Life Stages Archives

Q: What Is the Debt-to-Equity Ratio?

The debt-to-equity ratio is one of several metrics that you can use to evaluate individual stocks. At its simplest, the debt-to-equity ratio is a measure of how much debt it takes for a company to run its business.

Q: What Is a Good Debt-to-Equity Ratio?

As a very general rule of thumb, a good debt-to-equity ratio will equal about 1.0. However, the acceptable rate can vary by industry, and may depend on the overall economy.

Q: What Does It Mean For Debt-to-Equity Ratio To Be Negative?

Negative debt equity ratios may tell investors that the company indicates investment risk and shows that the company is not financially stable. Therefore, investing in such a company may result in a loss for investors.

Nov

2024

How to Calculate the Debt-to-Equity Ratio

By Samuel Becker | Growing Wealth, Investing | No Comments

The debt-to-equity ratio (D/E) is one of many financial metrics that helps investors determine potential risks when looking to invest in certain stocks.

Companies also use debt, also known as leverage, to help them accomplish business goals and finance operating costs. Calculating a company’s debt-to-income ratio requires a relatively simple formula investors can use on their own or with a spreadsheet.

Key Points

• The debt-to-equity ratio (D/E) is a financial metric that compares a company’s total liabilities to its shareholder equity, indicating its reliance on debt for financing.

• Calculating the D/E ratio involves dividing total liabilities by shareholder equity, with the resulting figure helping investors assess potential risks associated with a company’s financial structure.

• A high D/E ratio may suggest a company is overleveraged, making it riskier for investors, while a low ratio could indicate underutilization of debt for growth opportunities.

• Different industries have varying acceptable D/E ratios, with capital-intensive sectors often operating with higher ratios due to their borrowing needs for growth.

• The D/E ratio is just one of many indicators investors should consider, as it should be contextualized within industry standards and accompanied by a broader analysis of a company’s financial health.

What Is the Debt-to-Equity Ratio?

The debt-to-equity ratio is one of several metrics that investors can use to evaluate individual stocks. At its simplest, the debt-to-equity ratio is a quick way to assess a company’s total liabilities vs. total shareholder equity, to gauge the company’s reliance on debt.

In other words, the D/E ratio compares a company’s equity — how much value is locked up in its shares — to its debts. Among other things, knowing this figure can help investors gauge a company’s ability to cover its debts. For example, if a company were to liquidate its assets, would it be able to cover its debt? How much money would be left over for shareholders?

Investors often use the debt-to-equity ratio to determine how much risk a company has taken on, and in return, how risky it may be to invest in that company. After all, if a company goes under and can’t cover its debts, its shares could wind up worthless.

💡 Quick Tip: When people talk about investment risk, they mean the risk of losing money. Some investments are higher risk, some are lower. Be sure to bear this in mind when investing online.

What Is Leverage?

To understand the debt-to-equity ratio, it’s helpful to understand the concept of leverage. A business has two options when it comes to paying for operating costs: It can either use equity, or it can use debt, a.k.a. leverage.

The company can use the funds they borrow to buy equipment, inventory, or other assets — or to fund new projects or acquisitions. The money can also serve as working capital in cyclical businesses during the periods when cash flow is low.

While it’s potentially risky to use leverage — a company might have to declare bankruptcy if it can’t pay its debt — borrowed funds can also help a company grow beyond the limitation of its equity at critical junctures.

The term “leverage” reflects the hope that the company will be able to use a relatively small amount of debt to boost its growth and earnings. Wise use of debt can help companies build a good reputation with creditors, which, in turn, will allow them to borrow more money for potential future growth.

Understanding Different Types of Debt

Not all debt is considered equally risky, however, and investors may want to consider a company’s long-term versus short-term liabilities. Generally speaking, short-term liabilities (e.g. accounts payable, wages, etc.) that would be paid within a year are considered less risky.

A company’s ability to cover its long-term obligations is more uncertain, and is subject to a variety of factors including interest rates (more on that below).

The Debt-to-Equity Ratio Formula

Calculating the debt-to-equity ratio is fairly straightforward. You can find the numbers you need on a listed company’s balance sheet.

To calculate the D/E ratio, take the company’s total liabilities and divide it by shareholder equity. Here’s what the debt to equity ratio formula looks like:

D/E = Total Liabilities / Shareholder Equity

How to Calculate the Debt-to-Equity Ratio

In order to calculate the debt-to-equity ratio, you need to understand both components.

Total Liabilities

This component includes a company’s current and long-term liabilities. Current liabilities are the debts that a company will typically pay off within the year, including accounts payable. Long-term liabilities are debts whose maturity extends longer than a year. Think mortgages on buildings or long-term leases.

Equity

The equity component includes two portions: shareholder equity and retained earnings. Shareholder equity is the money investors have paid in exchange for shares of the company stock. Retained earnings are profits that the company holds onto that aren’t paid out in the form of dividends to shareholders.

Excel Formula for Debt-to-Equity Ratio

Using excel or another spreadsheet to calculate the D/E is relatively straightforward. First, using the company balance sheet, pull the total debt amount and the total shareholder equity amount, and enter these numbers into adjacent cells (e.g. E2 and E3).

Then, in cell E4 enter the formula “=E2/E3”, and this will give you the D/E ratio.

Debt-to-Equity Example

To look at a simple example of a debt to equity formula, consider a company with total liabilities worth $100 million dollars and equity worth $85 million. Divide $100 million by $85 million and you’ll see that the company’s debt-to-equity ratio would be about 1.18. In other words, the company has $1.18 in debt for every dollar of equity.

When using a real-world debt to equity ratio formula, you’ll probably be able to find figures for both total liabilities and shareholder equity on a company’s balance sheet. Publicly traded companies will usually share their balance sheet along with their regular filings with the Securities and Exchange Commission (SEC).

Putting the D/E in Context

Remember that arriving at this ratio is just that: a single number that reveals a certain aspect of a company’s potential performance, but doesn’t tell the whole story. It’s essential to compare a company’s D/E ratio to that of other companies in its industry.

In addition, there are many other ways to assess a company’s fundamentals and performance — by using fundamental analysis and technical indicators. Experienced investors rarely rely on one measure to evaluate a stock.

What Is a Good Debt-to-Equity Ratio?

Once you’ve calculated a debt-to-equity ratio, how do you know whether that number is good or bad?

As a general rule of thumb, a good debt-to-equity ratio will equal about 1.0. However, the acceptable rate can vary by industry, and may depend on the overall economy. A higher debt-to-income ratio could be more risky in an economic downturn, for example, than during a boom.

Recommended: Investing During a Recession

For example, if a company, such as a manufacturer, requires a lot of capital to operate, it may need to take on a lot of debt to finance its operations. A company like this may have a debt equity ratio of about 2.0 or more.

Other companies that might have higher ratios include those that face little competition and have strong market positions, and regulated companies, like utilities, that investors consider relatively low risk.

Companies that don’t need a lot of debt to operate may have debt-to-equity ratios below 1.0. For example, the service industry requires relatively little capital.

Modifying Debt-to-Equity Ratio

As noted above, it’s also important to know which type of liabilities you’re concerned about — longer-term debt vs. short-term debt — so that you plug the right numbers into the formula.

For example, if you have two companies, each with $2.5 million in shareholder equity, and $2.5 million in debt, their D/E ratios would be the same: 1.0.

But let’s say Company A has $2 million in long-term liabilities, and $500,000 in short-term liabilities, whereas Company B has $1.5 million in long-term debt and $1 million in short term debt. The long-term D/E ratio for Company A would be 0.8 vs. 0.6 for company B, indicating a higher risk level.

Depending on the industry they were in and the D/E ratio of competitors, this may or may not be a significant difference, but it’s an important perspective to keep in mind.

What Does a Company’s Debt-to-Equity Ratio Say About It?

A debt-to-equity-ratio that’s high compared to others in a company’s given industry may indicate that that company is overleveraged and in a precarious position. Investors may want to shy away from companies that are overloaded on debt.

Not only that, companies with a high debt-to-equity ratio may have a hard time working with other lenders, partners, or even suppliers, who may be afraid they won’t be paid back.

In some cases, creditors limit the debt-to-equity ratio a company can have as part of their lending agreement. Such an agreement prevents the borrower from taking on too much new debt, which could limit the original creditor’s ability to collect.

It is possible that the debt-to-equity ratio may be considered too low, as well, which is an indicator that a company is relying too heavily on its own equity to fund operations. In that case, investors may worry that the company isn’t taking advantage of potential growth opportunities.

Ultimately, businesses must strike an appropriate balance within their industry between financing with debt and financing with equity.

What Does It Mean for a Debt-to-Equity Ratio to Be Negative?

There could be several reasons for a negative debt-to-equity ratio, including:

• Interest rates are higher than the returns

• A negative net worth (more liabilities than assets)

• A financial loss after a large dividend payout

• Dividend payments that surpass investor’s equity in the firm

So, what does this mean for investors?

Negative D/E ratios may tell investors that the company indicates investment risk and shows that the company is not financially stable. Therefore, investing in such a company may result in a loss for investors.

💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

Which Industries Have High Debt-to-Equity Ratios?

The depository industry (banks and lenders) may have high debt-to-equity ratios. Because banks borrow funds to loan money to consumers, financial institutions usually have higher debt-to-equity ratios than other industries.

Other industries with high debt-to-equity ratios include:

• Non-depository credit institutions

• Insurance providers

• Hotels, rooming houses, camps, and other lodging places

• Transportation by air

• Railroad transportation

Effect of Debt-to-Equity Ratio on Stock Price

The debt-to-equity ratio can clue investors in on how stock prices may move. As a measure of leverage, debt-to-equity can show how aggressively a company is using debt to fund its growth.

The interest rates on business loans can be relatively low, and are tax deductible. That makes debt an attractive way to fund business, especially compared to the potential returns from the stock market, which can be volatile. And sometimes an aggressive strategy can pay off.

For example, if a company takes on a lot of debt and then grows very quickly, its earnings could rise quickly as well. If earnings outstrip the cost of the debt, which includes interest payments, a company’s shareholders can benefit and stock prices may go up.

The opposite may also be true. A highly leveraged company could have high business risk. If earnings don’t outpace the debt’s cost, then shareholders may lose and stock prices may fall.

Having to make high debt payments can leave companies with less cash on hand to pay for growth, which can also hurt the company and shareholders. And a high debt-to-equity ratio can limit a company’s access to borrowing, which could limit its ability to grow.

Debt-to-Equity (D/E) Ratio vs the Gearing Ratio

The debt-to-equity ratio belongs to a family of ratios that investors can use to help them evaluate companies. These ratios are collectively known as gearing ratios.

Here’s a quick look at other gearing ratios you may encounter:

Equity Ratio

This ratio compares a company’s equity to its assets, showing how much of the company’s assets are funded by equity.

Debt Ratio

This looks at the total liabilities of a company in comparison to its total assets. On the surface, this may sound like the debt ratio formula is the same as the debt-to-equity ratio formula. However, the total debt ratio formula includes short-term assets and liabilities as part of the equation, which the debt-to-equity ratio discounts. Also, this ratio looks specifically at how much of a company’s assets are financed with debt.

Time Interest Earned

This ratio helps indicate whether a company has the ability to make interest payments on its debt, dividing earnings before interest and taxes (EBIT) by total interest. Most of the information needed to calculate these ratios appears on a company’s balance sheet, save for EBIT, which appears on its profit and loss statement.

How Businesses Use Debt-to-Equity Ratios

Businesses pay as much attention to debt-to-equity as individual investors. For example, if a company wants to take on new credit, they would likely want their debt-to-equity ratio to be favorable.

Banks and other lenders keep tabs on what healthy debt-to-equity ratios look like in a given industry. A debt-to-equity ratio that seems too high, especially compared to a company’s peers, might signal to potential lenders that the company isn’t in a good position to repay the debt.

Publicly traded companies that are in the midst of repurchasing stock may also want to control their debt-to-equity ratio. That’s because share buybacks are usually counted as risk, since they reduce the value of stockholder equity. As a result the equity side of the equation looks smaller and the debt side appears bigger.

How Can the Debt-to-Equity Ratio Be Used to Measure a Company’s Risk?

While acceptable D/E ratios vary by industry, investors can still use this ratio to identify companies in which they want to invest. First, however, it’s essential to understand the scope of the industry to fully grasp how the debt-to-equity ratio plays a role in assessing the company’s risk.

Many companies borrow money to maintain business operations — making it a typical practice for many businesses. For companies with steady and consistent cash flow, repaying debt happens rapidly. Also, because they repay debt quickly, these businesses will likely have solid credit, which allows them to borrow inexpensively from lenders.

Therefore, even if such companies have high debt-to-equity ratios, it doesn’t necessarily mean they are risky. For example, companies in the utility industry must borrow large sums of cash to purchase costly assets to maintain business operations. However, since they have high cash flows, paying off debt happens quickly and does not pose a huge risk to the company.

On the other hand, companies with low debt-to-equity ratios aren’t always a safe bet, either. For example, a company may not borrow any funds to support business operations, not because it doesn’t need to but because it doesn’t have enough capital to repay it promptly. This may mean that the company doesn’t have the potential for much growth.

IPOs and Debt-to-Equity Ratios

Many startups make high use of leverage to grow, and even plan to use the proceeds of an initial public offering, or IPO, to pay down their debt. The results of their IPO will determine their debt-to-equity ratio, as investors put a value on the company’s equity.

So in the case of deciding whether to invest in IPO stock, it’s important for investors to consider debt when deciding whether they want to buy IPO stock.

The Limitations of Debt-to-Equity Ratios

Debt-to-equity ratio is just one piece of the puzzle when it comes to evaluating stocks. Whether the ratio is high or low is not the bottom line of whether one should invest in a company. A deeper dive into a company’s financial structure can paint a fuller picture.

A company’s accounting policies can change the calculation of its debt-to-equity. For example, preferred stock is sometimes included as equity, but it has certain properties that can also make it seem a lot like debt. Specifically, preferred stock with dividend payment included as part of the stock agreement can cause the stock to take on some characteristics of debt, since the company has to pay dividends in the future.

If preferred stock appears on the debt side of the equation, a company’s debt-to-equity ratio may look riskier. If it’s included on the equity side, the ratio can look more favorable.

In some cases, companies can manipulate assets and liabilities to produce debt-to-equity ratios that are more favorable. Additionally, investors may want to keep an eye on interest rates. If they’re low, it can make sense for companies to borrow more, which can inflate the debt-to-equity ratio, but may not actually be an indicator of bad tidings.

Finally, the debt-to-equity ratio does not take into account when a debt is due. A debt due in the near term could have an outsized effect on the debt-to-equity ratio.

As a result of temporary imbalances like these, investors may want to compare debt-to-equity ratios from various time periods to get an idea of a company’s normal wage, or whether fluctuations are signaling more noteworthy movement within the company.

Investing in Businesses With SoFi

Investors can use the debt-to-equity ratio to help determine potential risk before they buy a stock. As an individual investor you may choose to take an active or passive approach to investing and building a nest egg. The approach investors choose may depend on their goals and personal preferences.

Investors who want to take a more hands-on approach to investing, choosing individual stocks, may take a look at the debt-to-equity ratio to help determine whether a company is a risky bet.

Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.

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FAQ

What is a good debt-to-equity ratio?

Generally speaking a D/E ratio of about 1.0 doesn’t raise any red flags, but it’s important to consider the needs of the company, its industry, and its competitors, as any of these factors might justify a higher debt-to-equity ratio.

How do you interpret debt-to-equity ratio?

Taking a broader view of a company and understanding the industry its in and how it operates can help to correctly interpret its D/E ratio. For example, utility companies might be required to use leverage to purchase costly assets to maintain business operations. But utility companies have steady inflows of cash, and for that reason having a higher D/E may not spell higher risk.

What is considered a bad debt-to-equity ratio?

A D/E ratio of about 1.0 to 2.0 is considered good, depending on other factors like the industry the company is in. But a D/E ratio above 2.0 — i.e., more than $2 of debt for every dollar of equity — could be a red flag. Again, context is everything and the D/E ratio is only one indicator of a company’s health.

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Nov

2024

What Does Flood Insurance Cover?

By Kim Franke-Folstad | Family Finances, Insurance, servicing | Comments Off

Flood insurance is designed to help homeowners, renters, and business owners cover losses caused by a flood. You can buy it to protect a building, the possessions in that building, or both.

Most standard homeowners policies don’t cover flood damage. So this separate insurance coverage is your best option for repairing or replacing property after rising water rises enters your home. In some areas, mortgage lenders can make buying flood insurance mandatory. Even if your lender doesn’t require flood insurance, you may want to consider it.

Read on for information that can help you decide if a flood policy should be part of your insurance coverage.

Key Points

• Flood insurance covers direct physical losses due to floods, including damage to the building and its contents.

• Coverage extends to foundation walls, electrical and plumbing systems, and major appliances.

• Personal property such as clothing, furniture, and electronics are also covered under flood insurance.

• The National Flood Insurance Program offers up to $250,000 for building and $100,000 for personal property damage.

• Flood insurance does not cover items outside the building, cars, or business interruption losses.

What Is Flood Insurance?

According to the Federal Emergency Management Agency (FEMA), just one inch of floodwater can cause up to $25,000 in damage. And that damage probably won’t be covered by your homeowners or renters insurance. You can, however, purchase a standalone flood insurance policy to help cover your losses.

A flood insurance policy is meant to cover losses directly caused by flooding or, as FEMA describes it, “an excess of water on land that is normally dry, affecting two or more acres of land or two or more properties.”

If your sewer backed up after heavy rainfall, or rising inland or tidal waters flooded your property, the damage would likely be covered by flood insurance. But if the backup wasn’t caused by flooding, the damage wouldn’t be covered by flood insurance. (Whether it’s covered by your homeowners insurance depends on your individual policy.)

Most people get their flood policy through the National Flood Insurance Program (NFIP), which is managed by FEMA and works with a network of insurance companies across the country. But some private insurance companies also offer their own flood policies, which are not government-backed.

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What Is Included in Standard Flood Insurance?

The NFIP offers two types of flood insurance coverage: one that covers buildings and another that covers the owner’s or renter’s personal contents.

A policy purchased through the NFIP can reimburse up to $250,000 in building damage and typically covers:

• Foundation walls, anchoring systems, and staircases

• Detached garages

• Electrical and plumbing systems

• Furnaces and water heaters

• Fuel tanks, well water tanks and pumps, and solar energy equipment

• Appliances, including refrigerators, stoves, and built-in dishwashers

• Permanently installed cabinets, paneling, and bookcases

• Permanently installed carpeting and window blinds

An NFIP policy can provide up to $100,000 in personal property damage, and typically covers:

• Personal belongings, such as clothing, furniture, and electronic equipment (TVs, computers, etc.)

• Valuables (like original artwork and furs) up to $2,500

• Portable and window air conditioners

• Washers and dryers

• Microwave ovens

• Carpets that may not be included under building coverage

• Curtains and other window coverings

What Doesn’t Flood Insurance Cover?

There are a few things NFIP flood insurance doesn’t cover, even if the damage is directly caused by flooding. Items that aren’t covered include:

• Any property that’s outside the insured building (such as a well, septic system, deck or patio, fences, seawall, hot tub or pool, and landscaping)

• Cars and most other self-propelled vehicles and their parts

• Cash, coins, precious metals, stock certificates, and other valuable paperwork

• Damage from mold or mildew that could have been prevented by the property owner

• Financial losses caused by an interruption in business

Flood insurance also doesn’t cover costs incurred if you have to live in temporary housing because of damage to your property. Unfortunately, neither will the “loss of use coverage” you may have through your homeowners policy. (Loss of use coverage pays those expenses only when the reason you’ve been displaced is covered by your homeowners policy.)

What Does Flood Insurance Cover in the Basement?

The NFIP’s coverage for flood damage in the basement is limited to some specific (usually permanent or attached) items and cleanup. Some examples of what should be covered include:

• Central air conditioners

• Fuel tanks and the fuel in them

• Furnaces and water heaters

• Sump pumps, heat pumps, and well water tanks and pumps

• Electrical outlets, switches, and junction and circuit breaker boxes

• Elevators, dumbwaiters, and related equipment

• Unfinished drywall for walls and ceilings

• Attached stairways and staircases

• Foundation elements and anchoring systems required for building support

Most personal property kept in the basement isn’t covered, including clothing, computers, TVs, and furniture.

Where Can You Get Flood Insurance?

Federal flood insurance isn’t sold directly by the federal government. Instead, you can buy NFIP policies through private insurance companies, under what’s known as a Write Your Own (WYO) program.

The NFIP partners with more than 50 insurance companies, so you may be able to work with the same insurance agent or broker who helped you purchase your home and auto policies to get flood coverage.

You can get help finding an NFIP provider online at floodsmart.gov/flood-insurance-provider or by calling the NFIP at 877-336-2627. You also can also check into any private, non-government-backed flood insurance policies that are offered in your area.

You may want to look at including flood insurance as part of your overall personal insurance planning. Don’t wait until you hear predictions of a storm heading your way to start inquiring about a policy, though. There is typically a 30-day waiting period for a flood insurance policy to go into effect.

How Much Does Flood Insurance Cost?

Like most insurance, the cost of a flood policy can depend on the coverage type (building and/or personal contents), the size and age of the building covered, the risk level in your location (based on your flood zone), and other factors, including whether you’re buying a private or NFIP policy.

According to the Federal Emergency Management Agency (FEMA), the average cost of one year of coverage with an NFIP policy is $786. And though that’s not nearly as much as the average cost of a homeowners policy, it can still be a hit to many household budgets.

You may be able to lower the cost of a flood policy by choosing a higher deductible. You can also elevate your home’s electrical panels, heating and cooling systems, and other utilities so they’re less vulnerable to water damage.

For renters, the NFIP offers contents-only policies for as low as $99 annually.

You can also look for a competitive quote on a private flood policy that isn’t backed by FEMA and the NFIP. Just make sure you’re getting a fair price from a stable company that is capable of paying out claims in the event of a major flood.

When Is Flood Insurance Required?

If you have a government-backed mortgage and your home or business is in a high-risk flood area, you are required to have flood insurance. If you don’t have a government-backed loan, your lender may still require that you purchase a flood policy. Even lenders in moderate- to low-risk locations may make it a loan requirement.

Who Should Buy Flood Insurance?

Knowing your designated flood zone can help you decide whether you want to prioritize purchasing flood insurance. You can find your zone by entering your address at the FEMA Flood Map Service Center at MSC.FEMA.gov.

Structures in zones A and V are at the highest risk, while those in zones B, C, and X are considered at moderate to minimal risk. Keep in mind, though, that you can still experience flood damage even if you don’t live in a high-risk zone. According to NFIP data, more than 20% of all insurance claims come from moderate- to low-risk zones.

If you’re moving to a new area where flood insurance isn’t required, you may want to speak with your real estate agent or neighbors about the area’s history and potential for flooding.

How Much Flood Insurance Do You Need?

In many ways, shopping for flood insurance is similar to how you buy homeowners insurance: Calculating how much you’ll need will depend on what you plan to protect and what it might cost to replace if it’s destroyed.

In fact, whether you go with an online insurance company or a traditional insurer, your homeowners insurance company may give you an idea of what it might cost to rebuild or repair your home if it’s damaged. Then you can add on the value of your furnishings and other personal possessions to decide how much flood insurance you need. (If you’re a renter, you can purchase a policy that covers only your belongings.)

Remember, there are limits to how much coverage you can get through an NFIP policy ($250,000 for a building and $100,000 for the contents). If your needs go beyond those limits, you may want to consider buying excess flood insurance through a private flood policy.

Recommended: Does Renters Insurance Cover Floods?

The Takeaway

An average flood insurance policy for homeowners costs $786 a year. But most homeowners insurance policies don’t cover flood damage, which can leave a big gap when it comes to protecting your home and belongings. Purchasing a separate flood insurance policy can help fill that gap, and it can be an important part of your overall insurance planning.

Flood policies can cover the building itself, its contents, or both. Make sure you understand what isn’t covered by your policy, such as personal belongings stored in the basement or outside.

If you’re a new homebuyer, SoFi Protect can help you look into your insurance options. SoFi and Lemonade offer homeowners insurance that requires no brokers and no paperwork. Secure the coverage that works best for you and your home.

SoFi brings you real rates, with no bait and switch.

FAQ

What losses are covered by flood insurance?

A flood insurance policy covers direct physical losses caused by a flood. That could mean repairing or replacing your home, or the furnishings and other belongings in your home, or both.

How do I know if I’m in a flood zone?

Everyone is in a flood zone, but some areas are at a higher risk than others. You can find your zone by entering your address at the FEMA Flood Map Service Center at MSC.FEMA.gov.

Is flooding covered by homeowners insurance?

Some types of water damage are covered by a standard homeowners policy, but flooding usually is not.

Photo credit: iStock/onurdongel

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Nov

2024

Similarities and Differences Between Initial and Maintenance Margin

By Michael Flannelly | Growing Wealth, invest, Investing | Comments Off

Initial and maintenance margin are separate margin requirements investors must adhere to when trading on margin. The two requirements are similar in that they are both sums of money that the broker requires the investor to have in their account to open or maintain a position with a margin loan. The main difference between the two is that the initial margin is the amount of money required to open a position, while the maintenance margin is the amount needed to keep a position open.

Investors interested in trading on margin need to understand the similarities and differences between initial and maintenance margin. Moreover, knowing how to calculate maintenance margin may help investors from being subject to a margin call or other adverse outcomes.

What Is Initial Margin?

Initial margin is the minimum amount of cash or collateral an investor must deposit in a margin account in order to buy securities on margin.

Initial Margin Requirements

The initial margin requirement is expressed as a percentage of the total purchase price of a security. The Federal Reserve Board’s Regulation T requires a minimum initial margin of 50% for stock purchases, meaning investors must have cash or collateral to cover at least half of the market value of stocks they buy on margin. However, Regulation T only sets the minimum for margin accounts. Stock exchanges and brokerage firms can set their initial margin requirement higher than 50% based on a stock’s volatility, the state of the markets, or other considerations.

How Initial Margin Works

If you meet the initial margin requirement, your broker will provide you with a margin loan to cover the rest of the trade’s purchase price. For example, if the initial margin requirement is 50% and an investor wants to purchase $6,000 of a stock, then the investor will have to cover an initial margin of $3,000 with cash or other equity and borrow $3,000 from the broker to make the trade.

Investors use margin trading as a way to increase their buying power. In the example above, if the investor bought the same amount of stock in a cash account, then they would need $6,000 in cash to make the trade. But by using a margin, the investor doubles their buying power by using only $3,000 to buy $6,000 worth of stock.

However, using margin involves risk, and may lead to more significant losses than buying stock
directly in a cash account. If a trade declines below the threshold, investors will need to bring it back up to effectively pay back the margin loan.

What Is Maintenance Margin?

Maintenance margin is the minimum amount of equity an investor must have in their margin account to keep a position open after making a trade. The margin equity in the account is the value of securities minus the amount of the margin loan borrowed to make the trade. If the account’s equity falls below the maintenance margin, the broker may issue a margin call or close out the investor’s trade.

Maintenance Margin Requirements

Maintenance margin is usually expressed as a percentage of the position’s value. The Financial Industry Regulatory Authority (FINRA), which regulates maintenance requirements, says maintenance margin must be at least 25% of the total market value of the securities bought on margin. However, like initial margin, brokerage firms may have higher maintenance requirements, depending on various factors like market volatility and liquidity.

How Maintenance Margin Works

Suppose an investor purchased $6,000 worth of stock by paying $3,000 in cash and borrowing $3,000 from their broker, and the broker has a 25% maintenance margin requirement. If the market value of the stock drops from $6,000 to $5,000, the investor’s equity will now be $2,000 ($5,000 – $3,000 margin loan) and the maintenance margin will be $1,250 ($5,000 x 25%). In this case, the investor still has enough equity to cover the maintenance margin.

However, if the stock’s value drops to $3,500, the investor will no longer have enough equity to cover the maintenance margin requirement. The investor’s account has $500 in equity ($3,500 – $3,000), while the maintenance margin is $875 ($3,500 x 25%). The broker will likely issue a margin call, requiring the investor to deposit additional funds into the account or sell some assets to increase the equity in the account.

The broker may also sell some of the investor’s holdings without notifying them to bring the account back up to the maintenance margin level.

The purpose of the maintenance margin is to protect the broker in case the value of the securities in the account falls.

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 4.75% to 9.50%* and start margin trading.

*For full margin details, see terms.

Initial Margin vs Maintenance Margin

Here’s a quick look at how initial margin and maintenance margin stack up:

Initial Margin vs Maintenance Margin
Initial Margin	Maintenance Margin
50% minimum initial margin requirement regulated by the Federal Reserve Board’s Regulation T	25% minimum maintenance margin requirement regulated by FINRA
Initial margin is deposited at the start of a trade	Maintenance margin must be maintained throughout the life of a trade

Similarities

Initial margin and maintenance margin are similar in that they are both used as deposits to cover potential losses in a margin account. The two margin requirements are both calculated as a percentage of the value of the account’s assets.

Additionally, both initial margin and maintenance margin can be increased or decreased by an exchange or brokerage firm depending on a stock’s volatility, the financial situation of a client, and other factors.

Differences

The initial margin is the amount of cash or collateral an investor must deposit with a broker when buying or selling an asset on margin. In contrast, the maintenance margin is the minimum amount of equity an investor must maintain in their account to keep the account open and avoid a margin call.

Another difference between the two is that the initial margin is typically higher than the maintenance margin.

Calculating Initial and Maintenance Margin

There are formulas for calculating both initial margin and maintenance margin. Note that the examples below may not include margin figures that are indicative of a typical brokerage firm, or of SoFi.

Initial Margin Calculation

The formula for calculating initial margin is:

Initial margin = initial margin percentage x total purchase price of security

So, if a brokerage firm has an initial margin percentage of 65% and an investor wants to buy $10,000 worth of stock ABC, then the initial margin would equal $6,500:

$6,500 initial margin = 65% initial margin percentage x $10,000 total purchase price

In this scenario, the investor would need to have $6,500 in an account and borrow $3,500 with a margin loan.

Maintenance Margin Calculation

The formula to calculate maintenance margin is:

Maintenance margin = Total value of securities owned on margin x maintenance margin percentage

So, if a brokerage firm has a maintenance margin percentage of 30% and an investor holds $1,000 of stock XYZ (100 shares at $10 per share) in their margin account, then the maintenance margin would equal $300:

$300 = $1,000 x 30% maintenance margin percentage

In this scenario, the investor would need to have $300 in equity in their margin account to avoid being subject to a margin call.

Investing Tips From SoFi

Understanding the nuances of initial and maintenance margin is essential before investors start trading on margin. Utilizing margin can help investors increase their buying power, but it comes with more risk, like the chance for margin calls.

If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.

Get one of the most competitive margin loan rates with SoFi, from 4.75% to 9.50%*

FAQ

Why is initial margin higher than maintenance margin?

The initial margin is higher because the Federal Reserve Board’s Regulation T sets a 50% minimum initial margin requirement, while FINRA sets a lower 25% minimum maintenance margin requirement.

How do you calculate maintenance margin?

Maintenance margin is the minimum equity an investor must have in the margin account after making a trade. Maintenance margin is expressed as a percentage of an investor’s total trade. Investors can calculate maintenance margin by multiplying the maintenance margin percentage by the total value of the margin account.

Photo credit: iStock/PeopleImages

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.

Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.

¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

SOIN-Q324-067

Nov

2024

Who Gets the Insurance Check When a Car Is Totaled?

By Kim Franke-Folstad | Budgeting & Goals, Financial Independence, Insurance | Comments Off

If your car is totaled in an accident, you may expect the insurance payment to come to you as the car’s owner. Not necessarily. If you financed or leased your car, the insurance company will make sure the lender or leaseholder is paid first. You’ll receive whatever remains of the settlement — if anything.

Read on for a breakdown of how the insurance claims process works and who gets the insurance check when a car is totaled.

Key Points

• Insurance pays the lender first if a car is financed or leased, with the owner receiving any remaining settlement.

• A car is totaled if repair costs exceed its market value.

• Actual cash value is based on pre-crash condition, age, and local market prices.

• Gap insurance covers the difference if the settlement is less than the loan balance.

• Comprehensive and collision coverage are two types of coverage that will pay for a totaled car.

Getting an Insurance Check for a Totaled Car

Unless your totaled car was only a few months old, or you have new-car replacement coverage, the check you receive from the insurance company probably won’t be enough to replace it with a brand-new model.

If your car is financed or leased, as noted above, the insurance company will first pay off the lender or leaseholder. The car’s owner will receive a check only if any funds remain after the car is paid off.

If you’re not sure what would happen if your car was totaled, it might be time for a personal insurance planning session to review your coverage.

What Happens If Your Car Is Totaled in an Accident?

After an accident, your insurance company will assign an adjuster to assess your car and estimate the cost of repairs. If the estimated cost of fixing the car is more than the car’s market value, the insurance company may declare it a “total loss.” The same thing may happen if the insurance company determines the car may not be safe to drive even if it were fixed.

How Your Car’s Value Is Determined

The insurance company will determine your car’s “actual cash value” based on its pre-crash condition and what similar models are selling for in your area. They’ll also factor in things like the car’s age, wear and tear (inside and out), mileage, and any optional equipment you’ve added. (You can learn more about the lingo discussed here in our guide to car insurance terms.)

Recommended: How to Get Car Insurance

What If the Accident Wasn’t Your Fault?

If another insured driver is found at-fault for the accident that damaged your car, that person’s insurance should pay the claim — and your insurance deductible won’t come into play.

However, you should expect to pay your deductible amount if:

• You’re responsible for an accident.

• The fault is shared.

• No one is at-fault for the damage to your vehicle. For example, a tree branch or other debris hits your car in a storm.

• The driver who caused the accident is uninsured or underinsured, and your uninsured motorist coverage pays your claim.

Is a Car Totaled When the Airbags Deploy?

The cost of replacing activated airbags will be considered in the overall cost of repairing your damaged vehicle. However, a vehicle won’t necessarily be declared totaled because the airbags deployed.

Who Decides If Your Car Is Totaled?

People often use the word “totaled” as a general description for a car that’s been badly damaged. But only your insurance company can decide a car is totaled based on its value and the cost of repairs.

What Types of Coverage Will Pay for a Totaled Car?

Drivers are often more concerned about the cost of their monthly premiums than with how much car insurance they really need. But not all types of coverage will pay for a totaled car.

After an accident, you’ll need one of the following policies — which should be available from both traditional and online insurance companies — to be reimbursed for a totaled car.

Collision

Collision coverage pays for damage to your vehicle or property. That can include damage caused by crashing into another vehicle or running off the road and into a tree or fence. Even if you’re responsible for the accident, collision coverage will pay for the repairs, minus the deductible amount you’ve chosen.

Comprehensive

Comprehensive coverage pays for losses caused by something other than a collision, such as a weather event, hitting an animal, theft, or vandalism.

Property Damage Liability

Property damage liability coverage pays for damage to your vehicle (and other property) if you’re in an accident and the other driver is found to be at fault.

Uninsured / Underinsured Motorist

If you’re in an accident and the other driver is at fault but isn’t insured or doesn’t have sufficient auto insurance, uninsured motorist coverage pays for your repairs.

New-Car Replacement

With new-car replacement coverage, if your car is totaled, your insurer will pay to replace it with a brand-new car of the same make and model (minus your deductible).

Gap Coverage

If you owe more on your car loan or lease than what your insurance company says your damaged car is worth, you could end up having to make up the difference. Gap insurance can bridge the gap between your settlement and what you still owe.

Rental Reimbursement

Unless you have a backup vehicle to use until you replace your totaled car, you may have to rent a car. If your auto policy includes rental reimbursement coverage, your insurer may refund your out-of-pocket costs for the rental, but only for a limited time.

Do You Still Have to Make Loan Payments on a Totaled Car?

Even if your vehicle has been declared a total loss, your lender will likely expect you to keep making timely loan payments until the claim is settled. (If you don’t, that can hurt your credit.) So it’s a good idea to stay on top of any paperwork, and to check in with your insurance company and lender regularly to be sure the claims process is on track.

What If the Insurance Payment Isn’t Enough to Pay Off Your Loan?

Unless you have gap coverage, the settlement you receive may not be enough to pay off your loan or lease. Insurers are required to pay only what a totaled car was worth before it was damaged. So if your car’s actual cash value is less than what you owe the lender — or less than the payoff amount on your lease — you can end up having to make up the difference out of pocket.

If you research what your car was worth and think your settlement amount is too low, you can try to negotiate a higher amount. The insurer may ask you to provide documentation that proves the car was worth more than they’re offering, so be ready to round up photos of the car, maintenance receipts, and other paperwork that backs up your position.

You can also research comparable cars in your area. You may even want to hire a private appraiser to get a second opinion. If you think it will help, you might consider hiring an attorney.

Do Insurance Rates Increase After a Car Is Totaled?

Each insurance company has its own policy that determines whether a driver’s rates will increase after an accident. The decision may depend on who was at fault, your driving record, whether you’re a longtime customer or new driver, and other factors.

If you decide to shop for lower insurance rates to save money, keep in mind that you may have to answer questions about prior claims and accidents.

The Takeaway

When a car is so badly damaged that fixing it would cost more than it’s worth, the insurer may decide it’s totaled. That means instead of repairing it, the insurance company will pay the owner the car’s actual cash value, based on its condition just prior to the accident.

If you own your car outright, the payment will come to you. If the car is financed and you’re still making payments, the insurer will make sure the lender is paid first. After that, you’ll get what’s left of the settlement. Either way, you can end up short of what you’ll need to replace your damaged vehicle.

When you’re ready to shop for auto insurance, SoFi can help. Our online auto insurance comparison tool lets you see quotes from a network of top insurance providers within minutes, saving you time and hassle.

SoFi brings you real rates, with no bait and switch.

FAQ

If my car is totaled, will the insurance company send me a check?

If you own the car, the settlement payment will go directly to you. When the car is financed, the lender will be paid first, and you’ll receive what’s left of the settlement.

Can I keep the money from the insurance claim?

If you owned the car that was totaled, you probably can use the insurance settlement for anything you like. But if the car was financed, the insurance company will make sure you pay off what you owe.

Photo credit: iStock/rocketegg

Auto Insurance: Must have a valid driver’s license. Not available in all states.
Home and Renters Insurance: Insurance not available in all states.
Experian is a registered trademark of Experian.
SoFi Insurance Agency, LLC. (“”SoFi””) is compensated by Experian for each customer who purchases a policy through the SoFi-Experian partnership.

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.

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.

SOPRO-Q424-005

Nov

2024

Guide to Building Credit at 18: Starting Early Is Key

By Jennifer Calonia | Credit, credit card, Financial Independence | Comments Off

Establishing a robust credit profile takes time, so teaching your children how to start building credit at 18 or even younger can help them get ahead. Building a positive credit history can play a key role in accessing competitive borrowing opportunities in the future.

If you have a teen or early-adult child, there are a few ways to help them establish credit at age 18. This can include getting a secured credit card, becoming an authorized user, or implementing other strategies.

Key Points

• Starting to build credit at 18 can help provide access to future borrowing opportunities.

• Becoming an authorized user on a parent’s credit card can help establish credit early.

• Secured credit cards are a good option for beginners seeking to build credit.

• Third-party services can help new users build credit by reporting non-traditional payments.

• Early credit building can positively impact credit scores, affecting future financial opportunities.

What Is Credit and How Does It Work?

When a person purchases an item on credit, they aren’t using money they already have. Instead, they’re borrowing the funds to make that purchase and promising to repay the amount, plus interest, in the future.

A credit history is a complete record of a consumer’s installment loans and revolving credit accounts. It logs data about the type of credit that’s borrowed, their amounts, the lender that issued the credit, whether payments were made on time, and each account’s status.

Creditors report this data to the three major credit bureaus: Experian®, Equifax®, and TransUnion®. Activity is submitted at regular intervals as soon as a consumer submits an application, and as long as the account is active. Data is also reported when an account is closed.

Recommended: What Is a Charge Card?

Why Is It Important to Start Building Credit Early?

The earlier your child builds their credit, the more time they have to establish and positively impact their credit history and their scores. Credit scoring models, like the commonly used FICO® score, will use your child’s credit history to calculate their credit score.

This score is like a snapshot of your child’s creditworthiness. Businesses and lenders may refer to that score when evaluating your child for future jobs, apartment rental applications, and new loans and credit cards.

Tips to Start Building Credit at 18 Years of Age

As a parent of a teenager or early-adult child, there are a handful of ways to assist them in building credit under their name.

1. Add Your Teen as an Authorized Card User

One of the easiest and best ways to start building credit at 18 for your child — and sometimes younger, depending on your card issuer — is by adding them as an authorized user. As an authorized user, your child will be able to make purchases using the card, with the primary account holder remaining liable for monthly payments.

If you have a credit card in good standing, making your child an authorized user on your account lets them reap the benefits of your positive borrowing habits. See if your card issuer allows authorized users (different types of credit cards may have different policies). Also double-check if it reports the account’s data to the credit bureaus for all users under the account.

Your credit card company might have a minimum age requirement for card users (and it often differs from the age to get a credit card independently). If your child meets the issuer’s requirement, your continued good borrowing activity on the card will get reported to credit bureaus to develop their credit file.

Recommended: How to Avoid Interest on a Credit Card

2. Work a Student Loan Into Their Education Financing Strategy

Talk to your college-bound high school graduate about strategically using a student loan to pay for some of their higher education costs. Student loans are installment loans in which your child is the primary borrower. They’re designed to cover school-related expenses and are paid back over time.

Some students might be eligible for a federal student loan, which offers fixed interest rates and borrower protections, like student loan forgiveness as well as flexible repayment and forbearance options. Although payments can be deferred on federal student loans while your child is in school, making payments during school can help them establish credit early on through student loan payment data.

Recommended: When Are Credit Card Payments Due?

3. Help Them Research for a Starter Credit Card

Getting a credit card for the first time can be an overwhelming process for your 18-year-old. There are many types of credit cards on the market with varying benefits. A credit card for individuals who are new to credit, like a secured card, might be an effective way for your child to initiate their credit history.

With a secured card, your child will need to provide the card issuer with a deposit that sets the card’s borrowing limit. Since the issuer uses the deposit as collateral for the account, it can be easier for individuals without credit to qualify. As your child uses the card and makes on-time monthly payments on the account, that data is reported to the credit bureaus.

Recommended: What Is the Average Credit Card Limit?

4. Find Ways To Report Their Payment History

If your child is moving into their own apartment or has done so already, look into whether their landlord is willing to report their rental payment history to the credit bureaus. Additionally, other types of non-traditional payment data can be reported to the credit bureaus by utility service providers.

Your child also might look into a service like Experian Boost®, which is offered by the credit bureau Experian. This service helps individuals who are new to credit start their credit history by accounting for payments toward services, like cell phone and streaming plans.

The Takeaway

Helping your child understand how to build credit at 18 can help them access favorable borrowing opportunities later on. That is, assuming they maintain positive borrowing habits once they have credit accounts of their own, like making payments on time and not taking on too much debt. Strategies can include getting their own credit card or becoming an authorized user on a family member’s card.

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

FAQ

Can you build your credit before 18?

Yes, parents can help their child’s credit during their high school years by adding them on their credit card account as an authorized user. Depending on the credit card, there might not be an additional fee for adding an authorized user, though some card issuers do charge an annual fee per card user.

What credit score do you start with at 18?

If at 18 years old, a consumer hasn’t had a credit account, they simply won’t have a credit score at all since a credit score of “zero” does not exist. The lowest FICO score possible is actually 300, but a person’s starting score is typically higher than this, unless they’ve already demonstrated poor borrowing behavior early in their credit-building history.

When should I get my first credit card?

There’s no one “right age to get a credit card”; however, card issuers typically set a minimum age requirement of 18 for their card users. Parents can help their child access their first credit card as an authorized user, sometimes before the age of 18 years old. As an authorized user, your child can make purchases on your card, and start building their credit without being liable for monthly payments.

What is the fastest way to build credit at 18?

One of the fastest ways for parents to help their 18-year-old child build credit is by adding them to the parent’s existing credit card account as an authorized user. As parents make on-time monthly payments for at least the minimum amount due, some card issuers report this positive payment data to the credit bureaus for all users listed on the account.

Photo credit: iStock/PeopleImages

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 Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®

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