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How does a home equity loan work? First, it’s important to understand that the term home equity loan is simply a catchall for the different ways the equity in your home can be used to access cash. The most common types of home equity loans are fixed-rate home equity loans, home equity lines of credit (HELOCs), and cash-out refinancing. The best type of home equity loan option for you will depend on your specific needs, so it’s helpful to know the characteristics of each to do an informed home equity loan comparison.

What Are the Main Types of Home Equity Financing?

When folks think of home equity loans, they typically think of either a fixed-rate home equity loan or a home equity line of credit (HELOC). There is a third way to use home equity to access cash, and that’s through a cash-out refinance.

With fixed-rate home equity loans or HELOCs, the primary benefit is that the borrower may qualify for a better interest rate using their home as collateral than by using an unsecured loan — one that is not backed by collateral. Some people with high-interest credit card debt may choose to use a lower-rate home equity loan to pay off those credit card balances, for instance.

This does not come without risks, of course. Borrowing against a home could leave it vulnerable to foreclosure if the borrower is unable to pay back the loan. A personal loan may be a better fit if the borrower doesn’t want to put their home up as collateral.

How much a homeowner can borrow is typically based on the combined loan-to-value ratio (CLTV ratio) of the first mortgage plus the home equity loan. For many lenders, this figure cannot exceed 85% CLTV. To calculate the CLTV, divide the combined value of the two loans by the appraised value of the home. In addition, utilizing a home equity loan calculator can help you understand how much you might be able to borrow using a home equity loan. It’s similar to the home affordability calculator you may have used during the homebuying process.

Of course, qualifying for a home equity loan or HELOC is typically contingent on several factors, such as the credit score and financial standing of the borrower.

Fixed-Rate Home Equity Loan

Fixed-rate loans are pretty straightforward: The lender provides one lump-sum payment to the borrower, which is to be repaid over a period of time with a set interest rate. Both the monthly payment and interest rate remain the same over the life of the loan. Fixed-rate home equity loans typically have terms that run from five to 30 years, and they must be paid back in full if the home is sold.

With a fixed-rate home equity loan, the amount of closing costs is usually similar to the costs of closing on a home mortgage. When shopping around for rates, ask about the lender’s closing costs and all other third-party costs (such as the cost of the appraisal if that will be passed on to you). These costs vary from bank to bank.

This loan type may be best for borrowers with a one-time or straightforward cash need. For example, let’s say a borrower wants to build a $20,000 garage addition and pay off a $4,000 medical bill. A $24,000 lump-sum loan would be made to the borrower, who would then simply pay back the loan with interest. This option could also make sense for borrowers who already have a mortgage with a low interest rate and may not want to refinance that loan.

Recommended: What Is a Fixed-Rate Mortgage?

Home Equity Line of Credit (HELOC)

A HELOC is revolving debt, which means that as the balance borrowed is paid down, it can be borrowed again during the draw period (whereas a home equity loan provides one lump sum and that’s it). As an example, let’s say a borrower is approved for a $10,000 HELOC. They first borrow $7,000 against the line of credit, leaving a balance of $3,000 that they can draw against. The borrower then pays $5,000 toward the principal, which gives them $8,000 in available credit.

HELOCs have two periods of time that borrowers need to be aware of: the draw period and the repayment period.

•   The draw period is the amount of time the borrower is allowed to use, or draw, funds against the line of credit, commonly 10 years. After this amount of time, the borrower can no longer draw against the funds available.

•   The repayment period is the amount of time the borrower has to repay the balance in full. The repayment period lasts for a certain number of years after the draw period ends.

So, for instance, a 30-year HELOC might have a draw period of 10 years and a repayment period of 20 years. Some buyers only pay interest during the draw period, with principal payments added during the repayment period. A HELOC interest-only calculator can help you understand what interest-only payments vs. balance repayments might look like.

A HELOC may be best for people who want the flexibility to pay as they go. For an ongoing project that will need the money portioned out over longer periods of time, a HELOC might be the best option. While home improvement projects might be the most common reason for considering a HELOC, other uses might be for wedding costs or business startup costs.

How Interest Rates Work on a HELOC

Unlike the rate on a fixed-rate loan, a HELOC’s interest rate is variable and will fluctuate with market rates, which means that rates could increase throughout the duration of the credit line. The monthly payments will vary because they’re dependent on the amount borrowed and the current interest rate.

When you take out a HELOC, you’ll start out in the draw period. Once you take out funds, you’ll be charged interest on what you’ve withdrawn. With some HELOCs, during the draw period, you’re only required to pay that interest; others charge you for both interest and principal on what you’ve withdrawn. During the repayment period, you won’t be able to withdraw money any longer, but you will need to make regular payments to repay the principal and interest on what you withdrew.

Home Equity Loan and HELOC Fees

Home equity loans and HELOCs both come with closing costs and fees, which may be anywhere from 1% to 5% of the loan amount. What those fees are and how you pay them, however, can vary by loan type. HELOCs may involve fewer closing costs than home equity loans, but often come with other ongoing costs, like an annual fee, transaction fees, and inactivity fees, as well as others that don’t pertain to home equity loans.

Generally, under federal law, fees should be disclosed by the lender. However, there are some fees that are not required to be disclosed. Borrowers certainly have the right to ask what those undisclosed fees are, though.

Fees that require disclosure include application fees, points, annual account fees, and transaction fees, to name a few. Lenders are not required to disclose fees for things like photocopying related to the loan, returned check or stop payment fees, and others. The Consumer Finance Protection Bureau provides a loan estimate explainer that will help you compare different estimates and their fees.

Home Equity Loan and HELOC Tax Deductibility

Since the passage of the One Big Beautiful BIll Act in July 2025 made permanent the mortgage deduction provisions of the Tax Cuts and Jobs Act of 2017, interest on home equity loans and HELOCs is only deductible if the funds are used to buy, build, or substantially improve the home securing the loan. What’s more, there’s a max of $750,000 on the amount of mortgage interest you can deduct ($375,000 each for spouses filing separately). Checking with a tax professional to understand how a home equity loan or HELOC might affect a certain financial situation is recommended.

Cash-Out Refinance

Mortgage refinancing is the process of paying off an existing mortgage loan with a new loan from either the current lender or a new lender. Common reasons for refinancing a mortgage include securing a lower interest rate, or either increasing or decreasing the term of the mortgage. Depending on the new loan’s interest rate and term, the borrower may be able to save money in the long term. Increasing the term of the loan may not save money on interest, even if the borrower receives a lower interest rate, but it could lower the monthly payments.

With a cash-out refinance, a borrower may be able to refinance their current mortgage for more than they currently owe and then take the difference in cash. For example, let’s say a borrower owns a home with an appraised value of $400,000 and owes $200,000 on their mortgage. They would like to make $30,000 worth of repairs to their home, so they refinance with a $230,000 mortgage, taking the difference in cash.

As with home equity loans, there typically are some costs associated with a cash-out refinance. Generally, a refinance will have higher closing costs than a home equity loan.

This loan type may be best for people who would prefer to have one consolidated loan and who need a large lump sum. But before pursuing a cash-out refi you’ll want to look at whether interest rates will work in your favor. If refinancing will result in a significantly higher interest rate than the one you have on your current loan, consider a home equity loan or HELOC instead.

When to Consider a Cash-Out Refinance

A cash-out refinance is worth looking into when you’ve built up equity in your home but feel that your mortgage terms could be better – and you need a lump sum. Let’s say you want to renovate your kitchen, and you need $40,000. You’ve had your mortgage for a few years but your credit score has improved since you got it and you could be eligible for a significantly better interest rate now. That combination of factors makes a cash-out refi worth considering. If a refinance would not make sense for you, then a cash-out refi wouldn’t, either. Instead, you might want to consider another kind of loan.

Pros and Cons of Cash-Out Refinancing

Cash-out refinances involve both advantages and drawbacks. Here are some of the most significant.

Comparing Home Equity Financing Options

The different types of home equity loans all allow you to draw on the equity you’ve built in your home to access funds. But each type has different strengths and weaknesses, and the best type of home equity loan option for you will depend on your situation and the characteristics of the loan.

Which Type Is Right for You?

If you’re content with your mortgage – you don’t think you could get a better rate and your payments fit your budget – and you need a lump sum all at once, a home equity loan might make the most sense. To consolidate high-interest debt, buy a boat, or take a once-in-a-lifetime vacation, this might be a good option.

If your mortgage is fine and you need funds for a project that’s going to require withdrawals over time, a HELOC might be a good fit. Say you’re financing your child’s college education or starting a new business – having a line of credit to draw on when you need it could be extremely helpful.

Finally, if you’re looking for a lump sum and you feel that your mortgage isn’t a good fit, a cash-out refinance could be for you. Perhaps you could get a lower interest rate now or you’d like your term to be shorter and can afford the higher payments. In that case, a cash-out refinance could be useful.

Factors to Consider Before Choosing

As you do your home equity loan comparison and think about your options, it’s important to consider carefully what will really work best for you. Here are some questions to review.

•   Will you be able to handle the additional debt in your budget?

•   Do you need an upfront cash sum or access to funds over time?

•   Can you realistically improve significantly on your current mortgage terms?

•   Is what you stand to gain worth more than the price of your closing costs and any other fees involved?

•   Are you okay with payments that vary or would you prefer knowing that your payments will stay the same?

•   Are you comfortable knowing that your lender may be able to foreclose on your home if you can’t make your payments?

The Takeaway

There are three main types of home equity loans: a fixed-rate home equity loan, a home equity line of credit (HELOC), and a cash-out refinance. Just as with a first mortgage, the process will involve a bank or other creditor lending money to the borrower, using real property as collateral, and require a review of the borrower’s financial situation. Keep in mind that cash-out refinancing is effectively getting a new mortgage, whereas a fixed-rate home equity loan and a HELOC involve another loan, which is why they’re referred to as “second mortgages.”

While each can allow you to tap your home’s equity, what’s unique about a HELOC is that it offers the flexibility to draw only what you need and to pay as you go. This can make it well-suited to those who need money over a longer period of time, such as for an ongoing home improvement project.

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

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

FAQ

What is the downside of a home equity loan?

The primary downside of a home equity loan is that the collateral for the loan is your home, so if you found yourself in financial trouble and couldn’t make your home equity loan payment, you risk foreclosure. A second consideration is that a home equity loan provides you with a lump sum. If you are unsure about how much you need to borrow, consider a home equity line of credit (HELOC) instead.

How much does a $50,000 home equity loan cost?

The exact cost of a $50,000 home equity loan depends on the interest rate and loan term. But if you borrowed $50,000 with a 6.50% rate and a 10-year term, your monthly payment would be $568 and you would pay a total of $18,129 in interest over the life of the loan.

Can you use a home equity loan for anything?

Typically, you can use a home equity loan for just about anything you want to. Common reasons for taking out a home equity loan are to consolidate higher-interest debt, to pay for medical bills, and to fund major home repairs or upgrades. It’s important to remember that your house serves as collateral for the loan, so you want to be sure your use is worth the risk.

How do I qualify for a home equity loan?

To qualify for a home equity loan, you generally need to be a homeowner with at least 20% equity in your home. You’ll also need to have a credit score of at least 620 and a debt-to-income ratio of no more than 43%. Typically, lenders will want to see that you have a steady, reliable source of income and will be able to pay back the loan.

What is the difference between a HELOC and a cash-out refinance?

A home equity line of credit (HELOC) and a cash-out refinance are both ways of tapping your home equity to get cash, but they work differently. With a HELOC, you use your home as collateral to get a revolving line of credit, which lets you take out cash as you need it, up to a set limit, during the initial draw period (usually 10 years). During the repayment period that follows, you repay principal and interest on what you’ve borrowed. A cash-out refinance involves refinancing your mortgage for more than you currently owe and taking the difference as a cash lump sum.

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

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

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.

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

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

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

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

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

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If your monthly mortgage payment no longer fits your lifestyle or financial goals, you may be able to change it with mortgage refinancing or recasting. Recasting and refinancing are two ways a borrower can save on mortgage costs — sometimes a jaw-dropping amount. To understand which might be best for you, it helps to understand the difference between them and the pros and cons of recasting your mortgage vs. refinancing.

The Difference Between Recast and Refinance

Recasting is the reamortizing of an existing mortgage, meaning the lender will recalculate your monthly payments. Refinancing involves taking out a completely new mortgage with a new rate, and possibly a new term, and paying off your old mortgage in the process.

Recasting

If your lender offers mortgage recasting and your loan is eligible, here’s how it works: You make a large lump-sum payment — $10,000 might be required — toward the principal balance of your mortgage loan. The lender recalculates the monthly payments based on the new, lower balance, which shrinks the payments. The lender may charge a few hundred dollars to reamortize the loan.

Mortgage recasting does not change your loan length or interest rate. But because your principal amount is lower, you’ll have lower monthly payments and will pay less interest over the life of the loan.

If you were to put a chunk of money toward your mortgage principal and not recast the loan, your payments would not change, though the extra principal payment would reduce your interest expense over the life of the loan.

Who might opt for mortgage recasting? Someone who has received a windfall and wants to put it toward the mortgage might like this option. Sometimes it’s someone who has bought a new home before selling the previous one. Once the old home is sold, the homeowner can use some of the proceeds to recast the new mortgage.

Another candidate for recasting might be someone who wants to use the lump sum to pay their loan down to 80% of the home’s value so they can request to stop paying for private mortgage insurance (PMI) or get it automatically dropped (when they reach 78%).

FHA, VA, and USDA loans are not eligible for mortgage recasting. Some jumbo loans are also excluded. If you want to change the monthly payments on those types of mortgages, you’ll need to refinance your loan.

Refinancing

When you seek refinancing, you’re applying for a brand-new loan with a new rate and terms, possibly from a new lender. Most people’s goal is a lower interest rate, a shorter loan term, or both.

While finding a competitive offer might take some legwork, refinancing could help you save money. A lower interest rate for a home loan of the same length will reduce monthly payments and the total amount of interest paid over the life of the loan.

A homeowner who refinances to a shorter term, say from 30 years to 15, will pay much less total loan interest. Fifteen-year mortgages also often come with a lower interest rate than 30-year home loans.

Refinancing may make sense for homeowners who are planning to stay put for years; those who want to switch their adjustable-rate mortgage to a fixed-rate one; and borrowers with FHA loans who want to shed mortgage insurance premiums (MIP), on a loan they’ve paid down or a home that has appreciated. Most FHA loans carry mortgage insurance for the life of the loan. Equity-rich homeowners who’d like to get their hands on cash may find cash-out refinancing appealing.

Recommended: Mortgage Questions for Your Lender

Pros and Cons of Mortgage Recasting

There are both positive and negative aspects to mortgage recasting.

Pros of Recasting

Mortgage recasting lowers your monthly mortgage payments and lets you save on total loan interest while keeping the same interest rate. Since you recast your mortgage with your existing lender, the process is pretty straightforward, and the cost could be as low as $150.

Cons of Recasting

There are some potential drawbacks to mortgage recasting, as well. Making a large lump-sum payment means you could be trading liquidity for equity – and creating financial instability if unexpected expenses arise or if the housing market takes a downward turn.
If you have other debts with higher interest rates, you may want to avoid mortgage recasting. It could make more sense to use the money you would put toward the principal to pay down your higher-interest debt first.

“No matter what method works best for you, it’s important to cut spending as much as you can while you’re tackling your debts,” said Kendall Meade, a Certified Financial Planner at SoFi.

Recommended: Cash-Out Refinance vs HELOC

Pros and Cons of Mortgage Refinancing

Mortgage refinancing also has upsides and downsides.

Pros of Refinancing

If you are eligible to refinance, you won’t need a large cash source in order to lower your mortgage payments. Instead, your main goal is to qualify for a lower interest rate. If you succeed, you will save a lot of money in interest over time.

With a cash-out refi, you can tap your home equity and use that money for whatever you need to do: pay down higher-interest debt, add to the college fund, or remodel your kitchen.

Cons of Refinancing

Reducing your loan term with a refi could result in a higher mortgage payment, even though it can let you save total interest over the life of the new loan.

Refinancing involves closing costs, which could range from 2% to as much as 6% of the remaining principal. You’re taking out a new mortgage, after all. Some lenders will let you roll closing costs into your loan, though this may raise your interest rate or your loan balance.

To figure out whether a refinance might be worth the price of closing costs, it’s a good idea to calculate the break-even point, when interest savings will exceed closing costs. Everything beyond that break-even point will be savings.

💡 Quick Tip: Generally, the lower your debt-to-income ratio, the better loan terms you’ll be offered. One way to improve your ratio is to increase your income (hello, side hustle!). Another way is to consolidate your debt and lower your monthly debt payments.

When to Choose Recasting Over Refinancing

Recasting vs. refinancing can seem like a tough choice. But there are a number of situations in which a recast may make more sense.

•   You’ve gotten a windfall and don’t have other pressing financial issues. A recast allows you to cheaply and easily reduce your monthly payments.

•   You have a better rate on your mortgage than you could get today. A recast will let you keep that rate, while reducing your payments.

•   You’re self-employed or have poor credit and would have difficulty qualifying for a mortgage refinance, but you want to lower your monthly payments.

•   You want to lower your monthly payments with a cheaper, faster process than a refinance.

Factors to Consider Before Making a Decision

As you contemplate getting a mortgage recast vs. a refinance, there are a few things to keep in mind.

Loan Type and Lender Policies

It may sound appealing to recast vs. refinance your mortgage but only conventional loans are eligible. If you have a government-backed loan – like a VA home loan or an FHA mortgage – you may need to consider a refinance vs. a recast.

Even if you do have a conventional loan, you’ll still need to find out if your lender offers mortgage recasts (not all of them do). If your lender does provide mortgage recasts, ask what your lender’s requirements are and see if you meet them. Typically, lenders may want:

•   A minimum payment toward principal – typically $10,000

•   Sufficient home equity, as determined by the lender

•   Good financial standing, meaning that you have built up a history of on-time payments

Long-Term Financial Goals

Before you decide on mortgage recasting vs. refinancing, you’ll want to review which process aligns better with your long-range plans.

Say you’re planning an early retirement. If you’d really like to pay off your mortgage soon and not have to budget for that monthly payment any longer, you may want to consider a mortgage refinance vs. a recast. It will let you adjust your interest rate and loan term. And though closing costs are more expensive than a recast servicing fee, a refinance can let you pay your loan off earlier.

However, if you’re planning to work for the next 30 years but would like to pay less each month and save on your overall interest, a mortgage recast vs. a refinance may make sense for you. That’s especially true if you’ve gotten a windfall – from a bonus at work or from selling a previous home, for instance – and don’t have other pressing debts or needs.

A recast may also be appealing if you already have a great interest rate and probably couldn’t get a better one, for instance. Or if you just started a business and don’t have the kind of documentable financial stability a lender would want to see before giving you a refinance. In these situations, you may want to consider recasting your mortgage vs. refinancing.

The Takeaway

A mortgage recast vs. refinance: different animals with similar aims. A recast requires a lump sum upfront but will shrink payments and total loan interest. A mortgage refinance may greatly reduce borrower costs and sometimes free up cash or shorten the loan term. The one that is right for you will depend on your current loan terms and your available cash, among other factors.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

SoFi Mortgages: simple, smart, and so affordable.

FAQ

Can you recast and refinance at the same time?

Not exactly. However, a cash-in refinance combines characteristics of both, letting you make a large payment toward your principal as you get a new home loan. This allows you to get new and, ideally, more favorable terms on a smaller loan, which can save you money. You will, however, have to pay closing costs.

Can you recast any type of mortgage loan?

No. You can recast conventional loans, but not government-backed loans like FHA or VA mortgages. Some lenders may recast jumbo loans.

Does recasting your mortgage affect your interest rate?

Unlike refinancing, recasting your mortgage doesn’t change your interest rate or your loan term.

Are there fees associated with a mortgage recast?

There may be service fees for a mortgage recast, but those are typically no more than a few hundred dollars.

When is refinancing better than recasting?

You may be better off with a refinance vs. a recast if you are interested in paying your loan off earlier than originally planned, if you can get a better interest rate now, or if you don’t have a significant lump sum to put toward your loan principal.

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

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 requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

^¹FHA loans are subject to unique terms and conditions established by FHA and SoFi. Ask your SoFi loan officer for details about eligibility, documentation, and other requirements. FHA loans require an Upfront Mortgage Insurance Premium (UFMIP), which may be financed or paid at closing, in addition to monthly Mortgage Insurance Premiums (MIP). Maximum loan amounts vary by county. The minimum FHA mortgage down payment is 3.5% for those who qualify financially for a primary purchase. SoFi is not affiliated with any government agency.
^†Veterans, Service members, and members of the National Guard or Reserve may be eligible for a loan guaranteed by the U.S. Department of Veterans Affairs. VA loans are subject to unique terms and conditions established by VA and SoFi. Ask your SoFi loan officer for details about eligibility, documentation, and other requirements. VA loans typically require a one-time funding fee except as may be exempted by VA guidelines. The fee may be financed or paid at closing. The amount of the fee depends on the type of loan, the total amount of the loan, and, depending on loan type, prior use of VA eligibility and down payment amount. The VA funding fee is typically non-refundable. SoFi is not affiliated with any government agency.
Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®

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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Emerging markets or emerging market economies (EMEs) are in the process of achieving the building blocks of developed nations: they’re establishing regulatory bodies, creating infrastructure, fostering political stability, and supporting mature financial markets. But many emerging markets still face challenges that developed market countries have overcome, and that contributes to potential instability.

Developed economies have higher standards of living and per-capita income, strong infrastructure, typically stable political systems, and mature capital markets. The U.S., Europe, U.K, and Japan are among the biggest developed nations. India, China, and Brazil are a few of the larger countries that fall into the emerging markets category. Some emerging market economies, like these three, are also key global players — and investors may benefit by understanding the opportunities as well as the potential risks emerging markets present.

What is an Emerging Market?

In essence, an emerging market refers to an economy that can become a developed, advanced economy soon. And because an emerging market may be a rapidly growing one, it may offer investment potential in certain sectors.

Internationally focused investors tend to see these countries as potential sources of growth because their economies can resemble an established yet still-young startup company. The infrastructure and blueprint for success have been laid out, but things need to evolve before the economy can truly take off and ultimately mature. At the same time, owing to the challenges emerging market economies often face, there are also potential risks when investing in emerging markets.

Investors might bear the brunt of political turmoil, local infrastructure hurdles, a volatile home currency and illiquid capital markets (if certain enterprises are state-run or otherwise privately held, for example).

Emerging Market Examples

What constitutes an emerging market economy is somewhat fluid, and the list can vary depending on the source. Morgan Stanley Capital International (MSCI) classifies 24 countries as emerging; Dow Jones also classifies 24 as emerging. There is some overlap between lists, and some countries may be added or removed as their status changes.

India is one of the world’s biggest emerging economies. Increasingly, though, some investors see India as pushing the bounds of its emerging market status.

China

China is the second-largest economy globally by gross domestic product (GDP). It has a large manufacturing base, plenty of technological innovation, and the largest population of any country in the world.

Yet China still has a few characteristics typical of an emerging market, and with its Communist-led political system, China has embraced many aspects of capitalism in its economy but investors may experience some turbulence related to government laws and policy changes. The Renminbi, China’s official currency, has a history of volatility.

India

India is another big global economy, and it’s considered among the top 10 richest countries in the world, yet India still has a low per-capita income that is typical of an emerging market and poverty is widespread.

At the same time, India was ranked as being among the more advanced emerging markets, thanks to its robust financial system, growing foreign investment, and strong industrials, especially in telecommunication and technology.

Brazil

Brazil is a large country, with more than 200 million people, 26 states, and 5,500 municipalities. In 2024, Brazil’s GDP clocked in at more than 3%, and its economy has grown steadily in recent years, despite hiccups caused by the pandemic.

As the largest country in South America, and one that is continuing to see growth, it’s attracted the attention of some investors. In all, it’s one of a handful of emerging markets, though there are still areas rife with poverty, similar to India.

South Africa

South Africa is the largest economy in Africa, and one of only a handful that has seen a relatively stable macroeconomic environment. It’s a country that has its issues, of course, and some ugly history to contend with — as most countries do. Even so, it’s created a fairly welcoming environment for businesses, and thus, investors.

Mexico

Mexico is another country that ticks all the boxes to qualify as an emerging market, and is a major trading partner with countries like the U.S. Like the aforementioned countries, though, it still has economic weaknesses, and widespread poverty.

Characteristics of an Emerging Market Economy

As noted above, there isn’t a single definition of an emerging market, but there are some markers that distinguish these economies from developed nations.

Fast-Paced Growth

An emerging market economy is often in a state of rapid expansion. There is perhaps no better time to be invested in the growth of a country than when it enters this phase.

At this point, an emerging market has typically laid much of the groundwork necessary for becoming a developed nation. Capital markets and regulatory bodies have been established, personal incomes are rising, innovation is flourishing, and gross domestic product (GDP) is climbing.

Lower Per-Capita Income

The World Bank keeps a record of the gross national income (GNI) of many countries. For the fiscal year of 2025, lower-middle-income economies are defined as having GNI per capita of between $1,146 and $4,515 per year. At the same time, upper-middle-income economies are defined as having GNI per capita between $4,516 and $14,005.

The vast majority of countries that are considered emerging markets fall into the lower-middle and upper-middle-income ranges. For example, India, Pakistan, and the Philippines are lower-middle-income, while China, Brazil, and Mexico are upper-middle-income. Thus, all these countries are referred to as emerging markets despite the considerable differences in their economic progression.

Political and Economic Instability

For most EMEs, volatility is par for the course. Risk and volatility tend to go hand in hand, and both are common among emerging market investments.

Emerging economies can be rife with internal conflicts, political turmoil, and economic upheaval. Some of these countries might see revolutions, political coups, or become targets of sanctions by more powerful developed nations.

Any one of these factors can have an immediate impact on financial markets and the performance of various sectors. Investors need to know the lay of the land when considering which EMEs to invest in.

Infrastructure and Climate

While some EMEs have well-developed infrastructure, many are a mix of sophisticated cities and rural regions that lack technology, services and basic amenities like reliable transportation. This lack of infrastructure can leave emerging markets especially vulnerable to any kind of crisis, whether political or from a natural disaster.

For example, if a country relies on agricultural exports for a significant portion of its trade, a tsunami, hurricane, or earthquake could derail related commerce.

On the other hand, climate challenges may also present investment opportunities that are worth considering.

Currency Crises

The value of a country’s currency is an important factor to keep in mind when considering investing in emerging markets.

Sometimes it can look like stock prices are soaring, but that might not be the case if the currency is declining.

If a stock goes up by 50% in a month, but the national currency declines by 90% during the same period, investors could see a net loss, although they might not recognize it as such until converting gains to their own native currency.

Heavy Reliance on Exports

Emerging market economies tend to rely heavily on exports. That means their economies depend in large part on selling goods and services to other countries.

A developed nation might house all the needs of production within its own shores while also being home to a population with the income necessary to purchase those goods and services. Developing countries, however, must export the bulk of what they create.

Emerging Economies’ Impact on Local Politics vs. Global Economy

Emerging economies play a significant role in the growth of the global economy, accounting for about 50% of the world’s economic growth. Moreover, it’s estimated that by 2050 three countries could represent the biggest economies: the U.S., China, and India, with only one currently being classified as a developed economy.

But, while emerging markets help fuel global growth, some of those with higher growth opportunities also come with turbulent political situations.

As an investor, the political climate of emerging market investments can pose serious risks. Although there is potential for higher returns, especially in EMEs that are in a growth phase, investors should consider the potential downside. For example, Thailand and South Korea are emerging economies with high growth potential, but there is also a lot of political instability in these regions.


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Pros and Cons of Investing in Emerging Markets

Let’s recap some of the pros and cons associated with EME investments.

Pros

Pros of investing in emerging markets include:

•  High-performance potential: Selecting the right investments in EMEs at the right time may result in returns that might be greater than other investments. Rapidly growing economies could provide opportunity for potential returns. But as noted above, it’s impossible to guarantee the timing of any investment.

•  Global diversification: Investing in EMEs provides a chance to hold assets that go beyond the borders of an investor’s home country. So even if an unforeseen event should happen that contributes to slower domestic growth, it’s possible that investments elsewhere could perform well and provide some balance.

Cons

Cons of investing in emerging markets include:

•  High volatility: As a general rule, investments with higher liquidity and market capitalization tend to be less volatile because it takes significant capital inflows or outflows to move their prices.

EMEs tend to have smaller capital markets combined with ongoing challenges, making them vulnerable to volatility.

•  High risk: With high volatility and uncertainty comes higher risk. What’s more, that risk can’t always be quantified. A situation might be even more unpredictable than it seems if factors coincide (e.g. a drought plus political instability).

All investments carry risk, but EMEs bring with them a host of fresh variables that can twist and turn in unexpected ways.

•  Low accessibility: While liquid capital markets are a characteristic of emerging markets, that liquidity still doesn’t match up to that of developed economies.

It may be necessary to consult with an investment advisor or pursue other means of deploying capital that may be undesirable to some investors.

Why Invest in Emerging Markets?

Emerging markets are generally thought of as high-risk, high-reward investments.

They can provide yet another way to diversify an investment portfolio. Having all of your portfolio invested in the assets of a single country may put you at the mercy of that country’s circumstances. If something goes wrong, like social unrest, a currency crisis, or widespread natural disasters, that might impact your investments.

Being invested in multiple countries may help mitigate the risk of something unexpected happening to any single economy.

The returns from emerging markets could potentially exceed those found elsewhere. If investors can capitalize on the high rate of growth in an emerging market at the right time and avoid any of the potential mishaps, they could stand to profit. Of course timing any market, let alone a more complex and potentially volatile emerging market, may not be a winning strategy.

Strategies for Investing in Emerging Markets

There are a few ways or strategies that investors can utilize to invest in emerging markets, such as buying funds, or buying stocks directly.

Exchange-Traded Funds (ETFs) and Mutual Funds

Investors can look at different exchange-traded funds (ETFs) or mutual funds that comprise assets from emerging markets. Funds may have some degree of built-in diversification, too, within those markets (such as holding different types of assets, or stocks of companies from various industries). This may be a simple way to add exposure to a specific or slate of emerging economies to a portfolio.

Direct Stock Investments

It’s also possible to buy stocks of companies based in various emerging markets. That could entail buying Chinese or Indian stocks, for example, but it’s possible that you may need to buy them over-the-counter (OTC).

Diversification Strategies

If diversification is a chief concern for mitigating risk, then investors may want to look at starting with some emerging market funds that are already diversified to some degree. There are many options out there, and it may also be worth discussing with a financial professional to see what your options are.

The Takeaway

While developed nations like the U.S. and Europe and Japan regularly make headlines as global powerhouses, emerging market countries actually make up a major part of the world’s economy — and possibly, some opportunities for investors. China and India are two of the biggest emerging markets, and not because of their vast populations. They both have maturing financial markets and strong industrial sectors and a great deal of foreign investment. And like other emerging markets, these countries have seen rapid growth in certain sectors (e.g., technology).

Despite their economic stature, though, both countries still face challenges common to many emerging economies, including political turbulence, currency fluctuations and low per-capita income.

It’s factors like these that can contribute to the risks of investing in emerging markets. And yet, emerging markets may also present unique investment opportunities owing to the fact that they are growing rapidly. But investors need to carefully weigh the potential risks.

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FAQ

What qualifies as rapid growth to make a market emerging?

Generally, “rapid growth” in reference to an emerging market would take economic growth into account, often measured by GDP. So, if an emerging market is seeing high GDP growth, it may be said to be experiencing rapid growth.

How do emerging markets compare to developed markets from an investing standpoint?

Developed markets are inherently more stable, and investing in those markets may introduce less risk to a portfolio. Emerging markets are generally riskier for a variety of reasons, but could also provide the opportunity to see faster growth, and thus, bigger potential returns. There are no guarantees, however.

Which industries thrive in emerging markets?

It’s possible that industries such as tech, health care, and even renewable energy could thrive in emerging markets, but there are many factors that could stymie their growth, too. Suffice it to say that each market is different, and because an industry thrives in one country doesn’t mean it necessarily would in another.

How can investors gain exposure to emerging markets?

Investors can buy shares of stocks from companies in emerging markets, or even buy shares of funds with significant holdings in those markets.

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