I buy a house with bad credit and income?
Lenders look at your full financial picture, not just credit and income, in a mortgage application. Certain loan types don’t have strict credit or income requirements either.
What is a good down payment for a house with bad credit?
A 20% down payment is ideal, but most borrowers aren’t able to put that much down. Any increase in your down payment could improve your loan terms.
How do I know if I’m eligible for an FHA loan?
FHA loan requirements include proof of employment and the necessary down payment based on the borrower’s credit score (those with scores of 580 or above qualify for the 3.5% down payment advantage). The home must be a primary residence, get appraised by an FHA-approved appraiser, and meet minimum property standards.
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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.
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