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Carrying a balance on a card can impact your credit — sometimes in negative ways. For instance, having a large balance can drive up your credit utilization rate, which impacts your credit score. And if you rack up too high of a balance on your credit card, you run the risk of starting to fall behind on payments.

Learn more about how keeping a balance can impact your credit score and your financial health.

What to Know About Carrying a Balance on Your Credit Card

When you carry a credit card balance, that means you did not pay off your last statement balance in full. Technically, you only have to make the minimum monthly payment by the due date to avoid a late fee. However, when you carry a balance, you’ll start to accrue interest on the unpaid amount.

Interest can add up quickly. For instance, say you have a credit card balance of $5,000 and your credit card’s annual percentage rate (APR) is 24%. If you were to make monthly payments of $200, it would take you about 36 months to pay off the full amount, and you’d pay a grand sum of $2,000 in interest.

What Happens to Your Credit Score When You Carry a Balance?

Carrying a balance will cause your credit utilization to go up. Credit utilization compares your balance against your total credit limit across all of your cards, and it’s expressed as a percentage. For example, let’s say you have a balance of $1,000, and your total credit limit is $10,000. Your credit utilization would be 10%.

This matters because credit utilization is a major factor considered among popular consumer credit scoring models, such as the VantageScore and FICO®, where it makes up 30% of your score. Generally, it’s advised to keep your credit utilization below 30% to avoid adverse effects to your score, though the lower, the better.

Situations in Which Carrying a Balance Isn’t Worth It

Sometimes, carrying a balance can give you a bit of breathing room to pay off a large purchase. But often, it’s not worth the potential effects on your credit score.

Your Credit Utilization Is Too High

If your credit utilization is too high because you’re carrying a large balance, it can hurt your score. Aim to pay off your credit card bill as soon as possible, rather than adding to your existing balance. That way, you’ll give your credit card a chance to bounce back.

Your Interest Rate Is High

If your balance is on a credit card with a high annual percentage rate (APR), you’ll want to think twice before carrying it. In general, credit cards tend to have higher interest rates than other types of debt, which is why credit card debt is hard to pay off. Plus, credit card interest accrues on a daily basis, so it’s easy for a balance to balloon.

You Can’t Keep Up With Payments

If you’re carrying a high balance, it’s probably best to keep your credit card balance to a minimum rather than adding to it and risking falling behind. The consequences of credit card late payment can include paying late fees, having your account sent to collections, and suffering potential impacts to your credit score.

When Will You Be Charged Interest on Your Credit Card Balance?

The majority of credit cards offer a grace period. During this time, you won’t be charged any interest. This grace period usually extends from the date your billing statement is issued to the credit card payment due date, and it’s typically at least 21 days long.

Once the grace period ends, you’ll be charged interest on your balance. Most credit card interest is compounded daily. In other words, each day interest will get charged to your account based on that day’s balance.

Advantages of Paying Off Your Credit Card on Time

Unsure of whether to pay off your credit card or keep a balance? Here’s the case for paying off your credit card on time and in full:

•   Avoid late fees and other consequences: Should you miss making your credit card minimum payment by the due date, you’ll get charged a late fee. The Consumer Financial Protection Bureau has worked to lower these from an average of $32 to $8 as of mid 2024. Beyond that charge, late payments of more than 30 days can get reported to the credit bureaus, affecting your credit score. You could also see an increase in your credit card APR.

•   Skip paying interest: Perhaps one of the biggest advantages of paying off your credit card balance in full is that you’ll avoid paying any interest. Thanks to the grace period, credit card interest only starts to accrue if you carry a remaining balance after the statement due date. Some credit cards even reward you for paying on-time, lowering the APR after a period of on-time monthly payments of at least the minimum due.

•   Dodge credit card debt: Paying off your statement balance in full will get you into the habit of only charging your credit card how much you can afford to pay. Plus, you’ll avoid the possibility of debt starting to pile up if you stay on top of your payments.

•   Lower your credit utilization: Another perk of paying off your credit card on time and in full is that it will lower your credit utilization rate. A lower credit utilization rate can positively affect your credit score — a rule of thumb to keep in mind if you’re working on building credit.

What Is the Best Way to Pay Off a Credit Card Balance?

The “best” way to pay off a credit card balance is whichever method works best for you and your unique financial situation. Some common ways to go about paying off a credit card balance, or making it easier to pay, include:

•   Paying promptly in full: If possible, pay your credit card balance in full each month. This will prevent you from paying interest, as well as getting hit with potential late fees if you fall behind.

•   Making early or multiple payments: Another option is to make an early payment. Paying off all or part of your balance before the due date lowers your credit utilization, which in turn can positively affect your credit score.

•   Adjusting your payment date: Reach out to your credit card issuer to see if you can move your credit card payment due date so that it’s easier for you to to stay on time with your payments. For instance, you might set your due date for right after you usually get paid.

•   Considering the debt snowball or debt avalanche payoff method: If you’re staring down a mountain of debt, consider one of two popular debt payoff strategies. With the debt snowball method, you pay off the card with the lowest balance first. Once that’s knocked out, you move to paying down the card with the next-highest balance. The debt avalanche method, on the other hand, is where you start with paying down the card with the highest interest rate. Once you get that card paid off, you focus on the card with the next highest interest rate and so on, until all of your debt is paid down.

Recommended: How Credit Card Payments Work

What to Do if You Need to Carry a Balance

Sometimes it’s just not feasible to pay down your credit card balance in a single month. If that’s your situation, here’s what to do to make sure you stay on top of your debt and can pay it off sooner rather than later:

•   Make at least the minimum payment: Falling behind on your payments can negatively impact your credit score, so make sure you’re at least making the minimum payment on time. This will also allow you to avoid getting hit with any late fees, not to mention the potential danger of your credit card issuer increasing your APR or worse, your account getting sent to collections.

•   Consider credit card debt consolidation: If you’re carrying a balance across a handful of different types of credit cards with high-interest rates, you might consider debt consolidation. With this approach, you’d effectively lump together your debts into a new loan. The potential advantages of doing this include paying it off quicker and saving in interest, depending on the terms of your loan.

•   Look into a debt management plan: Another option is to work with a third-party organization to create a debt management plan. You’d then make a single monthly payment to the organization. The organization might be able to negotiate on your behalf with credit card companies for lower monthly payments or a lower interest rate. A potential downside of a debt management plan is that it might require you to close your accounts until your balances are paid off, which could affect your credit score.

•   Research the option of a balance transfer: When you use a balance transfer credit card to move over your outstanding balances, you might be able to take advantage of a promotional APR that’s sometimes as low as 0%. If you can pay off your credit card before the promotional period ends, it could save you in interest fees. Note that you generally need good credit to qualify though (in other words, if you’re still establishing credit, this might not be the right option for you).

The Takeaway

Carrying a balance isn’t necessary to help build your credit score, and in some cases, it can hurt your score. If you need to carry a balance, make it a priority to at least make your minimum monthly payments and aim to pay down your balance in full as soon as you can.

Whether you're looking to build credit, apply for a new credit card, or save money with the cards you have, it's important to understand the options that are best for you. Learn more about credit cards by exploring this credit card guide.

FAQ

Should I carry a balance or pay off credit cards?

Ideally, you should aim to pay off your balance in full each month. That way, you won’t pay any interest. Plus, you’ll lower your credit utilization and improve your history of on-time payments, both of which are factors that determine your credit score.

How much of a balance is ideal for me to keep on my credit card?

The lower the balance, the better. Contrary to popular belief, carrying a balance will not help your credit, so there is no benefit in doing so. You should pay off your credit cards in full as quickly as possible. And if you do need to carry a balance, consider a balance transfer, credit card consolidation, or debt management plan.

Is it advisable to keep a zero balance on a credit card?

Yes, keeping your balance at zero will help you to build your credit or maintain a strong score. Plus, it will keep your credit usage low, and you won’t pay any interest.

What amount is too much of a balance on a credit card?

There’s no specific, one-size-fits-all amount. Rather, a credit card balance becomes too high if it brings up your credit utilization to over 30%, or if you have trouble keeping up with payments.

Photo credit: iStock/Delmaine Donson

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.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

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 .

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.

Third Party Trademarks: Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

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There are many ways that you can build and establish credit. Your credit score is made up of a number of factors, two of which are how much you currently owe and your overall payment history. As such, applying for and responsibly using a credit card can help build your credit, as can paying off your credit card statement on time and in full.

When deciding how much to use your credit card to build credit, it’s a bit of a balancing act. If you simply have a credit card but don’t use it, it may not improve your credit score very much. But if you spend too much on your credit card, you may damage your score. Building your credit comes down to finding the sweet spot between not using your card at all and using it too much.

How Making Purchases With Your Credit Card Could Possibly Help Your Credit Score

The amount of credit that you use and your overall payment history are two of the most important factors that determine your credit score. As you start to establish credit, you’ll want to responsibly use your credit card, making sure to keep your spending low in comparison to your overall credit limit. You’ll also want to make at least the minimum payment by the statement due date or, even better, pay off your statement balance in full each month.

Recommended: Does Applying For a Credit Card Hurt Your Credit Score?

Minor Purchases to Build Credit

As you work toward building your credit, you’ll likely want to put some of your everyday purchases on your credit card. Just make sure that you set aside enough money to pay off your statement balance when it comes, which can signal that you are using your credit card responsibly.

Recommended: What Is the Average Credit Card Limit?

Groceries

Groceries are one of the biggest monthly expenses for many families and households, so it can make sense to put your grocery purchases on your credit card. Most grocery stores accept credit card payments for no additional charge. Then you can plan to pay off your statement balance by the due date to help build your credit.

Gas

Gas is another large expense for many people. Most gas stations accept credit cards with no additional charges. Plus, paying for gas with a credit card is also usually more convenient. Keep in mind that some gas stations may offer a discount for paying for gas with cash, which can be a good way to save money on gas.

Utilities

Admittedly, utilities can be challenging to pay with a credit card. Some utilities may offer online payments with a credit card without a fee, though others may only allow fee-free payments by cash, check, or ACH. Unless you can find a way to dodge fees, it doesn’t make financial sense to pay a convenience fee just to pay bills with your credit card.

Coffee

If a daily coffee run is part of your regular routine, consider paying for it with your credit card. That way, you can earn credit card rewards and possibly build your credit, too, from a purchase you’d be making anyways. Also check if your coffee shop offers its own rewards program — you’ll want to make sure to sign up for that as well to take advantage of perks and offers.

Streaming Subscriptions

If you have recurring monthly subscriptions to places like Netflix, Hulu, or Disney+, that can be another cost to move over to your credit card. Setting up those recurring streaming subscriptions for autopay can help ensure your service is not interrupted and possibly build up your credit history.

Gym Membership

A gym membership is another potential cost to pay with a credit card in order to build your credit. You’ll want to make sure that you are getting value from your gym membership, however. If you find that you rarely go to the gym, you might get better value from canceling your membership and saving or investing that money.

Entertainment

If going out to eat or other forms of entertainment are frequent monthly expenses for you, consider covering those with a credit card. Having a variety of expenses on your credit card statement can help you stay organized and more easily track your spending — plus, you could build your credit in the process.

Major Purchases to Build Credit

Besides everyday smaller purchases, it can make sense to use a credit card for major purchases as well. Many credit cards offer price protection or an extended warranty, which can provide additional benefits. Managed wisely, these larger purchases can positively impact your credit.

Car

Whether or not you’ll be able to use one of the different kinds of credit cards to pay for a car purchase will depend on the policies of the place where you’re buying the car. Some dealerships will allow you to cover the full cost of the car with a credit card, while others only allow credit cards for partial payment, such as the down payment.

Just make sure to negotiate a final price before you offer to pay with a card — otherwise, the dealer may try to charge a higher price to make up for credit card processing fees.

Recommended: What Is a Charge Card?

Jewelry

Jewelry is another big-ticket item that you might cover with a credit card. Talk with the store where you’re making your purchase to see what options are available. Some jewelry stores might offer a discount for paying with cash, which might sway you in the choice between cash or credit card.

Home Appliances

There are several reasons it can make sense to buy large home appliances with a credit card. Not only could you earn rewards and build your credit, but the credit card you use may also offer credit card protection. This can potentially save you hundreds of dollars or more if you end up having a problem with your appliance down the road.

Taxes

It is possible to pay your taxes with a credit card, though there are very few ways to do it for free. Depending on where you live and the type of taxes you’re trying to pay, you’ll likely pay a convenience fee of 2% to 3%. Still, depending on what kind of rewards your card earns and your overall financial situation, it can make sense to pay taxes with a credit card.

The Takeaway

Just having a credit card may help build credit some, since your total amount of available credit plays a factor in determining your credit score. But if you’re really looking to build credit, you’ll want to use your credit card, and use it responsibly. Put some of your regular purchases and big-ticket items on your credit card, and make sure to have a plan to pay your statement off in full, each and every month.

Whether you're looking to build credit, apply for a new credit card, or save money with the cards you have, it's important to understand the options that are best for you. Learn more about credit cards by exploring this credit card guide.

FAQ

What is a credit score?

Your credit score is a number that lenders can use to help determine how likely you are to repay your debts and obligations. The higher the credit score, the better, with the maximum credit score being 850.

What items help you build credit?

There are a variety of factors that make up your credit score, including the age and type of credit accounts you have, how much of your available credit you’re using, and your payment history. Responsibly using your credit card and paying off your balance in full and on time, for example, can help to build credit.

What is the fastest way to build up your credit?

There generally are not any magic bullets to build up your credit from scratch fast. That said, one of the best ways to build up your credit is to show a history of reliably paying your bills on-time, each and every month. The longer your track record of using your existing credit responsibly, the better it is for your credit score.

Photo credit: iStock/Tingting Ji

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.

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 .

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.

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

Third Party Trademarks: Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

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Credit allows you to borrow money to access money, goods, or services, with the expectation that you’ll later pay back the amount you borrowed. This could come in handy if you want to make a purchase that you can’t immediately pay for, such as taking out a mortgage to buy a home or an auto loan to cover your car purchase.

However, credit is only extended based on the lender’s confidence that the borrower will repay them. Those who have good credit are viewed as more likely to fulfill their debt obligations, and thus are more likely to get approved for credit opportunities and secure better terms. This is why building and improving credit is important — it can open up doors in your financial future.

What Is Credit?

The meaning of credit boils down to a contractual agreement: If a lump sum of money or something of value is borrowed, the borrower agrees to pay it back in full at a later date, along with any applicable fees and interest. Credit can take a number of different forms, from a credit card to a mortgage to an auto loan to student loans.

When you have good credit, that means you’ve established a track record of paying your debt on time and within the agreed-upon conditions. If you’re deemed creditworthy, meaning less of a risk to lenders, you’ll have an easier time in the future borrowing money, at more favorable terms and rates.

On the flipside, if you’ve had trouble paying back money you borrowed or staying on top of payments, you’ll have a not-so-great credit score. In turn, lenders, creditors, and merchants will be less inclined to loan you money or extend a line of credit due to your higher perceived credit risk.

Recommended: When Are Credit Card Payments Due?

Why Do You Need Credit?

In an ideal world, you’d have all the cash on hand needed to get those big-ticket items, like a house or a new car, or to fund your child’s college education. But in reality, you might need to borrow money to make those purchases, which is where credit can come into play.

Credit can help you reach your long-term goals and lead to greater opportunities. For instance, a student loan can help you obtain a higher education, which can be your ticket to higher-paying jobs. Or a mortgage could make it possible for you to become a homeowner.

Additionally, credit can offer various protections and perks that you might not get with other payment methods. For instance, with some of the different kinds of credit cards available, you can enjoy benefits like purchase protection and also earn rewards on your purchases.

Types of Credit

While not the only types, two of the main types of credit are installment credit and revolving credit. Both installment and revolving credit come with interest rates, potential fees, and repayment terms.

Installment Credit

Installment credit is a type of credit where you receive a lump sum upfront that you then pay back in fixed amounts over time, usually with interest. Examples of installment credit include personal loans, car loans, and mortgages.

Revolving Credit

Revolving credit allows you to borrow as much or as little money as you need up to your credit limit. Once you repay your balance, you can borrow that amount again. While you have to at least make a minimum payment each month, you can carry over your balance onto the next month.

Types of revolving credit include credit cards and home equity lines of credit (HELOC).

Tips for Building Your Credit

When working to build credit from scratch, here are some tips to keep in mind.

Make On-Time Payments

Since payment history makes up 35% of your credit score, you’ll want to prioritize staying on top of your payments. Ideally, you’d pay off your full balance each month, but make sure you’re at least making the minimum payment to avoid a late fee and negative effects on your credit.

Keep Your Balances Low

Keeping your balances low will make them more manageable to pay off. Plus, it will help you to maintain a lower credit utilization, which is a comparison of your credit card balances against the total credit limit across all of your cards. Credit utilization makes up 30% of your credit score, and a lower credit utilization ratio is generally viewed as more favorable.

Don’t Apply for More Credit Than Necessary

When you apply for a credit card, it results in a hard credit pull, which will usually negatively impact your score by a few to several points for a brief period of time. Further, too many credit applications in a short window of time can raise a red flag for lenders, as you may appear overextended. In turn, you’ll want to apply to cards sparingly, and only those you’re most interested in.

Keep an Eye on Your Credit

Monitoring your credit will help you learn how different financial movements and behaviors affect your credit score. It also will alert you when your score takes a dip, and when it is positively impacted. Plus, it can help you detect suspicious activity. It’s recommended that you check your credit at least once a year, but many people may prefer to do so more frequently, especially if they are, say, planning on applying for a home loan soon.

How Credit Scores Work

Credit scores are calculated using dozens of different scoring models. However, the most widely used scoring models for consumer scores are FICO® and VantageScore.

These scoring models take into account various data that appears in your credit report. This information is compiled by the three major credit bureaus — Experian®, Equifax®, and TransUnion® — and sourced from various creditors who report your borrowing and payment activity.

That information is then distilled into a three-digit number that’s known as your credit score. Interestingly, while everyone’s credit score is based on five main categories of information, how those categories are weighted can vary from person to person. For instance, if you’re just starting to establish credit, your length of credit history will be weighted differently than it would be for someone with a lengthy credit history.

Factors That Affect Your Credit Score

As mentioned, there are five main factors that are considered when determining your credit score. These are:

•   Payment history: Your history of making payments on-time is considered the most important factor in your credit score by FICO®. Even just one missed payment can negatively impact your score. Given the importance of a good credit score, it’s wise to avoid falling behind.

•   Amounts owed: Otherwise known as credit usage, this looks at how much of your total available revolving credit you’re using. It’s recommended to keep this rate at no more than 30% to avoid negative effects, so keep this in mind when using a credit card throughout the month.

•   Length of credit history: How long you’ve had your accounts open is another factor that makes up your credit score. As such, think twice before closing old accounts, even if you’re not using them that often.

•   Credit mix: A diverse mix of credit — credit cards, auto or personal loans, mortgage — can help your score. Lenders want to see how well you can manage a wide range of credit products.

•   New credit: This is the number of new credit accounts you’ve applied for and recently opened. Remember, an application leads to a hard inquiry, which will temporarily lower your credit score. Numerous applications at once can signal increased risk to lenders.

How to Check Your Credit Score

You can check your credit score in a few different ways:

•   At AnnualCreditReport.com, where you can access a free report at least once a year

•   By signing up for a free credit monitoring service

•   Through a credit card issuer, lender, or money management app

•   With a nonprofit credit counselor

With any of the above options, just make sure to note the terms before requesting your score — there’s no need to pay for information you can get for free.

Calculating Your Credit Score

Credit scores generally range from 300 to 850, though someone’s starting credit score isn’t necessarily at the lowest end (nor will it be zero). While exact intervals can vary a bit depending on the scoring model, here’s a look at how FICO® breaks down the credit score ranges:

•   Poor: 300 to 579

•   Fair: 580 to 669

•   Good: 670 to 739

•   Very good: 740 to 799

•   Exceptional (or Excellent): 800 to 850

As mentioned, five factors are taken into account when calculating your credit score: payment history, amounts owed, length of credit history, credit mix, and new credit.

When it comes to how exactly your score is calculated, it gets a bit complex. Consumer scoring models, such as FICO® and VantageScore, use statistical analysis methods to find patterns of behavior that are linked to your perceived ability to pay back your loans.

The Takeaway

Credit is important in your life as a consumer. It can help you make purchases you wouldn’t be able to, opening doors to new financial opportunities. Further, having a strong credit can save you in interest and fees and make it more likely that you’ll get approved for more competitive credit opportunities.

Whether you're looking to build credit, apply for a new credit card, or save money with the cards you have, it's important to understand the options that are best for you. Learn more about credit cards by exploring this credit card guide.

FAQ

What is a simple definition of credit?

Credit is the agreement under which someone borrows money to access goods and services, with the expectation that they’ll then pay back the amount borrowed in full, along with any applicable interest charges or fees.

What is the difference between credit and debit?

With debit, the money spent is deducted from existing funds you have in an account. Credit, on the other hand, allows you to borrow money that you’ll repay at a later date.

How do I get to know my credit score?

You can check your credit score in a number of ways, including a free credit scoring website, through your credit card issuer or lender, or by visiting a nonprofit credit counselor.

Photo credit: iStock/tommaso79

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.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

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 .

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.

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 Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

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A mortgage lien may sound scary, but any homeowner with a mortgage has one. It’s simply the legal claim that your mortgage issuer has on your home until you have paid off your mortgage.

Then there are involuntary liens, which can be frightful. Think tax liens, mechanic’s liens, creditor liens, and child support liens.

What Is a Mortgage Lien?

Mortgage liens are part of the agreement people make when they obtain a mortgage loan. Not all homebuyers can purchase a property in cash, so lenders give buyers cash upfront and let them pay off the loan in installments, with the mortgage secured by the property, or collateral.

If a buyer stops paying the mortgage, the lender can take the property. If making monthly mortgage payments becomes a challenge, homeowners would be smart to contact their loan servicer or lender immediately and look into mortgage forbearance.

Mortgage liens complicate a short sale.

They will show up on a title report and bar the way to a clear title.

Recommended: Tips When Shopping for a Mortgage

Types of Liens

Generally, there are two lien types: voluntary and involuntary.

Voluntary

Homebuyers agree to a voluntary, or consensual, lien when they sign a mortgage. If a homeowner defaults on the mortgage, the lender has the right to seize the property.

Voluntary liens include other loans:

•  Car loans

•  Home equity loans

•  Reverse mortgages

Voluntary liens aren’t considered a negative mark on a person’s finances. It’s only when a borrower stops making payments that the lien could be an issue.

Involuntary

On the other side of the coin is the involuntary, or nonconsensual, lien. This lien is placed on the property without the homeowner’s consent.

An involuntary lien could occur if homeowners are behind on taxes or homeowners association payments. They can lose their property if they don’t pay back the debt.

Property Liens to Avoid

Homeowners will want to avoid an involuntary lien, which may come from a state or local agency, the federal government, or even a contractor.

Any of the following liens can prohibit a homeowner from selling or refinancing property.

Judgment Liens

A judgment lien is an involuntary lien on both real and personal property and future assets that results from a court ruling involving child support, an auto accident, or a creditor.

If you’re in this unfortunate position, you’ll need to pay up, negotiate a partial payoff, or get the lien removed before you can sell the property.

Filing for bankruptcy could be a last resort.

Tax Liens

A tax lien is an involuntary lien filed for failure to pay property taxes or federal income taxes. Liens for unpaid real estate taxes usually attach only to the property on which the taxes were owed.

An IRS lien, though, attaches to all of your assets (real property, securities, and vehicles) and to assets acquired during the duration of the lien. If the taxpayer doesn’t pay off or resolve the lien, the government may seize the property and sell it to settle the balance.

HOA Liens

If a property owner in a homeowners association community is delinquent on dues or fees, the HOA can impose an HOA lien on the property. The lien may cover debts owed and late fees or interest.

In many cases, the HOA will report the lien to the county. With a lien attached to the property title, selling the home may not be possible. In some cases, the HOA can foreclose on a property if the lien has not been resolved, sell the home, and use the proceeds to satisfy the debt.

Mechanic’s Liens

If a homeowner refuses to pay a contractor for work or materials, the contractor can enforce a lien. Mechanic’s liens apply to everything from mechanics and builders to suppliers and subcontractors.

When a mechanic or other specialist files a lien on a property, it shows up on the title, making it hard to sell the property without resolving it.

Lien Priority

Lien priority refers to the order in which liens are addressed in the case of multiple lien types. Generally, lien priority follows chronological order, meaning the first lienholder has priority.

Lien priority primarily comes into play when a property is foreclosed or sold for cash. The priority dictates which parties get paid first from the home’s sale.

Say a homeowner has a mortgage lien on a property, and then a tax lien is filed. If the owner defaults on their home loan and the property goes into foreclosure, the mortgagee has priority as it was first to file.

Lien priority also explains why lenders may deny homeowners a refinance or home equity line of credit if they have multiple liens to their name. If the homeowner were to default on everything, a lender might be further down the repayment food chain, making the loan riskier.

How to Find Liens

Homeowners or interested homebuyers can find out if a property has a lien on it by using an online search. Liens are a public record, so interested parties can research any address.

For a DIY approach:

•  Search by address on the local county’s assessor or clerk’s site.

•  Use an online tool like PropertyShark.

Title companies can also search for a lien on a property for a fee.

If sellers have a lien on a property they’re selling, they’ll need to bring cash to the closing to cover the difference. If the seller doesn’t have enough money, the homebuyer is asked to cover the cost, or they can walk away from the deal.

How Can Liens Affect Your Mortgage?

An involuntary lien can affect homeowners’ ability to buy a new home, sell theirs, or refinance a mortgage. Lenders may deem the homeowner too big a risk for a refinance if they have multiple liens already.

Or, when homeowners go to sell their home, they’ll need to be able to satisfy the voluntary mortgage lien or liens at closing with the proceeds from the sale. If they sell the house for less than they purchased it for or have other liens that take priority, it may be hard to find a buyer willing to pay the difference.

Liens can also lead to foreclosure, which can impede a person’s chances of getting a mortgage for at least three to seven years.

How to Remove a Lien on a Property

There are several ways to remove a lien from a property, including:

•  Pay off the debt. The most straightforward approach is to pay an involuntary lien, or pay off your mortgage, which removes the voluntary lien.

•  Ask for the lien to be removed. In some cases, borrowers pay off their debt and still have a lien on their property. In that case, they should reach out to the creditor to formally be released from the lien and ask for a release-of-lien form for documentation.

•  Run out the statute of limitations. This approach varies by state, but in some cases, homeowners can wait up to a decade and the statute of limitations on the lien will expire. However, this doesn’t excuse the homeowner from their debt. It simply removes the lien from the home, making it easier to sell and settle the debt.

•  Negotiate the terms of the lien. If borrowers are willing to negotiate with their creditors, they may be able to lift the lien without paying the debt in full.

•  Go to court. If a homeowner thinks a lien was incorrectly placed on their property, they can file a court motion to have it removed.

Before taking any approach, you might consider reaching out to a legal professional or financial advisor to plan the next steps.

Recommended: Home Loan Help Center

The Takeaway

Liens can be voluntary and involuntary. Many homeowners don’t realize that the terms of their mortgage include a voluntary lien, and as long as you make your mortgage payments this is nothing to be concerned about. It’s involuntary liens that homeowners would be smart to avoid.

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.

FAQ

What type of lien is a mortgage?

A mortgage lien is a voluntary lien because a homeowner agrees to its terms before signing the loan.

Will having a lien prevent me from getting a new loan?

Some liens can keep people from getting new loans. Lenders are unlikely to loan applicants money if they have multiple liens.

Is it bad to have a lien on my property?

A mortgage lien is voluntary and not considered bad for a borrower. But an involuntary lien prohibits owners from having full rights to their property, which can affect their ability to sell the home.

How can I avoid involuntary liens?

Homeowners can avoid involuntary liens by staying up to date on payments, including property taxes, federal income taxes, HOA fees, and contractor bills.

Can an involuntary lien be removed?

Yes, an involuntary lien can be removed in several ways, including paying off the debt, filing bankruptcy, negotiating the debt owed, and challenging the lien in court.

Photo credit: iStock/adaask
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SOHL-Q324-041

A 5/1 adjustable-rate mortgage (ARM) is a mortgage whose interest rate is fixed for the first five years and then adjusts once a year. Adjustable-rate mortgages often have lower initial interest rates than other loans and they can be a good choice for a short-term homeowner.

While most borrowers will opt for a conventional 30-year fixed-rate mortgage, some buyers are drawn to the low teaser rate of an ARM.

Here’s a closer look at adjustable-rate mortgages and the 5/1 ARM in particular.

Adjustable-Rate Mortgages, Defined

An adjustable-rate mortgage typically has a lower initial interest rate — often for three to 10 years — than a comparable fixed-rate home loan.

Then the rate “resets” up (or down) based on current market rates, with caps dictating how much the rate can change in any adjustment.

With most ARMs, the rate adjusts once a year after the initial fixed-rate period.

Recommended: Fixed Rate vs. Adjustable Rate Mortgages: Key Differences to Know

What Is a 5/1 ARM?

Adjustable-rate mortgages come in the form of a 3/1, 7/1, 10/1 (the rate adjusts once a year after the initial fixed-rate period), 10/6 (the rate adjusts every six months after 10 years), and more, but the most common is the 5/1 ARM.

With a 5/1 ARM, the interest rate is fixed for the first five years of the loan, and then the rate will adjust once a year — hence the “1.” Adjustments are based on current market rates for the remainder of the loan.

Because borrowers may see their rate rise after the initial fixed-rate period, they need to be sure they can afford the larger payments if they don’t plan to sell their house, pay off the loan, or refinance the loan.

How 5/1 ARM Rates Work

An ARM interest rate is made up of the index and the margin. The index is a measure of interest rates in general. The margin is an extra amount the lender adds, and is constant over the life of the loan.

Caps on how high (or low) your rate can go will affect your payments.

Let’s say you’re shopping for a 5/1 ARM and you see one with 3/2/5 caps. Here’s how the 3/2/5 breaks down:

•   Initial cap. Limits the amount the interest rate can adjust up or down the first time the payment adjusts. In this case, after five years, the rate can adjust by up to three percentage points. If your ARM carries a 4.5% initial rate and market rates have risen, it could go up to 7.5%.

•   Cap on subsequent adjustments. In the example, the rate can’t go up or down more than two percentage points with each adjustment after the first one.

•   Lifetime cap. The rate can never go up more than five percentage points in the lifetime of the loan.

When Does a 5/1 ARM Adjust?

The rate will adjust annually after five years, assuming you don’t sell or refinance your home before you hit the five-year mark.

Pros and Cons of 5/1 ARMs

Borrowers should be aware of all the upsides and downsides if they feel a call to ARMs.

Pros of a 5/1 ARM

A lower interest rate up front. The initial five-year rate is usually lower than that of a fixed-rate mortgage. This can be an advantage for new homeowners who would like to have a little extra cash on hand to furnish the home and pay for landscaping and maintenance. And first-time homebuyers may gravitate toward an ARM because lower rates increase their buying power.

Could be a good fit for short-term homeowners. Some buyers may only need a home for five years or less: those who plan to downsize or upsize, business professionals who think they might be transferred, and the like. These borrowers may get the best of both worlds with a 5/1 ARM: a low interest rate and no risk of higher rates later on, as they’ll likely sell the home and move before the rate adjustment period kicks in.

A 5/1 ARM borrower may be able to save significantly more cash over the first five years of the loan than they would with a 30-year fixed rate loan.

Modern ARMs are less dicey. The risky ARMs available before the financial crisis that let borrowers pay just the interest on the loan or choose their own payment amount are no longer widely available.

Potential for long-term benefit. If interest rates dip or remain steady, an ARM could be less expensive over a long period than a fixed-rate mortgage.

Cons of a 5/1 ARM

Risk of higher long-term interest rates. The good fortune with a 5/1 ARM runs out after five years, with the possibility of higher interest rates. We’ve all seen how rising inflation affects mortgage rates. While no one can see what the future holds, it’s possible that the loan could reset to a rate that leads to mortgage payments the borrower finds uncomfortable or downright unaffordable.

Higher overall home loan costs. If interest rates rise with a 5/1 ARM, homeowners will pay more over the entire loan than they would have with a fixed-rate mortgage.

Refinancing fees. You can refinance an ARM to a fixed-rate loan, but expect to pay closing costs of 2% to 6% of the loan. A no-closing-cost refinance offers no real escape: The borrower either adds the closing costs to the principal or accepts an increased interest rate.

Possible negative amortization. Payment caps limit the amount of payment increases, so payments may not cover all the interest due on your loan. The unpaid interest is added to your debt, and interest may be charged on that amount. You might owe the lender more later in the loan term than you did at the start. Be sure you know whether the ARM you are considering can have negative amortization, the Federal Reserve advises.

Possible prepayment penalty. Prepayment penalties are rare now, but check for any penalty if you were to refinance or pay off the ARM within the first three to five years.

Recommended: Mortgage Prequalification vs. Preapproval

Comparing Adjustable-Rate Mortgages

When you take out a mortgage, you choose a mortgage term. Most fixed-rate mortgage loans, and ARMs, are 30-year loans.

5/1 ARM vs. 10/1 ARM

A five-year ARM has a five-year low fixed rate followed by 25 years with an adjustable rate. A 10-year ARM offers 10 years at a fixed rate, then 20 years of adjustments.

In general, the shorter the fixed-rate period, the lower the introductory rate.

5/1 vs. 7/1 ARM

Same song, different verse. The 7/1 ARM has a seven-year fixed rate instead of five for the 5/1 ARM. The initial interest rate on the 7/1 probably will be a little higher than the 5/1.

Is a 5/1 ARM Right for You?

Is a 5/1 ARM loan a good idea? It depends on your finances and goals.

In general, adjustable-rate mortgages make sense when there’s a sizable interest rate gap between ARMs and fixed-rate mortgages. If you can get a great deal on a fixed-rate mortgage, an ARM may not be as attractive.

If you plan on being in the home for a long time, then one fixed, reliable interest rate for the life of the loan may be the smarter move.

An ARM presents a trade-off: You get a lower initial rate in exchange for assuming risk over the long run.

Your best bet on ARMs?

•   Talk to a trusted financial advisor or housing counselor.

•   Get information in writing about each ARM program of interest before you have paid a nonrefundable fee.

•   Ask your mortgage broker or lender about anything you don’t understand, such as index rates, margins, and caps. Ask about any prepayment penalty.

•   If you apply for a loan, you will get more information, including the mortgage APR and a payment schedule. The annual percentage rate takes into account interest, any fees paid to the lender, mortgage points, and any mortgage insurance premium. You can compare APRs and terms for similar ARMs.

•   It’s a good idea to shop around and negotiate for the best deal.

The Takeaway

A 5/1 ARM offers borrowers a low initial rate but risk over the long run. Tempted by a sweet introductory rate? It’s a good idea to know how long you plan to stay in the home and to be clear about how rate adjustments might affect your monthly payments.

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.

FAQ

Is it a good idea to have a 5/1 ARM?

Whether a 5/1 ARM is a good idea for you will depend on how long you plan to stay in the house. If you think you will move or refinance before the initial low interest rate ends after five years, then a 5/1 ARM could be a good fit for you.

Can you pay off a 5/1 ARM early?

Maybe. Some mortgages have prepayment penalties, meaning you would pay a fee if you refinanced or paid off the mortgage during the first five years. Prepayment penalties are not as common now as they were in the past, but they do still exist so read the fine print in your loan documents.

How long does a 5/1 ARM last?

Most mortgages, even adjustable-rate mortgages, are 30-year loans. A 5/1 ARM would have one fixed payment for the first five years, then the monthly payment would adjust annually for the remaining 25 years of the loan.

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.

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