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According to 2024 data from Experian®, the average credit score for a 24-year-old is 681. That’s one point higher than the 2023 average and is considered a “good” FICO® Score.

Here, we’ll walk you through the ins and outs of how your age can impact your credit score, how a 681 stacks up against the average score in the U.S., and ways to build your score over time.

Average Credit Score for a 24-Year-Old

As mentioned, the average credit score for a 24-year-old is 681, which the credit scoring model FICO classifies as “good.” With that score, you’re likely to qualify for an array of loans and credit cards, though you may not get the best interest rates and terms.

But take heart: Credit scores tend to increase with age. According to Experian data, the average credit score for Millennials (ages 28 to 43) is 691. Gen X (ages 44 to 59) has an average score of 709, while members of the Silent Generation (ages 79+) boast a 760 score.

What Is a Credit Score?

A credit score is a three-digit number that ranges from 300 to 850. It helps lenders and creditors gauge your creditworthiness, or the likelihood that you’ll pay back the money you borrowed. Generally speaking, the higher your score, the greater your chances of being approved for a credit card or loan.

Two common credit scoring models are FICO and VantageScore®. Most lenders use FICO. Though both models create scores based on similar key factors, the breakdown of scores is slightly different.

FICO Score

•   Exceptional (or excellent): 800 to 850

•   Very Good: 740 to 799

•   Good: 670 to 739

•   Fair: 580 to 669

•   Poor: 300 to 579

VantageScore

•   Super prime: 781 to 850

•   Prime: 661 to 780

•   Near prime: 601 to 660

•   Subprime: 300 to 600

Recommended: FICO Score vs. Credit Score

What Is the Average Credit Score?

According to the latest FICO data, the average FICO credit score in the U.S. is 717 — 36 points higher than the average 24-year-old’s score. And as of February 2025, the average VantageScore is 701. Both scores are well within the “good” or “prime” range, and could help borrowers qualify for favorable loan and line of credit terms.

Average Credit Score by Age

Age doesn’t necessarily determine your credit score. But as the chart below shows, the older you are, the more likely you are to have a higher score.

This makes sense. When you’re just starting out — as many 24-year-olds are — you may not have a long credit history. Plus, you might experience greater financial ups and downs as you find your professional footing, and this could impact your ability to pay off debts.

What’s a Good Credit Score for Your Age?

As we mentioned, the average credit score for a 24-year-old is 681. But remember, that’s just an average. No matter how old you are, FICO defines a good credit score as anywhere between 670 and 739. If your score falls within that range, your finances are likely in a sound place.

It’s worth noting that when you’re starting out, you may not have a credit score. Your credit history typically starts when you take out your first line of credit, and it normally takes around six months or so for credit bureaus to collect enough information for your starting credit to be calculated.

Though it can vary, a starting credit score may be anywhere from 500 to 700. You can gradually see it rise as you continue to bolster your credit.

How Are Credit Scores Used?

Credit scores are used in several ways. Lenders and creditors review your credit when you apply for a card or loan to help determine whether you qualify for financing. As you might expect, the higher your score, the greater your odds of getting approved for a credit card or loan with more favorable terms and rates.

But credit scores can also play a role in unexpected ways. For instance, this three-digit number could help determine how much you pay for insurance premiums or whether you’re approved to rent a home. And some potential employers might review your score during a routine background check.

Factors Influencing the Average Credit Score

To steadily build your credit score, it helps to understand the five key factors that influence it the most. Here’s a closer look at each component — and how much it counts toward your overall score.

•   Payment history (35%). Your track record of bill paying has the biggest impact on your FICO Score, so aim to pay your bills on time, every time. A spending app can help budget for the payments.

•   Credit utilization (30%). Also known as credit usage, this is how much credit you’re tapping into against the total amount available. Try to keep your credit card utilization low, as ringing up a too-high balance might signal to lenders and creditors that you’re spread thin financially.

•   Length of credit history (15%). A longer credit history shows lenders that you have a solid track record of using credit. Generally, the older the average age of your credit accounts, the higher your score tends to be.

•   Credit mix (10%). Having a diverse mix of credit can signal that you can responsibly manage different forms of debt. That said, you’ll want to only apply for the financing you need.

•   New credit (10%). When you apply for credit, a lender performs a hard credit pull, which can ding your credit score by a few points. Though the dip is temporary, it could stay on your credit report for up to a year.

How to Strengthen Your Credit Score

If you’re in your 20s, you might be in the early phases of understanding how long it takes to build credit. Here are a few things you can do to gradually lift your credit score.

Stay on Top of Payments

As we discussed, your payment history has a major impact on your credit score. Consider setting up automatic payments or changing your due dates to a time of the month that works better for you. For example, if the main cluster of bills is due at the top of the month, schedule your monthly credit card payments so they fall after your second paycheck. A money tracker app can help you keep track of payments so you won’t miss a due date.

Keep Credit Usage Low

If you have a credit card balance, try to ensure your credit utilization doesn’t exceed 30%. For instance, let’s say your credit limit on all your cards is $2,000. To maintain a 30% credit usage, you’ll want to carry a balance no larger than $600.

If you want to see whether your hard work is paying off, you can check your credit score for free.

Limit New Credit Application

There are reasons why you should avoid applying for unnecessary credit. For starters, a lender will likely do a hard inquiry with each application, which can temporarily ding your score. Also, applying for multiple lines of credit within an extremely short time frame could signal to lenders that you’re financially strapped.

There is an exception: If you shop for an installment loan, like a car loan or mortgage, lenders give you anywhere from 14 to 45 days to shop for rates. The hard pulls generally count as a single inquiry when you are rate shopping.

How Does My Age Affect My Credit Score?

While age doesn’t factor into your credit score, you may notice that your three-digit number may improve as you get older. This is because as you age, you’ve had more time to establish an account history and may have an easier time managing your debt obligations.

What Factors Affect My Credit Score?

As we discussed, the top factors impacting your credit score are payment history, credit usage, length of credit history, credit mix, and new credit.

If you’ve made some financial blunders and want to build or repair your credit, work on fixing the areas that have negatively impacted your score the most. So, for example, if you’ve fallen behind or missed payments, you’ll want to start paying bills on time.

Keep in mind that boosting credit doesn’t happen overnight. Your credit score updates every 30 to 45 days, so resist the urge to constantly check on your score. Instead, you’d be better off focusing on strategies that build up your credit.

At What Age Does Your Credit Score Improve the Most?

According to Experian data, the biggest jump in credit scores tends to happen between Gen Z and Baby Boomers. But again, the longer you’ve been responsibly managing an account, the higher your score will likely be.

How to Build Credit

There are several ways to build your credit — here are a few simple strategies to explore:

Become an Authorized User

If you have a family member or trusted friend with a solid credit history, ask if they can add you as an authorized user on your card. You’ll be able to make purchases with the card, but the primary cardholder is responsible for making payments.

Report Rent and Utility Payments

Alternative credit reporting, such as reporting your rent, cell phone bill, and utility payments, can be another way to improve your score when you’re just starting out. You usually need to sign up with a third-party platform that reports your on-time payments to the credit bureaus, and you may be required to pay a monthly subscription fee.

Open a Secured Credit Card

A secured credit card is usually easier to get than an unsecured one, though it requires you to put down a security deposit that typically matches your credit limit. Otherwise, a secured card works just like any other credit card. Making timely payments and using credit responsibly can help build your score.

Credit Score Tips

Besides being mindful of best practices to build your credit, you’ll want to check your credit score every so often and note any changes. You may be able to do this with credit score monitoring tools or through your bank or credit card company.

It’s also a good idea to regularly review your credit report for mistakes or inaccuracies. You can receive a free copy of your report each week via AnnualCreditReport.com.

Recommended: Why Did My Credit Score Drop After a Dispute?

The Takeaway

To recap, what’s the average credit score for a 24-year-old? According to Experian, it’s 681, which falls into the “good” category. When you practice sound financial behaviors, your score could increase even more over time. For instance, staying on top of payments, paying down debt, and keeping credit accounts open can all help bolster your score.

Take control of your finances with SoFi. With our financial insights and credit score monitoring tools, you can view all of your accounts in one convenient dashboard. From there, you can see your various balances, spending breakdowns, and credit score. Plus you can easily set up budgets and discover valuable financial insights — all at no cost.

FAQ

What is a good credit score for a 24-year-old?

The average credit score for someone who is 24 is 681, which is technically considered a “good” FICO score. Younger consumers who are starting out on their credit-building journey may have a harder time achieving an excellent score.

What is a good credit limit for a 24-year-old?

The average credit limit for 24-year-olds in the U.S. is $12,899, according to Experian. However, what’s considered good depends on the individual’s finances, spending habits, and ability to pay down the balance.

How rare is an 800 credit score?

According to Experian data, 22% of Americans have a credit score of 800 or higher, which is considered an excellent score.

Is a 900 credit score possible?

Consumer credit scores range from 300 to 850, so a 900 credit score isn’t feasible.

Is 650 a good credit score?

A 650 credit score falls in the “fair” range. With a fair credit score, you can get approved for some forms of financing, but you’ll likely get higher interest rates and the less-favorable terms.

What credit score is needed to buy a $300K house?

If you’re buying a home with a conventional loan, you’ll need a minimum credit score of 620. Lenders may accept a credit score as low as 500 if you’re taking out an FHA loan.

Photo credit: iStock/blackCAT

SoFi Relay offers users the ability to connect both SoFi accounts and external accounts using Plaid, Inc.’s service. When you use the service to connect an account, you authorize SoFi to obtain account information from any external accounts as set forth in SoFi’s Terms of Use. Based on your consent SoFi will also automatically provide some financial data received from the credit bureau for your visibility, without the need of you connecting additional accounts. SoFi assumes no responsibility for the timeliness, accuracy, deletion, non-delivery or failure to store any user data, loss of user data, communications, or personalization settings. You shall confirm the accuracy of Plaid data through sources independent of SoFi. The credit score is a VantageScore® based on TransUnion® (the “Processing Agent”) data.

*Terms and conditions apply. This offer is only available to new SoFi users without existing SoFi accounts. It is non-transferable. One offer per person. To receive the rewards points offer, you must successfully complete setting up Credit Score Monitoring. Rewards points may only be redeemed towards active SoFi accounts, such as your SoFi Checking or Savings account, subject to program terms that may be found here: SoFi Member Rewards Terms and Conditions. SoFi reserves the right to modify or discontinue this offer at any time without notice.

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

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SORL-Q225-017

Dealing with debt can be a very stressful experience and make you feel as if you’ll never be able to pay off what you owe. If you find yourself struggling to manage multiple debts, the snowball method can provide a practical and effective strategy to regain control of your financial situation. This method, popularized by personal finance expert Dave Ramsey, focuses on paying off debts in a specific order to build momentum and motivation.

Read on to learn how the snowball debt payoff method works, including its benefits, plus alternative payoff strategies you may want to consider.

Building the Snowball

With the snowball method you list your debts from smallest to largest based on balance and regardless of interest rates. The goal is to pay off the smallest debt first while making minimum payments on other debts. Once the smallest debt is paid off, you roll the amount you were paying towards it into the next smallest debt, creating a “snowball effect” as you tackle larger debts.

Getting rid of the smallest debt first can give you a psychological boost. If, by contrast, you were to try to pay down the largest debt first, it might feel like throwing a pebble into an ocean, and you might simply give up before you got very far.

A Word About Paying Off High-interest Debt First

From a purely financial perspective, it might make more sense to first tackle the debt that comes with the highest interest rate first, since it means paying less interest over the life of the loans (more on this avalanche approach below).

However, the snowball method focuses on the psychological aspect of debt repayment. By starting with the smallest debt, you experience quick wins and a sense of accomplishment right away. This early success can then motivate you to continue the debt repayment journey. In addition, paying off smaller debts frees up cash flow, allowing you to put more money towards larger debts later.

Recommended: How to Get Out of $10,000 in Credit Card Debt

Making Minimum Payments Doesn’t Equal Minimum Payoff Time

While you may feel like you’re making progress by paying the minimum balance on your debts, this approach can lead to a prolonged payoff timeline. The snowball method encourages you to pay more than the minimum on your smallest debt, accelerating the repayment process. Over time, as you pay off each debt, the amount you can allocate towards the next debt grows, increasing your progress.

The Snowball Plan, Step By Step

Here’s a step-by-step guide to implementing the snowball method.

1. List all debts from smallest to largest. You want to list them by the total amount owed, not the interest rates. If two debts have similar totals, place the debt with the higher interest rate first.

2. Make minimum payments. Continue making at least minimum payments on all debts except the smallest one.

3. Attack the smallest debt. Put any extra money you can towards paying off the smallest debt while still making your payments on others.

4. Roll the snowball. Once the smallest debt is paid off, take the amount you were paying towards it and add it to the minimum payment of the next smallest debt.

5. Repeat and accelerate. Repeat this process, attacking one debt at a time, until all debts are paid off.

A Word About Principal Reduction

It’s a good idea to reach out to your creditors and lenders and find out how they apply extra payments to a debt (they don’t all do it the same way). You’ll want to make sure that any additional payments you make beyond the minimum are applied to the principal balance of the debt. This will help reduce the overall interest you pay and expedite the debt payoff process.

Recommended: Personal Loan Calculator

Perks of the Snowball Method

The snowball method offers several advantages:

•   Motivation and momentum The quick wins and sense of progress provide motivation to continue the debt repayment journey.

•   Simplification Focusing on one debt at a time simplifies the process, making it easier to track and manage.

•   Increased cash flow As each debt is paid off, the money previously allocated to it becomes available to put towards the next debt, accelerating the payoff timeline.

Alternatives to the Snowball Method

While the snowball method has proven effective for many, it’s not the only debt repayment strategy available. Here are three alternative methods you may want to consider.

The Avalanche Method

The avalanche method involves making a list of all your debts in order of interest rate. The first debt on your list should be the one with the highest interest rate. You then pay extra on that first debt, while continuing to pay at least the minimum on all the others. When you fully pay off that first debt, you apply your extra payment to the debt with the next highest interest rate, and so on.

This method can potentially save more on interest payments in the long run. However, it requires discipline and may take longer to see significant progress compared to the snowball method.

The Debt Snowflake Method

The debt snowflake method is a debt repayment method you can use on its own or in conjunction with other approaches (like the snowball or avalanche method). The snowflake approach involves finding extra income through a part-time job or side gig, selling items, and/or cutting expenses and then putting that extra money directly toward debt repayment. While each “snowflake” may not have a significant impact on your debt, they can accumulate over time and help you become free of high-interest debt.

Debt Consolidation

If the snowball, avalanche, or snowflake methods seem overwhelming, you might want to consider combining your debts into one simple monthly payment that doesn’t require any strategizing. Known as debt consolidation, you may be able to do this by taking out a personal loan and using it to pay off your debts. You then only have one balance and one payment and, ideally, a lower interest rate, which can help you save money.

Often called debt consolidation loans, these loans provide a lump sum of cash, usually at a fixed interest rate and are repayable in one to seven years.

Recommended: How Refinancing Credit Card Debt Works

The Takeaway

The snowball method offers a practical and motivational approach to paying down debt. By starting with small debts and building momentum, you can gain control of your finances and work towards becoming debt-free. It can be a good way to take action and commit to a debt repayment strategy. If it doesn’t suit you, you might consider the avalanche or snowflake method or a personal loan to consolidate debt.

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

FAQ

What is the snowball method of paying down debt?

With the snowball method of paying down debt, you prioritize paying off the smallest balance first, no matter what its interest rate is. Once that debt is paid off, you prioritize the next smallest debt.

What is the disadvantage of using the debt snowball method?

The disadvantage of the debt snowball method is that, by prioritizing the lowest amount of debt, you may not be paying off the debt with the highest interest rate first. This means your most expensive debt could continue to grow as you pay off smaller debts.

What is the advantage of the debt snowball method?

By tackling the smallest debt first, regardless of interest rate, you can get a psychological boost from successfully paying that off and then build momentum for getting rid of your other debt.

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SOPL-Q225-103

You may have seen personal loans advertised as starting at a certain interest rate or annual percentage rate (APR). But when you check your personal loan interest rate, you may find that what is offered to you is significantly higher. Why is that?

The average personal loan interest rate is dependent on several factors, including the amount borrowed, credit history, and income, among others. Average interest rates for personal loans may also differ depending on the type of the loan. Here are some factors that may affect the personal loan interest rate you’re approved for.

Average Personal Loan Interest Rates By Credit Score

The APR for a personal loan is calculated by looking at several factors, including the requested amount, the applicant’s income history, and the reasons for borrowing. One of the biggest factors, however, is an applicant’s credit score. In general, the higher a borrower’s credit score, the lower the loan interest rate they will be offered.

Here’s a look at average personal loan interest rates for different credit scores as of May 2025.

Factors That Can Lower Personal Loan Interest Rates

One thing to know about how personal loans work is that your unique credit profile will likely affect the interest rate offered to you. Here’s a look at some ways you may be able to qualify for a lower personal loan interest rate.

Building Your Credit Score

Building your credit score can potentially be a way to qualify for a personal loan with better rates and terms. Some strategies that can help you positively impact your credit profile include:

•  Checking your credit report It’s a good idea to get copies of your credit reports (you have three; one each from Equifax®, TransUnion®, and Experian®) and make sure that your personal information — e.g., name, address, phone number, Social Security number — is correct in each one. Also look for any erroneous public record information, such as lawsuits or bankruptcies filed that you were not a part of and any errors or inaccuracies in the credit accounts section. You can dispute any errors with the credit reporting agency.

•  Lowering your credit utilization ratio Your credit utilization ratio — the amount of debt you have compared to the amount of credit available to you — plays a large part in credit score calculation. Paying down your debt will lower this ratio. Financial experts suggest keeping the ratio at 30% or lower (10% or lower is ideal).

•  Avoiding late payments Late payments can have a large and lasting impact on your credit score. If there are any late payments in your history, you may be able to minimize their impact by creating a record of on-time payments moving forward. Setting up autopay for debt payments is one way to make sure those payments are made regularly and on time.

Secured vs Unsecured Personal Loans

How a personal loan works depends on the type of personal loan you choose. As you research loan options, you may come across options for secured and unsecured personal loans.

What’s the difference between a secured and unsecured personal loan?

•  A secured personal loan requires the borrower to pledge collateral to guarantee the loan. This collateral is something of value that the borrower owns, such as a car, investments, or a savings account. If the borrower cannot or does not make the loan payments, then the lender can seize that collateral to recoup its losses.

•  An unsecured personal loan, also called a signature loan, is backed by the borrower’s estimated creditworthiness. If the borrower can’t pay back the loan, the lender can’t take any of their property or valuables to recoup its loss. The lender can, however, take other steps to recoup its loss, such as suing the borrower, which may affect the borrower’s credit score and future financial options.

Personal loans are commonly unsecured loans. However, some lenders offer secured personal loans, which can allow borrowers with fair credit to qualify for a loan or get a better rate than they otherwise would with an unsecured loan.

Income and Employment Status

Your income and employment status may affect the rate you’re offered on a personal loan. Lenders generally see borrowers with solid, steady income as lower risk and, therefore, offer them lower rates. If you’re a freelancer, independent contractor, or business owner, you might need additional paperwork to prove your income than you would if you work a W-2 job.

If your income is irregular, having a creditworthy co-applicant may help you get approved for more favorable interest rates. Asking someone to be a co-applicant is a big commitment, though, and having a conversation about all that it entails can help alleviate any concerns of both parties.

Factors That May Increase Personal Loan Interest Rates

Lenders must assess how risky an unsecured loan might be and the likelihood of the loan being paid back. To do that, they look at the applicant’s credit history, employment status, and loan amount requested, among other factors. Here are some things that may lead a lender to think a loan is more risky — and potentially offer a higher rate to the borrower.

Credit Score

An applicant’s credit score is one factor that affects the personal loan interest rate they might be approved for. In general, the lower the applicant’s credit score (which indicates poor management of credit in the past), the higher the rate of interest they will be offered. Improving your credit over time may make it possible to qualify for a loan with a lower interest rate.

Debt-to-Income Ratio

Debt-to-income (DTI) ratio refers to how much debt someone has in relation to how much income they have. To calculate your DTI, you add up your monthly debts (including mortgage payments, car payments, and credit card payments) then divide that number by your gross monthly income and multiply by 100. DTI ratio is expressed as a percentage. In general, the higher your DTI ratio, the riskier you may seem to lenders. Each lender sets its own DTI ratio requirement.

Unemployment

A personal loan application will ask for proof of income, usually in the form of W2s or tax returns from prior years. The lender wants to know that a borrower has a steady source of income. If a loan applicant is unemployed, it may be harder — but not impossible — to have a loan approved.

Recent Bankruptcy

Bankruptcy will appear on an applicant’s credit report and stay there for seven to 10 years, typically making it challenging to be approved for a personal loan. Applying with a cosigner can make it easier to be approved for a personal loan after recent bankruptcy. But keep in mind that if you are unable to repay the loan, your cosigner would be responsible for the debt.

Is a Personal Loan the Right Choice for You?

Individual circumstances really determine whether a personal loan is the right choice for any one person.

•  A personal loan can be a good option for people who want to consolidate high-interest debt, like that of credit cards, to save money. For a debt consolidation loan to be successful, it’s important to discontinue using the credit cards to accumulate more debt.

•  Having a fixed interest rate and steady payment amount can be helpful when using a personal loan to cover a big purchase. A personal loan is installment debt with a payment end date, in contrast to the revolving debt of a credit card.

•  A personal loan is still debt and increases a person’s overall debt load, so it can be a good idea to have a sense of how you’ll repay it. Making late payments or failing to repay the loan can negatively affect your credit score.

A personal loan rate calculator can be a helpful tool to estimate your personal loan rate and will not affect your credit score. Your offered rate may vary slightly when you officially apply for a loan, but an estimate can give you a good benchmark for comparison.

Recommended: How to Apply for a Personal Loan

The Takeaway

Personal loan interest rates vary depending on an applicant’s financial circumstances but can also vary by lender, so it can make sense to shop around for rates. If your credit profile is not as strong as it could be, you may want to work on building your credit before applying for a personal loan. This can help increase your chances of loan approval, as well as your odds of getting approved for a loan with a favorable interest rate.

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

FAQ

What is a good interest rate on a personal loan?

A good interest rate on a personal loan could be under the almost 14.00% average for those with superior credit as of May 2025. At that time, some of the lowest rates for personal loans began at around 7.99%.

Is 10.00% a good personal loan rate?

Yes. If you have good to very strong credit (720-plus), you could qualify for a 10.00% APR, which is considered a good personal loan interest rate. It is lower than the average personal loan rate for borrowers with excellent credit, which is 13.88% as of May 2025.

Is 12.00% a good personal loan rate?

Yes, a 12.00% APR is considered a good personal loan rate as of May 2025. You would probably need a very strong credit score (possibly 720 or higher) to qualify for this rate. It beats the average personal loan interest rate for excellent credit, which is 13.88%.

Which bank has the lowest interest rate on personal loans?

According to Forbes Advisor, the best low-interest personal loans are currently available from SoFi, Upgrade, LendingClub, PenFed, Happy Money, and U.S. Bank.

What is a personal loan interest rate?

A personal loan’s interest rate is the cost you pay each year to borrow money expressed as a percentage. The interest rate does not include fees charged for the loan. The annual percentage rate (APR) of a personal loan is the cost you pay each year to borrow money, including fees, expressed as a percentage. The higher the APR, the more you’ll pay over the life of the loan.

What is the interest rate on a $40,000 loan?

The interest rate on a $40,000 personal loan will depend on the lender, the loan’s term, and the creditworthiness of the borrower. The APR can range anywhere from the single digits to 35.99% or possibly higher.

What is a good interest rate for an unsecured personal loan?

A good interest rate for an unsecured personal loan can range anywhere from 7.99% to 13.88% as of May 2025. However, you will likely need to have excellent credit to qualify.

Photo credit: iStock/alexsl

SOPL-Q225-088

Convertible bonds are a type of corporate debt security that provide fixed-income payments like a bond, but can be converted to common shares of stock. As such, they’re often referred to as “hybrid securities.”

Most convertible bonds give investors a choice. They can hold the bond until maturity, or convert it to stock at certain times during the life of the bond. This structure protects investors if the price of the stock falls below the level when the convertible bond was issued, because the investor can choose to simply hold onto the bond and collect the interest.

How Do Convertible Bonds Work?

Companies will often choose to issue convertible bonds to raise capital in order to not alienate their existing shareholders. That’s because shareholders may be uneasy when a company issues new shares, as it can drive down the price of existing shares, often through a process called stock dilution.

Convertible bonds are also attractive to issue for companies because the coupon — or interest payment — tends to be lower than for regular bonds. This can be helpful for companies who are looking to borrow money more cheaply.

What Are the Conversion Ratio and Price?

Every convertible bond has its own conversion ratio. For instance, a bond with a conversion ratio of 3:1 ratio would allow the holder of one bond to convert that security into three shares of the company’s common stock.

Every convertible bond also comes with its own conversion share price, which is set when the conversion ratio is decided. That information can be found in the bond indenture of convertible bonds.

Convertible bonds can come with a wide range of terms. For instance, with mandatory convertible bonds, investors must convert these bonds at a pre-set price conversion ratio.

There are also reverse convertible bonds, which give the company — not the investor or bondholder — the choice of when to convert the bond to equity shares, or to keep the bond in place until maturity.

But it also allows the investor to convert the bond to stock in the case where they’d make money by converting the bond to shares of stock when the share price is higher than the value of the bond, plus the remaining interest payments.

In general, these options are not available when investing online.

How Big Is the Convertible Bond Market?

As of 2024, the size of the U.S. convertible bond market was estimated to be about $270 to $280 billion. Securities have been issued by hundreds of companies. But note that these numbers are miniscule compared to the U.S. equity market, which has trillions in value and thousands of stocks.

The total size of the convertible bond market does expand and contract, though, often with the cycling of the economy. In 2024, the total convertible bond issuance reached nearly $88 billion, versus $55 billion in 2023, and $29 billion in 2022. This may reflect the higher interest-rate environment, and companies’ desire to minimize debt payments.

Recommended: How Does the Bond Market Work?

Reasons to Invest in Convertible Bonds

Why have investors turned to convertible bonds? One reason is that convertible bonds can offer a degree of downside protection from the bond component during stock volatility. The companies behind convertibles are obligated to pay back the principal and interest.

Meanwhile, these securities can also offer attractive upside, since if the stock market looks like it’ll be rising, investors have the option to convert their bonds into shares. Traditionally, when stocks win big, convertibles can deliver solid returns and outpace the yields offered by the broader bond market.

For example, in 2024, the U.S. convertibles market returned 11.4%, outpacing the performance of all major fixed-income indices. And over the 10-year period ending December 31, 2024, convertible bonds have delivered a higher yield than equities, according to data by Bloomberg.

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Downsides of Convertible Bonds

One of the biggest disadvantages of convertible bonds is that they usually come with a lower interest payment than what the company would offer on an ordinary bond. As noted, the chance to save on debt service is a big reason that companies issue convertibles. So, for investors who are primarily interested in income, convertibles may not be the best fit.

There are also risks. Different companies issue convertible debt for different reasons, and they’re not always optimal for investors. Under certain conditions, convertible financing can lead to “death spiral financing.”

What Is Death Spiral Debt?

The death spiral is when convertible bonds drive the creation of an increasing number of shares of stock, which drives down the price of all the shares on the market. The death spiral tends to occur when a convertible bond allows investors to convert to a specific value paid in shares, rather than a fixed number of shares.

This can happen when a bond’s face value is lower than the convertible value in shares. That can lead to a mass conversion to stock, followed by quick sales, which drives the price down further.

Those sales, along with the dilution of the share price can, in turn, cause more bondholders to convert, given that the lower share price will grant them yet more shares at conversion.

How to Invest in Convertible Bonds

Most convertibles are sold through private placements to institutional investors, so retail or individual investors may find it difficult to buy them.

But individual investors who want to jump into the convertibles market can turn to a host of mutual funds and exchange-traded funds (ETFs) to choose from. But because convertibles, as hybrid securities, are each so individual when it comes to their pricing, yields, structure and terms, each manager approaches them differently. And it can pay to research the fund closely before investing.

For investors, one major advantage of professionally managed convertible bonds funds is that the managers of those funds know how to optimize features like embedded options, which many investors could overlook. Managers of larger funds can also trade in the convertible markets at lower costs and influence the structure and price of new deals to their advantage.

The Takeaway

Convertible bonds are debt securities that can be converted to common stock shares. These hybrid securities offer interest payments, along with the chance to convert bonds into shares of common stock.

While convertible bonds are complex instruments that may not be suitable for all investors, they can offer diversification, particularly during volatile periods in the equity market. Investors can gain exposure to convertible bonds by putting money into mutual funds or ETFs that specialize in them.

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FAQ

Why would an investor choose convertible bonds?

Convertible bonds offer downside protection for an investor’s principal, and also offer the potential to see equity gains as well.

What is the difference between a corporate bond and a convertible bond?

The main difference is that a corporate bond pays a fixed rate of interest that’s typically higher than a convertible bond coupon. But a regular corporate bond doesn’t offer access to an equity upside the way a convertible bond can.

Can a convertible bond be converted into cash?

Yes. First, in some cases a convertible bond may offer the option to convert to cash value rather than a pre-set number of company shares. Then, there is always the option to redeem the bond at maturity for its cash value.