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What Is Payment for Order Flow?

Payment for order flow (PFOF) refers to the practice of retail brokerages routing customer orders to market makers, usually for a small fee that’s less than a penny. Market makers, who are required to deliver the “best execution,” carry out the retail orders, profiting off small differences between what shares were bought and sold for.

Retail brokerages, in turn, use the rebates they collect to offer customers lower — or often zero — trading fees.

How Does Payment for Order Flow Work?

Here’s a step-by-step guide to how payment for order flow generally works:

1.    A retail investor puts in a buy or sell order through their brokerage account.

2.    The brokerage firm routes the order to a market maker.

3.    The broker collects a small fee or rebate – the “payment” for sending the “order flow” or PFOF.

4.    The market maker is required to find the “best execution,” which could mean the best price, swiftest trade, or the trade most likely to get the order done.

The rebates allow companies offering brokerage accounts to subsidize rock-bottom or zero-commission trading for customers. It also frees them to outsource the task of executing millions of customer orders.

Usually the amount in rebates a brokerage receives is tied to the size of the trades. Smaller orders are less likely to have an impact on market prices, motivating market makers to pay more for them. The type of stocks traded can also affect how much they get paid for in rebates, since volatile stocks have wider spreads and market makers profit more from them.

Why Is PFOF Controversial?

While widespread and legal, payment for order flow is controversial. Critics argue it poses a conflict of interest by incentivizing brokerages to boost their revenue rather than ensure good prices for customers. The requirement of best execution by the Securities and Exchange Commission (SEC) doesn’t necessarily mean “best price” since price, speed, and liquidity are among several factors considered when it comes to execution quality.

Defenders of PFOF say that mom-and-pop investors benefit from the practice through enhanced liquidity, the ability to get trades done. They also point to data that shows customers enjoy better prices than they would have on public stock exchanges. But perhaps the biggest gain for retail investors is the commission-free trading that is now a mainstay in today’s equity markets.

What Are Market Makers?

Market makers — also known as electronic trading firms — are regulated firms that buy and sell shares all day, collecting profits from bid-ask spreads. The market maker profits can execute trades from their own inventory or in the market. Offering quotes and bidding on both sides of the market helps keep it liquid.

Market makers that execute retail orders are also called wholesalers. The money that market makers collect from PFOF is usually fractions of a cent on each share, but these are reliable profits that can turn into hundreds of millions in revenue a year. In recent years, a number of firms have exited or sold their wholesaling businesses, leaving just a handful of electronic trading firms that handle PFOF.

In addition to profits from stock spreads, the orders from brokerage firms give market makers valuable market data on retail trading flows. When it comes to using institutional or retail investors, market makers also prefer trading with the latter because larger market players like hedge funds can trade many shares at once. This can cause big shifts in prices, hitting market makers with losses.

PFOF in the Options Market

Payment for order flow is more prevalent in options trading because of the many different types of contracts. Options give purchasers the right, but not the obligation, to buy or sell an underlying asset. Every stock option has a strike price, the price at which the investor can exercise the contract, and an expiration date — the day on which the contract expires.

Market makers play a key role in providing liquidity for the thousands of contracts with varying strike prices and expiration dates.

The options market also tends to be more lucrative for the brokerage firm and market maker. That’s because options contracts trading is more illiquid, resulting in chunkier spreads for the market maker.

Criticism of Payment for Order Flow

Payment for order flow was pioneered in the 1980s by Bernie Madoff, who later pleaded guilty to running the largest Ponzi scheme in U.S. history.

Critics argue retail investors get a poor deal from PFOF. Since market makers and brokerages are only required to provide “best execution” and not necessarily the “best possible price,” firms can make trades that are profitable for themselves but not necessarily in the best interest of individual investors.

In 2016, the U.S. Department of Justice (DOJ) subpoenaed market making firms for information related to the execution of retail stock trades. The DOJ was looking into whether the varying speeds at which different data feeds deliver market prices made it look like retail clients were getting favorable prices, while market makers knew they actually weren’t from faster data feeds. A trading firm settled with regulators in 2017.

Defenders of Payment For Order Flow

Proponents of payment for order flow argue that both sides — the retail investors and the market makers — win from the arrangement. Here are the ways retail customers can benefit from PFOF, according to its defenders:

1.    No Commissions: In recent years, the price of trading has collapsed and is now zero at the biggest online brokerage firms. While competition has been a big part of that shift, PFOF has helped bring about low trading transactions for mom-and-pop investors. For context, online trading commissions were $40 or so a trade in the 1990s.

2.    Liquidity: Particularly in the options market, where there can be thousands of contracts with different strike prices and expiration dates, market makers help provide trading liquidity, ensuring that retail customer orders get executed in a timely manner.

3.    Price Improvement: Brokerages can provide “price improvement,” when customers get a better price than they would on a public stock exchange.

4.    Transparency: SEC Rules 605 and 606 require brokers to disclose statistics on execution quality for customer orders and general overview of routing practices. Customers are also allowed to request information on which venues their orders were sent to. Starting in 2020, brokers also had to give figures on net payments received each month from market makers.

The Takeaway

Payment for order flow (PFOF) refers to the practice of retail brokerages routing customer orders to market makers, usually for a small fee. Payment for order flow is controversial, but it’s become a key part of financial markets when it comes to stock and options trading today.

Industry observers have said that for retail investors weighing the trade-off between low trading costs versus good prices, it may come down to the size of their trades. For smaller trades, the benefits of saving money on commissions may surpass any gains from price improvement. For investors trading hundreds or thousands of shares at a time, getting better prices may be a bigger priority.

Ready to invest in your goals? It’s easy to get started when you open an Active Invest account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an account gives you the opportunity to win up to $1,000 in the stock of your choice.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
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.
Claw Promotion: Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
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Actively Managed Funds vs Index Funds: Differences and Similarities

Actively managed funds and index funds are similar in that they’re both a type of pooled investment fund, and they both come in a variety of styles (e.g. large cap, small cap, green bonds, and so on). The main difference between them is that actively managed funds rely on a team of live portfolio managers vs. index funds, which simply track or mirror a relevant index using an algorithm.

The difference in management style between active and so-called “passive” index funds leads to a series of other differences, including cost and transparency around securities in the fund.

The debate concerning the merits of actively managed funds vs. index funds is a longstanding one. Both types of funds have the potential to yield advantages to investors. But they each have drawbacks that should be weighed in the balance.

What Are Index Funds?

Index funds are a type of mutual fund or exchange-traded fund (ETF) that mirror the performance of a specific stock market index.

A stock market index measures a particular sector of the market. In the case of the S&P 500 Index, for example, what’s being measured is the performance of the 500 largest U.S. companies.

While it’s not possible to invest in an index directly, index funds and ETFs offer a work-around because when you invest in an index fund, you’re purchasing a fund that holds securities which are representative of its representative index.

If you’re buying a fund that tracks the Nasdaq-100 Composite Index, for example, the fund would include stocks from the 100 largest and most actively-traded non-financial domestic and international securities listed on the Nasdaq. The securities are not hand-picked by a portfolio manager, and an index fund doesn’t seek to outperform the benchmark — but rather to match it.

Index funds can be cap-weighted, meaning they track an index that relies on market capitalization to decide which securities to include. Market capitalization is a company’s value as determined by its share price multiplied by the number of shares outstanding.

For example, some index funds only track large-cap companies that have a market capitalization of more than $10 billion. Others focus on small-cap companies that have a market capitalization of $250 million to $2 billion.

Index funds and index investing follow a passive investment strategy. That means that the fund tracks the performance of a particular benchmark, rather than trying to beat the market by using the skills of a live portfolio manager.

What Are Actively Managed Funds?

Actively managed ETFs and mutual funds also represent a collection or basket of securities. The difference between these types of funds and index funds is that instead of being passively managed and tracking a specific index, a fund manager plays a hands-on role in determining which securities to include, in an attempt to beat the market.

Because of that, fund turnover — the movement of assets in and out of the fund — may be more frequent compared to an index fund. This has certain tax and cost implications for investors.

Index Funds vs Actively Managed Funds

Index funds do have some similarities to actively managed funds, but the chief difference between them — i.e. the use of passive management vs. active management — yields some important other differences.

Similarities

As noted above, both types of funds are pooled investment funds. You might have passively or actively managed mutual funds as well as exchange-traded funds.

Both types of funds can be invested in a wide range of different equities, bonds, and other securities. For example, you might have a small-cap ETF that’s passively managed (perhaps it tracks the Russell 2000 small-cap index) or an ETF that’s actively managed and also invested in small-cap companies.

Differences

The chief differences between actively managed funds show up in terms of cost and tax implications, and performance.

Actively managed funds are generally more expensive than index funds, because the fund employs a team of active managers who hand-pick securities and trade them.

Active funds also have a different investment objective: to beat the market. Index funds merely seek to mirror the performance of its benchmark index.

So a large-cap actively managed fund might seek to outperform the S&P 500, whereas a large-cap index fund that tracks the S&P 500 would aim to deliver the same results as the index itself.

Index Funds

Active Funds

Types of securities All securities (stocks, bonds, etc.) All securities (stocks, bonds, etc.)
Investment objective To mirror its benchmark To outperform its benchmark
Management style Passive (securities in the fund match the index) Active (fund managers select securities in the fund on the basis of performance)
Cost Average expense ratio is about 0.03 to 0.05% Average expense ratio is about 0.50% to 0.75%
Tax efficiency Less turnover, more tax efficient Higher turnover, less tax efficient

Pros and Cons of Index Funds

There’s a lot to like about index funds but with any investment, it’s important to consider the potential downsides. Reading through an index fund’s prospectus can offer more insight into how the particular fund works, in terms of what it invests in, its risk profile, and the costs you’ll pay to own it. This can help you better gauge whether a particular index fund aligns with your investment strategy.

When weighing index funds as a whole, here are some important points to keep in mind.

Index Fund Pros

•   Simplified diversification. Diversification may help manage risk inside a portfolio. Index funds can make diversifying easier through exposure to multiple securities that represent a specific index.

•   Cost. Because they are passively managed, index funds typically charge fewer fees and carry expense ratios that are well below the industry average of 0.57%. Fewer fees allow you to keep more of your investment returns.

•   Tax efficient. Index funds tend to turn over assets less frequently than actively managed funds, which means fewer capital gains tax events — another way index funds can save investors money.

•   Consistent returns. The idea behind an index fund is that it will closely track its benchmark to mirror performance. Index funds can offer stable returns over time when they perform in tandem with their respective indices.

Index Fund Cons

•   Underperformance. Index fund returns can differ from one fund to the next and factors such as fees, expense ratios, and market conditions can affect how well a fund performs. It’s possible that rather than matching its benchmark, an index fund may deliver returns below expectations.

•   Cost. Between index funds vs. managed funds, index funds tend to have lower costs — but that’s not always the case. It’s possible to invest in index funds that prove more expensive than actively managed funds.

•   Tracking error. Tracking error occurs when an index fund’s performance doesn’t match the performance of its benchmark. This can happen if the fund’s makeup doesn’t accurately reflect the makeup of securities tracked by the index.

•   Limit on returns. Index funds aren’t designed to beat the market. Investing in these funds, without considering active investing strategies, could limit your return potential over time and cause you to miss out on bigger investment gains.

Why Invest in Index Funds?

Index funds and index investing may work better for a buy-and-hold investor who’s focused on investing for the long-term. Buy-and hold-strategies often go hand in hand with value investing strategies, in which the emphasis lies on finding companies that are undervalued by the market.

Utilizing index funds could simplify investing over the long term, and it may suit people who want to minimize risk-taking in their portfolios. But it’s important to consider the trade-offs involved with choosing index funds vs. actively managed funds.

Pros and Cons of Actively Managed Funds

With active funds, fund managers use their knowledge and expertise to determine which securities to buy or sell inside the fund in order to reach the fund’s investment goals.

As with index investing, using actively managed funds to invest can have its high and low points. Here are some key things to know about investing with actively managed funds.

Actively Managed Funds Pros

•   Professional expertise. Actively managed funds allow investors to benefit from a fund manager’s know-how and experience in the market. This may be reassuring to an investor who’s still learning the ropes of how trading works, or who has faith in a particular fund manager.

•   Higher returns. Actively managed funds seek to outperform the market. If the fund realizes its objectives, returns could possibly exceed those offered by index funds. Historically, though, the majority of active funds don’t outperform the market.

Actively Managed Funds Cons

•   Underperformance. As with index funds, it’s possible that an actively managed fund’s returns won’t meet investor expectations. This can happen if the fund manager makes a miscalculation when choosing securities or unforeseen events, such as a major economic downturn, deliver a blow to the market.

•   High management fees. The costs associated with having a fund manager make decisions are typically higher than with passively managed index funds.

•   Risk. Active trading can be riskier than index investing, since performance relies on the fund manager to make buying and sellings decisions.

•   Taxes. Since asset turnover is higher for actively managed funds, more capital gains tax events are likely. Even though an actively managed fund may generate higher returns, those have to be weighed against the possibility of increased tax liability.

Why Invest in Actively Managed Funds

Actively managed funds may offer more downside than upside to investors. Unlike index funds, actively managed funds may not be suited for a long-term, buy-and-hold strategy. But for investors who have the time or inclination to take their chances for a greater potential yield, they might be an attractive part of a portfolio.

Are Index Funds Better than Managed Funds?

Both actively managed funds and index funds aim to help investors achieve their goals, but in different ways and with potentially different results. Whether index funds or managed funds are better hinges largely on the individual investor and what they need or expect their investments to do for them.

When considering index funds and actively managed funds, ask yourself what’s more important: Steady returns or a chance to beat the market? While actively managed funds can outperform market indices, results aren’t guaranteed and in some cases, active funds can lag behind their benchmarks.

Index funds, on the other hand, may offer a greater sense of stability over time and potentially more insulation against market volatility. While all investments carry the risk of loss, over time there may be a smaller chance of losing money in an index fund. But there are no guarantees.

Lower investment costs can also be attractive when estimating net returns, but again it’s important to compare fund costs against fund performance individually, to ensure that you’re comfortable with the number.

The Takeaway

Whether you prefer index funds vs. managed funds might depend on your age, time horizon for investing, risk tolerance, and goals. If you lean toward a hands-off, goals-based investing approach that carries lower costs, index investing could suit you well.

On the other hand, if you’re more interested in beating the market, and if you believe active management is more likely to deliver outperformance, then you may consider the benefits of active investing.

Ready to invest in your goals? It’s easy to get started when you open an Active Invest account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an account gives you the opportunity to win up to $1,000 in the stock of your choice.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
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.
Claw Promotion: Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
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What's the Difference Between Income and Net Worth?

What’s the Difference Between Income and Net Worth?

Put simply, income is the amount you earn whereas net worth is the total value of your assets minus any debt. When it comes to measuring your financial health, income isn’t the metric that matters. Sure, you want to know whether your income will help you reach your goals, but looking at your net worth is a better measure of your overall wealth.

That being said, it’s important to understand how both play into your finances, so let’s take a look at net worth vs income and how they factor into your financial health.

Income vs Net Worth: Two Measurements of Wealth

Both income and net worth can help measure the chances of someone creating wealth. However, the difference is that income is the primary way someone generates wealth, whereas net worth measures your level of wealth. To put it another way, income is how you make money, but it doesn’t necessarily lead to creating wealth.

Instead, looking at your net worth allows you to see the value of all your assets and liabilities at a specific point in time. It gives you a sense of your financial health in terms of whether you own more assets — such as your home, investments and cash — than liabilities (any money you owe, like credit card debt). Your net worth also allows you to see how much of your wealth is held in assets or cash. And it offers a reference point to help you measure your progress toward your financial goals.

Recommended: Should I Sell My House Now or Wait?

Is Net Worth More Important Than Income?

While income is a key aspect of your finances, net worth typically is more important. That’s because even if you have a large income, it doesn’t guarantee that you’ll generate more wealth than someone else who may have a slightly lower one. Sure, having a larger income can help you build wealth faster, but it’s all in how you handle your finances, such as the amount of money you save.

Let’s say your friend makes $100,000 per year but has a lot of debt, leading their net worth to be $15,000. On the other hand, you make $70,000 but have invested over 10 years, to the point where your net worth is $100,000. You have more wealth, and therefore, are more likely to be financially stable than your friend.

Another instance where income doesn’t correlate with wealth is when someone is older and getting ready to retire. Their income may be lower because they’re working part-time, but their wealth could be in the millions because they’ve worked for many years.

All this to say, income is important but only as important as how you use it to reach your financial goals.

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How to Calculate Income

Calculating your income doesn’t simply mean looking at the number on your paycheck. You’ll also want to factor in other sources of income, such as any government benefits, commissions, tips and dividends. Don’t forget to include irregular or occasional income sources like cash gifts, inheritances and even tax refunds.

Make sure that when you add these up, it’s your net income and not gross income, as that will give you a more accurate picture of what you’re bringing in. Gross income is pre-tax money and before deductions are taken out. Net income, on the other hand, is income that has taxes and deductions taken out.

Example of Calculating Income

Let’s say you have a day job that offers bonuses and commissions. You also invest in securities that provide dividends.

Here’s how you would calculate your income:

•   Annual net salary: $64,350

•   Annual commissions: $3,500

•   Annual bonus: $2,000

•   Annual dividends: $3,234

TOTAL INCOME: $73,084

You can then use this total to calculate monthly and weekly income — in this case, it’s $6,090.33 per month and $1,405.46 per week.

How to Calculate Net Worth

Calculating your net worth involves creating a net worth statement so you can see a snapshot of your assets and liabilities.

Start by looking at your assets and determining the total amount of all accounts under this category. Assets are items that have some sort of monetary value. These include:

•   Checking accounts

•   Savings Accounts

•   Your home

•   Real estate

•   Retirement fund

•   Personal property (such as your vehicle)

•   Pension equity

•   Securities (like stocks and bonds)

•   Life insurance policy

•   Profit-sharing equity

Once you’ve calculated all of your assets, you’ll need to calculate the total amount of your liabilities. Liabilities are any debts or financial obligations you have, including:

•   Mortgage

•   Credit card balance

•   Personal loans

•   Auto loans

•   Student loans

•   Unpaid medical and dental bills

•   Home equity loans

•   Money you owe to family and friends

•   Unpaid taxes

After totaling up your assets and liabilities, subtract the latter from the former. This number will be your net worth. If your liabilities are greater than your assets, you’ll have a negative net worth. The more assets you have than liabilities, the higher your net worth will be.

Example of Calculating Net Worth

As an example, let’s say that Barbara decided to calculate her net worth. First, she’d list out her assets and liabilities:

ASSETS

Checking accounts $600
Savings accounts $10,000
Home $365,000
401(k) balance $24,399
Vehicle (current value) $32,590
Brokerage account $12,000
TOTAL: $444,589

LIABILITIES

Mortgage $200,000
Car loan $29,251
Credit card $4,126
Student loans $36,700
Personal loans $13,857
Unpaid medical bill $300
TOTAL: $284,234

Once she’d written that all out, she would be able to calculate her net worth using the following formula:

Total assets – total liabilities = net worth

$444,589 – $284,234 = $160,355

Barbara has a positive net worth of $160,355.

Ways to Improve Your Net Worth

Ideally, you’ll have a positive net worth that keeps growing over time. Here are several ways to improve your net worth.

1. Keep Track of Your Assets and Debt

Tracking your assets and debt will give you an accurate picture of where you stand. That way, you’ll be able to see your progress and what you need to improve or keep doing to grow your net worth. For instance, if you notice that your debt keeps growing, you can use this information to help you figure out why and take steps to rectify the situation.

2. Pay Off Debt

The fewer liabilities you have, the more your net worth will grow. To improve your net worth, you can focus on making sure you’re making on-time payments and avoid taking out new loans if possible. If your budget allows, consider making extra payments toward loans to pay off your debt faster. Some loans, like mortgages, may have prepayment penalties, so check with your lender before sending that extra check.

3. Increase Your Income

Getting a higher salary will help you build wealth by paying off debt or putting money toward investment accounts. Ideally, you want to increase your income and pay off your debts as soon as you can. To increase income, you can consider negotiating for more in your current job, looking for a new one, or starting a side hustle to help you make more.

4. Invest

Sticking your cash in a savings or checking account can only get you so far. To accelerate your wealth-building journey, you’ll need to invest some of your money.

Start investing by contributing to your employer-sponsored account (bonus if they offer a match), and then branch out to other products as you see fit.

The Takeaway

Your net worth is a snapshot of your finances at a specific point in time and will fluctuate. It’s a good measure to see whether you’re on track with your financial goals. The more you track your assets and liabilities, increase your income, and decrease your debt, the more your net worth will grow.

A money tracker tool like SoFi Insights can make it easy to keep track of all of this, with a bird’s-eye view of your account balances and tools to track your spending.

Find out where your finances stand.


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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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What Credit Score is Needed to Rent an Apartment in 2021?

What Credit Score Is Needed to Rent an Apartment in 2023?

While there’s no universally required credit score needed to rent an apartment, having a solid credit score can certainly help your chances of a landlord handing you a set of keys. In general, a landlord will look for a credit score that is at least “good,” which is generally in the range of 670 to 739. However, that can vary by landlord or property manager, as well as the location in which you’re renting.

Read on to learn more about how your credit score can affect renting an apartment — and how you can approach renting if you have a lower credit score.

What Credit Score Do I Need to Rent an Apartment?

Truth is, the answer to what credit score you need to rent an apartment is a bit squishy. In general, you’ll have a better chance of approval if your credit score is at least deemed “good.”

What’s considered good? Credit scores are generally classified as follows per FICO® (keep in mind that different scoring models may vary):

•   Exceptional: 800-850

•   Very good: 740-799

•   Good: 670-739

•   Fair: 580-669

•   Very poor: 300-579

There also are variables that can affect whether your credit score qualifies you to rent an apartment. For example, if you live in a city where there is huge demand for apartments, landlords may give preference to those with higher credit scores.

Can You Get an Apartment if One Person Has Bad Credit?

If one person has bad credit, know that it will likely make it tougher for you to get an apartment. Landlords have a lot of leeway and can follow criteria of their choosing.

Still, it’s not impossible even if it is trickier. One smart strategy in this situation is to put the lease in the name of the person whose credit and income is best. You could also offer to show your income or provide a reference.

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What Landlords Look at on Your Credit Report

When your landlord reads your credit report, they will be looking for clues about your financial health and habits.

Of much importance is your debt-to-income ratio. In a nutshell, this is the amount of your monthly pre-tax income that gets spent on debt payments. It’s certainly not news to you that filing for bankruptcy can have a negative impact on one’s credit. A landlord also may be spooked if you have hefty credit card balances.

Your credit history disclosed on your credit report also may include your rental history, since some landlords and rental property managers share your data with the credit bureaus. This can be a plus if you’ve been doing the right thing; if not, this can work against you.

Too many hard inquiries also can raise red flags for a landlord. This is because frequently applying for different types of credit could suggest financial instability, which increases risk in the eyes of lenders — as well as landlords.

How to Rent an Apartment with a Lower Credit Score

Just because your credit score isn’t stellar doesn’t mean you’re resigned to sleeping on a friend’s couch or living with your parents. There are ways to rent an apartment even with a lower credit score.

Pay a Higher Security Deposit

One way to show that your credit history is just history is by offering to make a higher security deposit. Say you are required to pay first and last month’s rent upfront. To sweeten the deal, maybe you tack on a couple additional months of rent.

If you want to instill confidence in your potential new landlord, this might do it. Just make sure you actually have the room in your budget to offer up the cash.

Recommended: What Is The Difference Between Transunion and Equifax?

Get a Cosigner

While getting a cosigner may put a damper on feeling like you’re finally a grownup, it may be worth sucking it up and getting a creditworthy parent or other trusted individual to cosign for your apartment. This can give your landlord peace of mind if someone is willing to pay the rent on your behalf if you’re unable to.

Just keep in mind that your cosigner will be on the hook if you miss a payment, and that cosigners generally must meet even steeper credit score and income requirements.

Play Up Your Income

Maybe your credit score is nothing to brag about, but you’ve worked hard and now have your finances in order, with solid savings and a good income. If you could show that you earn three or four times your rent on a monthly basis, that might divert attention from your lousy credit score. Additionally, if you have a solid stash in your savings account, that can also give your landlord assurance that you have the funds to cover your monthly rent.

Consider Getting a Roommate

Adding a roommate to your lease or rental agreement can increase your creditworthiness and your qualifying income. This is especially the case if you can find a roommate with good credit — and get your landlord to pull their credit first.

Benefits of Good Credit When Renting an Apartment

A landlord needs more than their gut instinct to help them determine who to rent to, which is why a credit score carries a lot of weight when it comes to getting your rental application approved. A good or — better still — an excellent score can give landlords the confidence to consider you for the apartment, especially if all other signals they get when checking on your background indicate they should give you the green light.

Having a solid credit score can help you to snag the apartment you want, and avoid the hassles associated with trying to secure an apartment when your credit isn’t as great, such as getting a roommate or a cosigner. Especially if you live in a city with a competitive rental market, a good credit score can be a serious edge.

Recommended: Does Net Worth Include Home Equity?

How to Monitor Your Credit Score

Ideally, you want to check your credit and get a copy of your credit report before you start apartment hunting. It’s important to know where you stand, and if there are any errors, you want to fix them right away.

Through the end of 2023, you can get free weekly credit reports from the three national credit reporting agencies, Equifax, Experian and TransUnion. To get your free reports, simply go to
AnnualCreditReport.com
.

While your credit report provides information on your various credit accounts and their balances and your payment history, it does not include your credit score. You can check your credit score by looking at a loan or credit card statement or through an online credit score checker. You can also buy a score directly through credit reporting companies. Even if you might have checked your credit score not that long ago, don’t skip doing so again — your credit score updates every 30 to 45 days.

If your score is low, consider taking steps to improve it before jumping into your apartment search. Actions like paying down credit card balances and making sure you don’t have any more late or missed payments for a stretch can show progress.

Recommended: What Credit Score Is Needed to Buy a Car?

What to Expect in 2023

According to Zillow, demand for rentals will grow in the coming year. The U.S. rental property market is currently experiencing, heightened demand and high property prices, while those looking to rent are competing with a wealthier pool of renters. This is driving up prices, albeit at a slower rate than last year.

Further compounding the situation is the fact that housing prices are still so inflated that the percentage of people who can afford a home remains low. This could lead to a rental market that is even more competitive, which may not bode well for those with less than stellar credit.

Recommended: Should I Sell My House Now or Wait?

The Takeaway

You’ll want to shoot for having a good credit score — generally in the range of 570-739 — to get an apartment. While you may be able to still get an apartment if you don’t have solid credit, it will make it more challenging with the competition you’re likely to face.

If you have the luxury of time, do what’s necessary to improve your score so that when you begin your search, you’ll be an ideal candidate. An online credit monitoring tool like SoFi Insights can make it easier.

Stay on top of your credit score and easily see what impacts it.


Photo credit: iStock/MixMedia

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