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The 30-year fixed-rate mortgage dominates the American landscape, but the adjustable-rate mortgage gains some steam when rates are rising.

Because the initial ARM rate is usually lower than fixed-rate loans’, buyers who expect to sell within a few years are sometimes attracted to the low rates and payments.

Find out whether a fixed-rate or adjustable-rate mortgage works better for your particular situation.

Adjustable-Rate Mortgage Loans

In a nutshell: lower initial rate, more risk.

In most cases, an ARM rate will be fixed for three, five, seven, or 10 years and then periodically adjust.

ARMs are labeled with numbers that delineate a) the length of the introductory fixed phase and b) the frequency of rate adjustments afterward. The 5/1 ARM, for example, has a low five-year introductory rate that can then change every year for the remainder of the loan.

If you see a 7/6 or 10/6 ARM, that means the rate can adjust every six months after the introductory period.

Pros of Adjustable-Rate Mortgage Loans

A five- or seven-year ARM tends to have an introductory rate that’s lower than that of a 30-year fixed-rate conventional or FHA loan. A three-year ARM rate may be much lower.

So during periods of rising mortgage rates, ARMs offer a great option for borrowers to save money before the initial rate adjustment.

That includes first-time homebuyers who are looking for lower initial rates and monthly payments and who understand that their rate will likely rise if they keep the loan.

Also, higher conforming loan limits in 2022 made it possible for lenders to qualify more borrowers for ARMs that could be backed by Fannie Mae, Freddie Mac, and Ginnie Mae.

ARMs have caps on how much the rate can increase or decrease. There is usually an initial cap, a periodic adjustment cap, and a lifetime cap. More and more of the loans have rates tied to a new index, the Secured Overnight Financing Rate (SOFR). For those, the rate may go up or down a maximum of one percentage point every six months (which is why you see a 7/6 and so on) after an initial adjustment, which could be two or five percentage points, with a 5% lifetime cap.

Cons of Adjustable-Rate Mortgage Loans

ARMs provide less stability than fixed-rate mortgages. After the initial fixed-rate period, there’s no certainty about how much monthly payment amounts will go up or down.

Most ARMs are fully amortizing, but if you choose an interest-only loan, you won’t be paying down any principal for years.

One set of ARM devotees plans to refinance the loan before the initial rate adjustment — to a fixed-rate loan or to another adjustable-rate mortgage — betting that rates will be lower then. But that’s a risk.

Fixed-Rate Mortgage Loans

In a nutshell: long-term predictability.

A fixed-rate mortgage has an interest rate that stays the same for the life of the loan, regardless of changes in the broader economy.

Pros of Fixed-Rate Mortgage Loans

Fixed-rate mortgages offer greater stability and predictability over the long term compared with adjustable-rate loans.

The National Association of Realtors® puts the average homeowner tenure at 10 years. Redfin found that the typical homeowner had spent 13.2 years in their home in 2021. Older homeowners may stay longer. So if you’re not going to get a move on within a few years, it may be comforting to lock in. You can refinance later if rates decrease.

Cons of Fixed-Rate Mortgage Loans

The 30-year fixed-rate home loan has a higher average interest rate than most ARM introductory rates.

Small differences in interest rates can add up. Use a mortgage calculator to see for yourself.

Then again, lifetime rate caps on most ARMs are five percentage points above the introductory rate.

Lay the Groundwork for a Mortgage

Do you know how much of a mortgage you can afford?

You can get an idea by pre-qualifying with lenders and using a home affordability calculator.

Then there’s pre-approval for a mortgage, which requires a credit check and provides a specific amount that you can tentatively borrow.

Which lender will offer you the best loan options and the most competitive rates?

Think About How Long You May Keep the House

How long might you live in the home? If short term, an ARM might make sense.

If the rates you see are close to those of a fixed-rate mortgage, you might go with predictability.

Consider How Quickly You May Want to Pay Off Your Mortgage

If you go the traditional route, should you choose a 15-year or 30-year mortgage?

Generally the shorter the mortgage term, the lower the rate. Some people who can afford to make a high monthly payment take out 10-year loans.

Even if you initially take out a mortgage for a certain number of years, you have the option to pay off the mortgage early.

Understand How Your Adjustable Rate Would Work

If you’re seriously considering an adjustable-rate mortgage, you’ll want to understand the rate caps and adjustments.

If your rate reached the maximum, would you still be able to afford the payments?

It doesn’t hurt to get loan estimates for both fixed-rate and adjustable-rate mortgages when shopping for a mortgage. After learning the loan details, you may decide that an ARM is right for you. If you aren’t comfortable with the terms, you might opt for a fixed rate.

The Takeaway

If you’re looking for a mortgage, you’ll want to think about how long you might stay in the home and whether you’ll want to refinance in the coming years. Weigh the pros and cons of an adjustable-rate loan and a fixed-rate loan to decide what might be best for your situation.

If a fixed-rate mortgage seems the way to go, check out the deals and term lengths SoFi offers. And know that the rates are competitive.

Find your rate in minutes with no obligation.

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

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.

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There are few things as exciting as touring a house and thinking, “This is it! I’ve found my dream home.” Maybe the property has a fireplace or the perfect patio that has you imagining how great it would be to make it yours.
Then comes the less fun part: figuring out how to finance your home purchase.

For the vast majority of people, acquiring a new home means taking out a mortgage. For 90% of homebuyers, that means opting for a conventional 30-year fixed-rate mortgage.

Conventional mortgages are those that are not insured or guaranteed by the government.

But that doesn’t mean what is called a conventional home loan is right for everyone. Here, learn more about conventional mortgages and how they compare to other options, including:

•   How do conventional mortgages work?

•   What are the different types of conventional loans?

•   How do conventional loans compare to other mortgages?

•   What are the pros and cons of conventional mortgages?

•   How do you qualify for a conventional loan?

How Conventional Mortgages Work

Conventional mortgages are loans that are not backed by a government agency. Provided by private lenders, they are the most common type of home loan. A few points to note:

•   Conventional loans are offered by banks, credit unions, and mortgage companies, as well as by two government-sponsored enterprises, known as Fannie Mae and Freddie Mac. (Note: Government-sponsored and government-backed loans are two different things.)

•   Conventional mortgages tend to have a higher bar to entry than government-guaranteed home loans. You might need a better credit score and pay more in interest, for example. Government-backed FHA loans, VA loans, and USDA loans, on the other hand, are designed for certain kinds of homebuyers or homes and are often easier to qualify for. You’ll learn more about them below.

•   Among conventional loans, you’ll find substantial variety. You’ll have a choice of term length (how long you have to pay off the loan with installments), and you’ll probably have a choice between fixed-rate and adjustable-rate products. Keep reading for more detail on these options.

•   Because the government isn’t offering any assurances to the lender that you will pay back that loan, you’ll need to prove you are a good risk. That’s why lenders look at things like your credit score and down payment amount when deciding whether to offer you a conventional mortgage and at what rate.

Conventional vs Conforming Loans

As you pursue a home loan, you’ll likely hear the phrases “conventional loan” and “conforming loan.” Are they the same thing? Not exactly. Let’s spell out the difference:

•   A conforming loan is one in which the underlying terms and conditions adhere to the funding criteria of Freddie Mac and Fannie Mae. There’s a limit to how big the loan can be, and this figure is determined each year by the Federal Housing Finance Agency, or FHFA. In 2023, that ceiling was set at $766,550 for most of the United States. (It was a higher number for those purchasing in certain high-cost areas.)

So all conforming loans are conventional loans. But what is a conventional mortgage may not be conforming. If, for instance, you apply for a jumbo mortgage (meaning one that’s more than $766,550 in 2023), you’d be hoping to be approved for a conventional loan. It would not, however, be a conforming mortgage because the amount is over the limit that Freddie Mac or Fannie Mae would back.

Types of Conventional Loans

When answering, “What is a conventional loan?” you’ll learn that it’s not just one single product. There are many options, such as how long a term (you may look at 15- and 30-year, as well as other options). Perhaps one of the most important decisions is whether you want to opt for a fixed or adjustable rate.

Fixed Rate

A conventional loan with a fixed interest rate is one in which the rate won’t change over the life of the loan. If you have one of these “fully amortized conventional loans,” as they are sometimes called, your monthly principal and interest payment will stay the same each month.

Although fixed-rate loans can provide predictability when it comes to payments, they may initially have higher interest rates than adjustable-rate mortgages.

Fixed-rate conventional loans can be a great option for homebuyers during periods of low rates because they can lock in a rate and it won’t rise, even decades from now.

💡 Recommended: What Is a Fixed-Rate Mortgage?

Adjustable Rate

Adjustable-rate mortgages (also sometimes called variable rate loans) have the same interest rate for a set period of time, and then the rate will adjust for the rest of the loan term.

The major upside to choosing an ARM is that the initial rate is usually set below prevailing interest rates and remains constant for a specific amount of time, from six months to 10 years.

There’s a bit of lingo to learn with these loans. A 7/6 ARM of 30 years will have a fixed rate for the first seven years, and then the rate will adjust once every six months over the remaining 23 years, keeping in sync with prevailing rates. A 5/1 ARM will have a fixed rate for five years, followed by a variable rate that adjusts every year.

An ARM may be a good option if you’re not planning on staying in the home that long. The downside, of course, is that if you do stay put, your interest rate could end up higher than you want it to be.

Most adjustable-rate conventional mortgages have limits on how much the interest rate can increase over time. These caps protect a borrower from facing an unexpectedly steep rate hike.

Also, read the fine print and see if your introductory rate will adjust downward if rates shift lower over the course of the loan. Don’t assume they will.

💡 Recommended: Fixed-Rate vs Adjustable-Rate Mortgages

How Are Conventional Home Loans Different From Other Loans?

Wondering what a conventional home loan is vs. government-backed loans? Learn more here.

Conventional Loans vs. FHA Loans

Wondering whether a conventional or FHA loan is better for you? FHA loans are geared toward lower- and middle-income buyers; these mortgages can offer a more affordable way to join the ranks of homeowners. Unlike conventional loans, FHA loans are insured by the Federal Housing Administration, so lenders take on less risk. If a borrower defaults, the FHA will help the lender recoup some of the lost costs.

But are FHA loans right for you, the borrower? Here are some of the key differences between FHA loans and conventional ones:

•   FHA loans are usually easier to qualify for. Conventional loans usually need a credit score of at least 620 and 3% down. With an FHA loan, you may get approved with a credit score as low as 500 with 10% down or 580 to put down 3.5%.

•   Unlike conventional loans, FHA loans are limited to a certain amount of money, depending on the geographic location of the house you’re buying. The lender administering the FHA loan can impose its own requirements as well.

•   An FHA loan can be a good option for a buyer with a lower credit score, but it also will require a more rigorous home appraisal and possibly a longer approval process than a conventional loan.

•   Conventional loans require private mortgage insurance (PMI) if the down payment is less than 20%, but PMI will terminate once you reach 20% equity. FHA loans, however, require mortgage insurance for the life of the loan if you put less than 10% down.

💡 Recommended: Private Mortgage Insurance (PMI) vs Mortgage Insurance Premium (MIP)

Conventional Loans vs VA Loans

Not everyone has the choice between conventional and VA loans. Conventional loans are available to all who qualify, but VA loans are only accessible to those who are veterans, active-duty military, or surviving spouses of those who served.

VA loans offer a number of perks that conventional loans don’t:

•   No down payment is needed.

•   No PMI is required, which is a good thing, because it’s typically anywhere from 0.58% to 1.86% of the original loan amount per year.

There are a couple of potential drawbacks to be aware of:

•   Most VA loans demand that you pay what’s known as a funding fee. This is typically 1.25% to 3.3% of the loan amount.

•   A VA loan must be used for a primary residence; no second homes are eligible.

Conventional Loans vs USDA Loans

Curious if you should apply for a USDA loan vs. a conventional loan? Consider this: No matter where in America your dream house is, you can likely apply for a conventional loan. USDA loans, however, are only available for use when buying a property in a qualifying rural area. The goal is to encourage people to move into certain areas and help them along with accessible loans.

Beyond this stipulation, consider these upsides of USDA loans vs. conventional loans:

•   USDA loans can offer a very affordable interest rate versus other loans.

•   USDA loans are available without a down payment.

•   These loans don’t require PMI.

But, to provide full disclosure, there are some downsides, beyond limited geographic availability:

•   USDA loans have income-based eligibility requirements. The loans are designed for lower- and middle-income potential home buyers, but the exact cap on income will depend on your geographic area and how many household members you have.

•   This program requires that the loan holder pay a guarantee fee, which is typically 1% of the loan’s total amount.

Benefits and Drawbacks of Conventional Mortgages

Now that you’ve learned what is a conventional loan and how it compares to some other options, let’s do a quick recap of the pros and cons of conventional loans.

Benefits of Conventional Loans

The upsides are:

•   Competitive rates. Yes, mortgage rates have been rising steeply recently, but they are still far from their high point of 16.63% in 1981. Plus, lenders want your business and you may be able to find attractive offers.

•   The ability to buy with little money down. Some conventional mortgages can be had with just 3% down.

•   PMI isn’t forever. Once you have achieved 20% equity in your property, your PMI can be canceled.

•   Flexibility. There are different conventional mortgages to suit your needs, such as fixed and variable rate home loans. Also, these mortgages can be used for primary residences (whether single- or multi-family), second homes, and other variations.

Drawbacks of Conventional Loans

Now, the downsides of conventional loans:

•   PMI. If your mortgage involves a small down payment, you do have to pay that PMI until you reach a target number, such as 20% equity.

•   Tougher qualifications vs. government programs. You’ll usually need a credit score of 620 and, with that number, your rate will likely be higher than it would be if you had a higher score.

•   Stricter DTI requirements. It’s likely that lenders will want to see a 45% debt-to-income ratio (or DTI, your total monthly recurring payments divided by your monthly gross income). Government programs have less rigorous qualifications.

How Do You Qualify for a Conventional Loan?

Conventional mortgage requirements vary by lender, but almost all private lenders will require you to have a cash down payment, a good credit score, and sufficient income to make the monthly payments. Here are more specifics:

•   Down Payment: Many lenders that offer conventional loans require that you have enough cash to make a decent down payment. Even if you can manage it, is 20% down always best? It might be more beneficial to put down less than 20% on your dream house.

•   Credit score and history: You’ll also need to demonstrate a good credit history to buy a house, which means at least 620, as mentioned above. You’ll want to show that you make loan payments on time every month.

Each conventional loan lender sets its own requirements when it comes to credit scores, but generally, the higher your credit score, the easier it will be to secure a conventional mortgage at a competitive interest rate.

•   Income: Most lenders will require you to show that you have a sufficient monthly income to meet the mortgage payments. They will also require information about your employment and bank accounts.

💡 See what your mortgage payments would be using our mortgage calculator.

The Takeaway

A conventional home loan is a very popular option for homebuyers. These mortgages, which are not guaranteed by the government, have their pros and cons, as well as variations. It’s also important to know how they differ from government-backed loans, so you can choose the right product to suit your needs. Buying a home is a major step and a big investment, so you want to get the mortgage that suits you best.

That’s where SoFi can help. We offer fast, competitive fixed-rate mortgage loans with as little as 3% down for qualifying first-time homebuyers. Let us help make your dreams of homeownership come true.

It takes just minutes to get prequalified online.

FAQ

What is the minimum down payment for a conventional loan?

What is a conventional home mortgage’s minimum down payment? In most cases, 3% of the purchase price is the lowest amount possible.

How many conventional loans can you have?

A lot! The Federal National Mortgage Association (FNMA, aka Fannie Mae) allows a person to have up to 10 properties with conventional financing. Just remember, you’ll have to convince a lender that you are a good risk for each and every loan.

Do all conventional loans require PMI?

Most lenders require PMI (private mortgage insurance) if you are putting less than 20% down when purchasing a property. However, you may find some PMI-free loans available. They typically have a higher interest rate, though, so make sure they are worthwhile given your particular situation.

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

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

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

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.

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A personal loan is a strong option when you need to borrow money to cover a medical bill or home repair, or to consolidate debt. But before you decide that a personal loan will meet your needs, it’s important to understand the advantages and disadvantages that come along with them.

We’ll do a deep dive into interest rates, borrowing limits, fees and penalties, and lender requirements to get the best terms.

What Are Personal Loans?

A personal loan is money that you borrow from a bank, credit union, or online lender. It’s an installment loan, so you agree to repay the loan principal and interest at regular intervals — usually monthly.

When you apply for a personal loan, your lender will run a credit check, which will help determine your interest rate. Generally speaking, borrowers with higher credit scores have a better chance of being offered lower interest rates. The higher your interest rate, the more money it will cost you to borrow.

Recommended: 11 Types of Personal Loans

The Benefits of Personal Loans

Personal loans are a flexible option for borrowers looking to accomplish a variety of goals, from consolidating other debts to remodeling their home. Here’s a look at some of the advantages.

Comparatively Low Interest Rates

Personal loans offer relatively low interest rates when compared to other methods of short-term borrowing. The average personal loan interest rate is 9.41% according to the St. Louis Federal Reserve. Credit cards by comparison have average interest rates of 14.56% and up, and a personal line of credit can have interest rates that vary between 9.30% and 17.55%.

Some forms of predatory short-term lending, such as payday loans , can charge the equivalent of many times these rates to borrow.

	Average Interest Rates
Personal Loans	9.41%
Credit Card	14.56%
Personal Line of Credit	9.30% – 17.55%

Comparatively High Borrowing Limits

Small personal loans are usually for amounts of $3,000 or less. (Smaller loans often come with lower interest rates.) However, some lenders will offer loans of up to $100,000 to cover major expenses and life events, which may be quite a bit more than other credit options.

The average credit limit for credit cards, by comparison, is $30,365, according to credit reporting bureau Experian. Personal lines of credit have a range of limits from $1,000 to $100,000, similar to the range offered by personal loans.

	Borrowing Limits
Personal Loans	Up to $100,000
Credit Card	Average limit of $30,365
Personal Line of Credit	Up to $100,000

Personal Loans Can Be Used for Many Things

Some types of loans must be used for designated purposes. Auto loans must be used to buy a car, and a mortgage must be used to finance a house. Personal loans, on the other hand, have few restrictions on how you must use the money, and you can generally use it for any purpose.

Recommended: Common Uses for a Personal Loan

No Collateral Necessary

Unsecured personal loans are the most common type of personal loans. They are not backed by collateral, such as your car or home.

Some personal loans are secured, and require you to borrow against the equity in your personal assets, like a home or your savings. With a secured vs. unsecured personal loan, the lender can seize your property if you default, selling it to recoup their loss. As a result, secured loans present less risk for the lender and often come with lower interest rates than unsecured loans.

Simple to Manage

You can use personal loans to consolidate other, higher-interest debt, for example, by paying off the balance on several high-interest credit cards. A single personal loan can offer cheaper interest, lowering the cost of your debt over time. And it may be easier to manage, since you only have one bill to pay each month.

Can Help Building Credit

Your lender will likely report your personal loan and payment history to the three credit reporting bureaus — Experian, TransUnion, and Equifax. In fact, 35% of your FICO® score — the most commonly used credit score — is determined by your payment history. You can build up a strong credit history over time merely by avoiding late or missed payments.

The Disadvantages of Personal Loans

Without properly weighing the potential disadvantages, personal loans can be a bad idea for some borrowers.

Higher Interest Rates Than Some Alternatives

Personal loans may carry higher interest rates than some alternatives. For example, if you’re looking to remodel your home, you might consider taking out a home equity loan or a home equity line of credit (HELOC).

A home equity loan uses your home as collateral. As of June 2022, the average interest rate on a 10-year fixed home equity loan was 6.02%. A home equity line of credit, is a revolving credit line that uses your home as collateral. Borrowers with good credit can qualify for interest rates ranging from 3% to 5%. Those with below-average credit are likely to receive interest rates that range from 9% to 10%.

Fees and Penalties

Some lenders may charge fees and penalties in association with personal loans. For instance, an origination fee helps pay for the processing of your loan application and is usually equal to a percentage of the loan amount. Fortunately, it’s possible to avoid origination fees.

Lenders may also charge prepayment penalties if you pay off your loan ahead of schedule, to make up for profit they are losing on interest payments.

Can Increase Debt

Take out a personal loan only if you are sure you can pay it off and it makes financial sense. For example, a home remodel could increase the value of your home, and consolidating credit card debt could save you money in interest payments.

Avoid taking out a loan that is for more money than you need to avoid the risk of taking on more debt than necessary.

Alternatives to Personal Loans

In addition to personal loans, you may wish to explore other forms of credit that can help you finance big and small expenses.

•  Credit cards allow users to make purchases using credit, which they pay back at the end of each billing cycle. Borrowers must make minimum payments and owe interest on any balance they carry from month to month.

•  A personal line of credit (PLOC) is similar to a credit card. It allows you to tap your credit line as needed. Credit is replenished when you pay back your loan.

•  A home equity loan uses a borrower’s home as collateral. The value of the property determines the loan amount.

•  A home equity line of credit is a revolving source of credit, like credit cards and PLOCs. As with home equity loans, HELOCs use the borrower’s home as collateral.

Exploring Personal Loans Further

A personal loan is a type of installment loan, usually unsecured, that allows you to use the money for a variety of unexpected expenses. Borrowers with higher credit scores have a better chance of being offered lower interest rates. This is important because the higher your interest rate, the more money it will cost you to borrow. Also, some lenders charge extra fees and penalties.

If you’ve explored your options and decide that a personal loan is right for you, it’s wise to shop around to find the right loan. Consider personal loans from SoFi, which offers loans of up to $100,000 with no fees required. Check SoFi personal loan rates and your own personal loan rate. borrowers may receive funding as quickly as the same day it is approved.

Compared with high-interest credit cards, a SoFi Personal Loan is simply better debt.

FAQ

What is a personal loan?

A personal loan is a loan you receive from a bank, credit union, or online lender. Borrowers pay back the principal and interest in regular installments.

What can you use a personal loan for?

Personal loans have few usage restrictions. You can use them for everything from covering an unexpected medical bill to remodeling your kitchen.

How much money can you get from a personal loan?

Personal loan amounts may range from a few hundred dollars up to $100,000 from some lenders.

Photo credit: iStock/Anchiy
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.

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.

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

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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You may have heard that the better your credit score, the better your potential loan rates and offers may be. Why is that? That’s because your credit score determines your creditworthiness. A good credit score may qualify you for what’s known as a prime loan.

Here, what a prime loan is and how it works.

Understanding a Prime Loan

To understand a prime loan, it’s important to understand the prime rate. The prime rate is established by banks as the interest rate given to prime customers. This number is based on the federal funds rate set by the Federal Reserve.

When interest rates are low, the prime rate across banks will be low. But if the Fed raises interest rates, rates across banks — even for prime borrowers — will also increase.

This matters when you’re considering a fixed-rate loan, like a mortgage or a personal loan. Lower interest rates now mean that you will lock in a lower rate for the life of your loan. But prime rates also extend to variable-rate debt, like credit card debt or a home equity line of credit (HELOC).

Prime Loan Borrowers

When the bank sets its rates, they set a prime rate as the basis of their loan rates, which may be higher or lower based on the creditworthiness of each applicant. The prime rate is set considering the Federal Reserve rates, as well as other factors including the bank’s own desired return on the loan. But in general, prime rates are very similar, if not identical, between major banks.

According to the Consumer Finance Protection Bureau (CFPB), borrowers with a credit score of 660 to 719 generally receive prime rates. Borrowers with scores above 720 are considered “super-prime” borrowers, and will receive even more favorable interest rates. The interest rates for super-prime borrowers will be lower than the prime rate.

Here are the rate categories for borrowers:

Category	Credit Score
Deep subprime	Below 580
Near prime	620 to 659
Prime	660 to 719
Super prime	Above 720

Knowing your credit score can help you assess the category you will fit in.

Prime Loan Rates

As mentioned above, prime loan rates are set by the bank and change based on the federal fund rate. When the federal fund rate moves, so will the prime rate. As of this writing, the prime rate is 4.75%, according to the Wall Street Journal.

So does this mean that any loan you apply for will have a 4.75% interest rate? No. APR rates will vary based on the type of loan you apply for. Banks may have their own formula but there are some rules of thumb.

For example, credit card interest rates are generally set at “prime + 13.99%.” As the prime rate changes, so will your interest rate. But in general, the higher your credit score, the lower your interest rates will be.

Prime Loan Example

How Does the Prime Loan Rate Affect You?

The prime loan rate affects everyone. From buying a car to buying a house to opening a credit card, the prime loan rate will determine how much interest you’ll pay. You may be more vulnerable to prime loan rate fluctuations if you have a lot of variable interest loans, like credit card debt. As the prime rate climbs, so too might the APR of your cards. When you see a prime rate hike, it can mean that your APR will quickly rise as well.

Conversely, when the prime rate falls, some people use that time to refinance a mortgage or lock in a rate for a loan, like a personal loan or an auto loan.

Because the prime rate affects credit cards, some people who carry a high credit card balance who have good credit may consider using a personal loan to consolidate their credit card debt. This is one way to use a personal loan to pay less overall interest, depending on the rates offered.

What Is the Difference Between a Prime Loan and Subprime Loan?

There are a few differences between a prime loan and subprime loan. Not only do prime loans have the most favorable interest rates, but they also may affect how large a loan you can take, among other things. Here, some differences between a prime loan vs. a subprime loan.

Interest Rates

Interest rates are one of the most obvious differences between a prime and subprime loan. But even within categories, like a prime borrower, there may be subcategories that receive different interest rate offers. For example, a prime borrower with a credit score near super-prime territory may receive more favorable rates than a borrower whose credit is close to subprime.

Repayment Periods

A subprime borrower may also have fewer options when it comes to repayment periods. They may have a shorter repayment period at a higher interest rate than a prime borrower.

Down Payments

A prime borrower may have a low, or no, down payment required for a loan. But subprime borrowers may have to make a larger down payment to qualify for a loan. This is especially true for loans like car loans or mortgages.

Loan Amounts

Prime borrowers may have access to greater loan amounts than subprime borrowers.

Fees

Non-prime borrowers may also have to pay more loan fees than a prime borrower. This may be due to the types of loans they can access. If they can’t get a loan from a traditional bank, a subprime borrower may seek payday loans or other loans that require fees. Different types of personal loans besides loans offered by traditional banks may include payday loans, hard money loans, and other loans that may require collateral, or have high fees and interest rates.

What Do You Need To Qualify for a Prime Loan?

Your credit score will determine what type of loan is offered to you. But a lender will take other details into consideration, including your credit history and employment status. But a good rule of thumb is to make sure your credit score is as high as possible before you apply for a loan to receive the most favorable terms.

The Takeaway

The prime rate is out of your control. But so much of your interest rate is under your control, including your credit score. Building your credit score can help you have the most competitive loan options, whether you’re researching personal loans, credit card offers, mortgages, or refinancing your student loans.

If you’re applying for a personal loan, personal loan approval tips include assessing your credit score. If it’s not where you’d like it to be, you might want to consider building your credit before applying for a personal loan. Subprime personal loans may exist, but they may be for lower amounts at higher interest rates than ones offered for prime borrowers.

Rates may be different across banks so it’s worth comparing personal loan interest rates. You can check your rate for personal loans without it affecting your credit score. Doing so can help you determine the types of loan rates, as well as amounts, you may be eligible for.

Check your personal loan rate from SoFi here.

FAQ

What does prime mean in loans?

Prime in loans means the borrower is considered a low lending risk. The bank will set a prime rate that will then be the basis for interest rates across lending products, including mortgages, car loans, personal loans, and credit card offers.

Is there a difference between prime loans and subprime loans?

Yes. Prime loans are given to people whose credit scores generally fall into a 660 to 719 range. (Borrowers with credit scores above that are considered superprime borrowers and may be given even more favorable rates.) But there are also categories within the prime range — people with higher credit scores may get a lower rate than people with lower scores, even if their scores fall into the “prime” category.

In addition to interest rates, prime borrowers may also have longer repayment period options, more access to credit, lower fees, and a smaller down payment obligation than subprime borrowers.

What is the current loan prime rate?

The current loan prime rate is 4.75%.

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Photo credit: iStock/Imagesrouges
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.

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.

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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Labels like prime and subprime help denote loans that are designed for people with different credit scores. Prime loans are built for borrowers with good credit, while subprime loans are designed for those with less-than-perfect credit. While subprime loans can help this group finance big purchases like a home or a car, they also come with potentially significant downsides.

Here’s a look at what you need to know about prime and subprime loans to help you make better borrowing decisions.

Prime Loan vs Subprime Loan

When you’re shopping for a loan, lenders will consider your credit history to help them determine how much default risk they’d be taking on were they to loan you money.

Your credit score is a three-digit representation of your credit history that lenders use to understand your creditworthiness. While there are different credit scoring models, the FICO® score is one of the most commonly used. Lenders and other institutions may have varying models for which credit scores determine prime vs subprime loans.

For example, Experian, one of the three major credit reporting bureaus, defines a prime loan as requiring a FICO score of 670 to 739. With a score of 740 or above, you’re in super prime territory. Borrowers with a FICO score of 580 to 669 will likely only qualify for subprime loans.

Here are some key differences between the two that borrowers should be aware of.

Interest Rates

Borrowers with lower credit scores are seen as a greater lending risk. To offset some of that risk, lenders may charge higher interest rates on subprime loans than on prime loans.

What’s more, many subprime loans have adjustable interest rates, which may be locked in for a short period of time after which they may readjust on a regular basis, such as every year. If interest rates are on the rise, this can mean your subprime loan becomes increasingly more expensive.

Down Payments

Again, because subprime borrowers may be at a higher risk of default, lenders may protect themselves by requiring a higher down payment. That way, the borrower has more skin in the game, and their bank doesn’t need to lend as much money.

Loan Amounts

Subprime borrowers may not be able to borrow as much as their prime counterparts.

Higher Fees

Fees, such as late-payment penalties or origination fees, may be higher for subprime borrowers.

Repayment Periods

Subprime loans typically carry longer terms than prime loans. That means they take longer to pay back. While a longer term can mean a smaller monthly payment, it also means that you may end up paying more in interest over the life of the loan.

Prime Loan vs Subprime Loan: What Type of Loans Are They?

Prime and subprime options are available for a variety of loan types. For example, different types of personal loans come as prime personal loans or subprime personal loans \. When you’re comparing personal loan interest rates, you’ll see that prime loans offer lower rates than subprime. Common uses for personal loans include consolidating debt, paying off medical bills, and home repairs.

You can also apply for prime and subprime mortgages and auto loans. What is considered a prime or subprime score varies depending on the type of loan and the lender.

Recommend: How to Get Approved for a Personal Loan

Prime Loan vs Subprime Loan: How to Get One

By checking your credit score, you can get a pretty good idea of whether you’ll qualify for a prime or subprime loan. That said, as mentioned above, the categories will vary by lender.

The process for applying for a prime or subprime loan is similar.

Get Prepared

Lenders may ask for all sorts of documentation when you apply for a loan, such as recent paystubs, employer contact information, and bank statements. Gather this information ahead of time, so you can move swiftly when researching and applying for loans.

Research Lenders

Banks, credit unions, and online lenders all offer prime and subprime loans. You may want to start with the bank you already have a relationship with, but it’s important to explore other options too. You may even want to approach lenders who specialize in subprime loans.

To shop around for the best loan, you may want to apply for a few. That way you can see which lender can offer you the best terms and interest rates. Applying for credit will trigger a hard inquiry on your credit report, which will temporarily lower your credit score.

Consider a Cosigner

If you’re having trouble getting a subprime loan, you may consider a cosigner with better credit, often a close family member. They will be on the hook for paying off your loan if you miss any payments, so be sure you are both aware of the risk.

Subprime Loan Alternatives

There are alternatives to subprime loans that also carry a fair amount of risk. Some, like credit cards, are legitimate options when used responsibly. Others, like payday loans, should be avoided whenever possible.

Credit Cards

Credit cards allow you to borrow relatively small amounts of money on a revolving basis. If you pay off your credit card bill each month, you will owe no interest. However, if you carry a balance from month to month, you will owe interest, which can compound and send you deeper into debt.

Predatory Loans

Payday loans are a type of predatory loan that usually must be paid off when you receive your next paycheck. These lenders often charge high fees and extremely high interest rates — as high as 400%, or more. If you cannot pay off the loan within the designated period, you may be allowed to roll it over. However, you will be charged a fee again, potentially trapping you in a cycle of debt.

The Takeaway

Subprime loans can be a relatively expensive way to take on debt, especially compared to their prime counterparts. If you can, you may want to wait to increase your credit score before taking on a subprime loan. You can do so by always paying your bills on time and by paying down debt. That said, in some cases, taking on a subprime loan is unavoidable — you may need a new car now to get you to work, for example — so shop around for the best rates you can get.

If you’re paying more than 20% interest on your credit cards, a personal loan could be a great way to consolidate that high-interest debt. Borrow up to $100K with fixed rates and low APRs for those who qualify, and you could start paying a lower fixed monthly payment.

Explore personal loans of $5,000 to $100,000 from SoFi with no hidden fees.

FAQ

Why are subprime loans bad?

Subprime loans are not necessarily bad. However, these loans charge higher interest rates and fees than their prime counterparts. Borrowers may also be asked to put down a higher down payment, and they may be able to borrow less.

What is the difference between subprime and nonprime?

Nonprime borrowers have credit scores that are higher than subprime but lower than prime.

What type of loan is a subprime loan?

A variety of loan types may include a subprime category, including mortgages, auto loans, and personal loans. All loans in the subprime category likely have higher interest rates and fees.

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Photo credit: iStock/Nikola Stojadinovic

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.

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.

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

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