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Home equity loans, home equity lines of credit (HELOCs), and cash-out refinances are all borrowing options that allow homeowners to access the equity they’ve built in their home. By tapping into home equity — the difference between a home’s current value and the amount still owed on the mortgage — homeowners can secure funds to meet other financial goals, such as making home improvements.

While these three types of loans do have similarities, there also are key differences in how each one works. Understanding the differences in a home equity loan vs. HELOC vs. cash-out refi can help you better determine which option is right for you.

Defining Home Equity Loans, HELOCs, and Cash-Out Refi

To start, it’s important to know the basic definitions of home equity loans, HELOCs, and cash-out refinances.

Home Equity Loan

A home equity loan allows a homeowner to borrow a lump sum that they’ll then repay over a set period of time in regular installments at a fixed interest rate. Generally, lenders will allow homeowners to borrow up to 75% to 85% of their home’s equity.

This loan is in addition to the existing mortgage, making it a second mortgage. As such, a borrower usually will make payments on this loan in addition to their monthly mortgage payments.

HELOC

A HELOC is a line of credit secured by the borrower’s home that they can access on an as-needed basis, up to the borrowing limit. The amount of the line of credit is determined by the mortgage lender and based on the amount of equity a homeowner has built, though it’s usually around 80% to 90% of the equity amount. Like a home equity loan, this is a second mortgage that a borrower assumes alongside their existing home loan.

How HELOCs work is somewhat like a credit card, in that it’s a revolving loan. For example, if a borrower is approved for a $30,000 home equity line of credit, they can access it when they want, for the amount they choose (though there may be a minimum draw requirement). The borrower is only charged interest on and responsible for repaying the amount they borrowed.

Another point that borrowers should keep in mind is that there is a draw period of 5 to 10 years, during which a borrower can access funds, and a repayment period of 10 to 20 years. During the draw period, the monthly payments can be relatively low because the borrower pays interest only. During the repayment period, on the other hand, the payments can increase significantly because both principal and interest have to be paid.

Cash-Out Refinance

A cash-out refinance is a form of mortgage refinancing that allows a borrower to refinance their current mortgage for more than what they currently owe in order to receive extra funds. With a cash-out refinance, the borrower’s current mortgage is replaced by an entirely new loan.

As an example, let’s say a borrower owns a home worth $200,000 and owes $100,000 on their mortgage at a high interest rate. They could refinance at a lower interest rate, while at the same time taking out a larger mortgage. For instance, they could refinance the mortgage at $130,000. In this case, $100,000 would replace the old mortgage, and the borrower would receive the remaining amount of $30,000 in cash.

Recommended: Home Buyer’s Guide

Home Equity Loans and HELOCs vs Cash-Out Refi

Here’s a look at how a home equity loan vs. HELOC vs. cash-out refinance stack up when it comes to everything from borrowing limit to interest rate to fees:

	Home Equity Loan	HELOC	Cash-Out Refinance
Borrowing Limit	75% to 85% of borrower’s equity	Up to 85% of borrower’s equity	80% of borrower’s equity
Interest Rate	Fixed rate	Generally variable	May be fixed or variable
Type of Credit	Installment loan: Borrowers get a specific amount of money all at once that they then repay in regular installments throughout the loan’s term (generally 5 to 30 years).	Revolving credit: Borrowers receive a line of credit for a specified amount and have a draw period (5 to 10 years), followed by a repayment period (10 to 20 years).	Installment loan: Borrowers receive a lump sum payment from the excess funds of their new mortgage, which has a new rate and repayment terms (generally 15 to 30 years).
Fees	Closing costs (typically 2% to 5% of the loan amount)	Closing costs (typically 2% to 5% of the loan amount), as well as other possible costs, depending on the lender (annual fees, transaction fees, inactivity fees, early termination fees)	Closing costs (typically 3% to 5% of the loan amount)
When It Might Make Sense to Borrow	Home equity loans can make sense for borrowers who want predictable monthly payments, or who want to consolidate higher interest debt.	HELOCs can be useful for shorter-term needs or situations where a borrower may want to access funds over a specified period of time.	Cash-out refinances may be useful if borrowers need a large sum of money, often used to improve their overall financial situation (for example, to pay off debt or finance a large home improvement project).

Borrowing Limit

With a home equity loan, lenders generally allow you to borrow up to 75% to 85% of a home’s equity. HELOCs allow borrowers to tap a similar amount, generally up to 85%. Cash-out refinances, on the other hand, have slightly lower borrowing limits, at up to 80% of a borrower’s equity.

Interest Rate

With a home equity line of credit, the interest rate is usually adjustable. This means the interest rate can rise, and if it does, the monthly payment can increase. Home equity loans, meanwhile, generally have a fixed interest rate, meaning the interest rate remains unchanged for the life of the loan. This allows for more predictable monthly payment amounts.

A cash-out refinance can have either a fixed rate or an adjustable rate. Homeowners who opt for an adjustable rate may be able to access more equity overall.

Type of Credit

Both home equity loans and cash-out refinances are installment loans, where you receive a lump sum that you’ll then pay back in regular installments. A HELOC, on the other hand, is a revolving line of credit. This allows borrowers to take out and pay back as much as they need at any given time during the draw period.

Fees

With a home equity loan, HELOC, or cash-out refinance, borrowers may pay closing costs. HELOC closing costs may be lower compared to a home equity loan, though borrowers may incur other costs periodically as well, such as annual fees, charges for inactivity, and early termination fees. Cash-out refinances may also have higher closing costs because the loan amount taken out is higher.

When It Might Make Sense to Borrow

A home equity loan vs. HELOC vs. cash-out refi have varying use cases. With a fixed interest rate, home equity loans can allow for predictable payments. Their lower interest rates can make them an option for borrowers who want to consolidate higher interest debt, such as credit card debt.

HELOCs, meanwhile, provide more flexibility as borrowers can take out only as much as they need, allowing borrowers to continually access funds over a period of time. A cash-out refinance can be a good option for a borrower who wants to receive a large lump sum of money, such as to pay off debt or finance a large home improvement project.

Which Option Is Better?

Like most things in the world of finance, the answer to whether a cash-out refinance vs. HELOC vs. home equity loan is better will depend on a borrower’s financial circumstances and unique needs.

In all cases, borrowers are borrowing against the equity they’ve built in their home, which comes with risks. If a borrower is unable to make payments on their HELOC or cash-out refinance or home equity loan, the consequence could be selling the home or even losing the home to foreclosure.

Scenarios Where Home Equity Loans Are Better

A home equity loan can be the right option in certain scenarios, including when:

•   You want fixed, regular second mortgage payments: A home equity loan generally will have a fixed interest rate, which can be helpful for budgeting as monthly payments will be more predictable. Some may appreciate this regularity for their second monthly mortgage payment.

•   You want to get a lump sum while keeping your existing mortgage intact: Unlike a HELOC, where you draw just as much as you need at any given time, a home equity loan gives you a lump sum all at once. Plus, unlike a cash-out refinance, you aren’t replacing your existing mortgage. That way, if the terms of your current mortgage are favorable, those can remain as is.

Recommended: The Different Types Of Home Equity Loans

Scenarios Where HELOCs Are Better

In the following situations, a HELOC may make sense:

•   You have shorter-term or specific needs: Because HELOCs generally have a variable interest rate, they can be useful for shorter-term needs or for situations where a borrower may want access to funds over a certain period of time, such as when completing a home renovation.

•   You want the option of interest-only payments: During the draw period, HELOC lenders often offer interest-only payment options. This can help keep costs lower until the repayment period, when you’ll need to make interest and principal payments. Plus, you’ll only make payments on the balance used.

Scenarios Where Cash-Out Refi Is Better

Cash-out refinances can make sense in these scenarios:

•   You need a large sum of money: If there’s a need for a large sum of money, or if the funds can be used as a tool to improve your financial situation on the whole, a cash-out refinance can make sense.

•   You can get a lower mortgage rate than you currently have: If refinancing can allow you to secure a lower interest rate than your current mortgage offers, then that could be a better option than taking on a second mortgage, as you would with a home equity loan or HELOC. If interest rates have risen since you first took out your loan, however, a cash-out refi could mean paying more in interest over the life of the loan.

•   You want just one monthly payment: Because a cash-out refinance replaces your existing mortgage, you won’t be adding a second monthly mortgage payment to the mix. This means you’ll have only one monthly payment to stay on top of.

•   You have a lower credit score but still want to tap your home equity: In general, it’s easier to qualify for a cash-out refinance vs. HELOC or home equity loan since it’s replacing your primary mortgage.

The Takeaway

Cash-out refinancing, HELOCs, and home equity loans each have their place in a borrower’s toolbox. All three options give borrowers the ability to turn their home equity into cash, which can make it possible to achieve certain goals, consolidate debt, and improve their overall financial situation.

Homeowners interested in tapping into their home equity may consider getting a HELOC or taking a cash-out refinance with SoFi. Qualifying borrowers can secure competitive rates, and Mortgage Loan Officers are available to walk borrowers through the entire process.

Learn more about SoFi’s competitive cash-out refinancing and HELOC options. Potential borrowers can find out if they pre-qualify in just a few minutes.

FAQ

Can you take out a HELOC and cash-out refi?

If you qualify, it is possible to get both a HELOC and cash-out refinance. Qualified borrowers can use their cash-out refinance to help repay their HELOC.

Is it easier to qualify for a HELOC or cash-out refi?

It is generally easier to qualify for a cash-out refinance. This is because the cash-out refi assumes the place of the primary mortgage, whereas a HELOC is a second mortgage.

Can you borrow more with a HELOC or cash-out refi?

Ultimately, the amount you can borrow with either a cash-out refi or HELOC will depend on how much equity you have in your home. That being said, a HELOC can offer a slightly higher borrowing limit than a cash-out refi, at 85% of a home’s equity as opposed to a top limit of 80% for a cash-out refinance.

Are HELOCs or cash-out refi tax deductible?

Interest on your cash-out refinance or HELOC can be tax deductible so long as you use the funds for capital home improvements. This includes projects like remodeling and renovating.

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

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

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While your income doesn’t have a direct impact on your credit score, it can have indirect effects. A loss in income, a gap in cash flow, or a sudden layoff could put you in a financial pinch. This reduction in the size of your paycheck could hinder your ability to pay your bills, which can ding your credit. Additionally, your income can impact your ability to open a credit card or take out a loan.

Let’s take a closer look at how your income and salary could affect your credit, as well as what factors do directly determine your credit score.

Does Income Affect Credit Score?

Wondering if your salary impacts your credit score? Put simply, your income does not directly affect your credit.

That’s because the financial information that’s found on your credit report is primarily related to debt. As such, information like savings or checking account balances, investments, and income do not appear on your credit report.

Beyond that, there is quite a bit of information that a credit report explicitly cannot include. These exclusions are made in an effort to prevent lenders from potentially being biased or discriminating based on race, religious affiliation, and other personal details. The following information — including income — is not included on credit reports:

•   Income

•   Employment status

•   Marital status

•   Religious affiliation

•   Race or ethnicity

Recommended: How Having a Savings Account Affects Your Credit Score

What Then Impacts Your Credit Score?

While income doesn’t affect your credit score, what does impact your score has to do with your ability to be responsible with credit. Different credit scoring models vary slightly in the way they calculate credit scores. However, they generally look for signs of creditworthiness, which is your reliability in paying back money based on past behavior and financial habits.

Here’s a closer look at what affects your credit score.

Recommended: Tips for Using a Credit Card Responsibly

Payment History

Payment history makes up the lion’s share of your FICO Score, accounting for 35% of your credit score. Making timely payments on your bills and debt, such as your credit card balances, car loan, or personal loan, is crucial to establishing credit.

Recommended: When Are Credit Card Payments Due?

Credit Utilization

Your credit usage, or credit utilization ratio, is also a major player in your credit score. How much does credit utilization ratio affect credit score? Specifically, this makes up 30% of your FICO Score.

Your credit usage is your total outstanding balance among all your credit cards against your total credit limit. This is expressed as a percentage. For instance, if you have a $500 credit card balance, and the total limit on all of your cards is $5,000, then your credit usage is 10%.

You’ll want to aim to keep your credit utilization ratio under 30%. Credit usage over 30% can negatively impact your credit, as it indicates to lenders that you might be stretched too thin financially.

Age of Accounts

How long you’ve had and managed debt also impacts your credit score. This makes up 15% of your FICO Score. Keeping your old lines of credit open can help boost your score by extending the age of your credit accounts.

Credit Mix

Having a healthy mix of different types of credit — think installment loans like a car or personal loan, a mortgage, credit cards, and other accounts — can also help with building credit. Your credit mix makes up a smaller portion of our FICO Score at 10%.

New Credit

If you’ve recently opened several new lines of credits, or had a bunch of different hard credit pulls from applying for credit, this could negatively impact your credit. This is because it can suggest to lenders you’re desperate for funds and thus a potentially higher risk. New credit accounts for 10% of your FICO Score.

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

How Your Income Can Indirectly Affect Your Credit Score

While income doesn’t have a direct impact on your credit score, it can still affect your score in a couple of ways.

First, if you’re tight on money due to a recent job loss, reduced hours at your work, or a gap in cash flow, your reduced income could impact your ability to stay on top of your debt payments. As payment history makes up 35% of your FICO score, falling behind or missing payments altogether could result in your credit score taking a hit. In turn, a regular paycheck helps your credit score because it can help you to more easily make on-time payments.

Your income can also impact your credit score because income is something that lenders typically look at when you apply for a line of credit. Because your income can affect your odds of getting approved for a loan or credit card, it can indirectly impact your credit mix and length of credit, which both play into your credit score.

Recommended: Difference Between Income and Net Worth

How Your Income and Debt Impact Credit Approval

When lenders evaluate your application, one factor they may consider is your debt-to-income ratio, which is the percentage of your monthly income that goes toward paying down debts. The lower your income, the more easily you can have a higher debt-to-income ratio, which could affect your odds of approval.

Additionally, when you apply for a loan or credit card, lenders will typically request proof of income, such as a paystub or a tax return. Having a low income could affect your odds of approval, as well as the amount of the loan or credit limit you’re approved for.

Recommended: How Unemployment Affects Your Credit Score

The Takeaway

While the size of your paycheck doesn’t directly affect your credit score, it can impact your ability to stay on top of your debt payments. This in turn can influence your score. Understanding exactly what financial factors do impact your credit can help you to be mindful of financial behaviors and patterns that will keep your score in tip-top shape.

In the market for a credit card? The SoFi Credit Card charges no foreign transaction fees and offers competitive cash-back rewards.

The SoFi Credit Card offers unlimited 2% cash back on all eligible purchases. There are no spending categories or reward caps to worry about.¹

Take advantage of this offer by applying for a SoFi credit card today.

FAQ

How much does your debt-to-income ratio affect your credit score?

While your debt-to-income ratio doesn’t directly impact your credit score, it can affect your odds of getting approved for credit. If your debt-to-income ratio is too high, it’s a sign that you might be stretched thin moneywise. In turn, lenders might be less likely to extend credit to you.

Why do credit cards ask for income on applications?

Credit card issuers request your income on applications to gauge whether to extend you credit, and to determine how much of a credit limit to offer you.

How much annual income do you need to be approved for a credit card?

While there’s no set number, and credit card companies rarely post whether they have a minimum annual income requirement, they do take into account your income when looking over your application. Note that your annual income isn’t the only factor that credit card issuers look at when determining whether to approve your application though. Other factors like your debt load and credit score are also taken into account.

Will my income show up on my credit card?

Your income will not show up on your credit card, nor will it show up on your credit report. Personal information such as income isn’t permitted on your credit report to avoid the possibility for discrimination or bias.

How does my income affect my credit limit?

If you have a higher income, you could get approved for a higher line of credit. This is because you’ll have more available funds to pay off any debt you incur.

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¹Members earn 2 rewards points for every dollar spent on purchases. No rewards points will be earned with respect to reversed transactions, returned purchases, or other similar transactions. When you elect to redeem rewards points into your SoFi Checking or Savings account, SoFi Money® account, SoFi Active Invest account, SoFi Credit Card account, or SoFi Personal, Private Student, or Student Loan Refinance, your rewards points will redeem at a rate of 1 cent per every point. For more details please visit the Rewards page. Brokerage and Active investing products offered through SoFi Securities LLC, member FINRA/SIPC. SoFi Securities LLC is an affiliate of SoFi Bank, N.A.

¹See Rewards Details at SoFi.com/card/rewards.

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.

The SoFi Credit Card is issued by SoFi Bank, N.A. pursuant to license by Mastercard® International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

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.

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When you’re in the market for a new car, you have several options for how to finance the vehicle. Leasing a car, getting an auto loan, or paying for your car in cash are all possibilities, depending on your specific situation. If you’re unsure about your credit situation, you might wonder if leasing a car is possible for you, or how leasing a car affects your credit.

In most cases, you’ll need to have good credit to qualify for a lease on a car. If you have poor or no credit, you may have better luck getting an auto loan, although your interest rate may be high. Should you opt to lease a car or buy one with an auto loan, your payment history is usually reported to the major credit bureaus. As such, making on-time and regular payments can help build your credit.

Leasing vs Buying a Car

When you buy a car, you agree on a purchase price with the seller. You then can either pay for the full amount of the car at the time of purchase, or use an auto loan for some or all of the purchase amount.

With a lease, you may put some money down, and then you will pay a fixed amount each month for the duration of the lease. Your monthly lease amount will be based on how much the car is worth at the end of the lease period. At the end of your lease, you can either return your vehicle to the lessor or buy your leased car.

It’s also important to keep in mind that leasing a car often comes with some restrictions on how you use your car, which is not the case with buying a car. If you lease, you might have limits on the number of miles you can drive during the lease term, for instance.

Both buying and leasing a car can impact your credit score, since your monthly debt obligation and payment history (positive or negative) shows up on your credit report.

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

Pros and Cons of Leasing a Car

Beyond knowing whether leasing a car builds credit, it’s important to be aware of the pros and cons of leasing a car. By understanding the upsides as well as the drawbacks, you’ll be better able to choose between leasing or buying a car.

Here’s an overview of the major pros and cons of leasing a car to consider:

Pros	Cons
Leasing can often offer lower monthly payments than buying the car outright.	There may be restrictions on how you use the vehicle, such as the number of miles you can drive during the lease.
You can potentially upgrade your car every few years.	You don’t actually own the car, so you won’t build any equity to show for your monthly payments.
The lease may include coverage for maintenance and some repairs.	You may get charged for excessive wear and tear on the vehicle.

Recommended: What is a Charge Card?

Ways Leasing a Car Builds Credit

In most cases, your lessor will report the payments you make on a leased car to the major credit bureaus. This means that a car lease will show up on your credit report as an installment loan, and your payment history will be recorded. This can help your credit if you make on-time payments, but it may have a negative impact if you miss a payment or the lease becomes delinquent.

Recommended: When Are Credit Card Payments Due?

Can You Lease a Car With Bad Credit?

The exact credit score needed to lease a car will depend on the lender or lessor that you use, but you generally will need to have good or excellent credit (meaning 670+) to qualify for a lease. If you don’t have a good credit history or are still working on improving your credit, leasing a car may not be the right fit for you.

Alternatives to Leasing a Car

If you’re not able to or don’t want to lease a car, you do have some other alternatives.

Buying a Car With an Auto Loan

It is more realistic that you might be able to qualify for a car loan rather than a lease if your credit isn’t great. While your monthly payment may be higher with a purchase as compared to a lease (since you’re buying the car rather than just leasing it for a short period of time), that may still end up being the right option for you.

You will want to keep in mind that auto loan interest rates often vary depending on your credit score. That means that someone with fair credit will likely have a higher interest rate than someone with good or excellent credit.

Recommended: How to Avoid Interest On a Credit Card

Using a Cosigner

Another possibility if you can’t qualify for a lease is to use a cosigner. If you have a trusted friend or family member with good or excellent credit who is willing to cosign on your auto lease, you may stand a better chance of getting approved.

When you use a cosigner, the potential lessor can use the credit score and profile of both the primary applicant and the cosigner in determining whether to approve the lease.

Making a Large Down Payment

If you’re able to, you might consider making a large down payment as part of your auto lease. While you still may not be approved, providing a large down payment shows the potential lessor that you are serious and committed. Making a large down payment also will lower your required monthly lease payment, which may help you get approved as well.

Tips for Building Your Credit for the Next Lease

If you want to build up your credit to prepare for your next car lease, there are a couple of things you can do:

•   Improve your overall financial situation. For one, you can work on solidifying your finances overall, including by setting up a budget and paying down debt. Remember that owning a car means you have to pay not only for your monthly car payment but also auto-related expenses like repairs, gas, and car insurance.

•   Use credit cards responsibly. Responsibly using credit cards is another way to improve your credit profile. Make sure you’re paying off your monthly statement in full each and every month.

Recommended: Tips for Using a Credit Card Responsibly

The Takeaway

Leasing a car can build credit in much the same way as taking out an auto loan. When you lease a car, it is reported as an installment loan on your credit report. Your payments (either on-time or late) are also reported to the major credit bureaus, and can have a positive or negative impact on your credit score.

If you’re looking to build your credit profile, another path to consider might be a credit card, where you can show you’re responsible by paying off your statement in full, each and every month. One option to look at might be a cash-back rewards credit card like SoFi’s credit card. You can earn unlimited cash-back rewards if you’re approved for a credit card with SoFi. You can apply those rewards as a statement credit, invest them in fractional shares, or put them toward other financial goals, like paying down eligible SoFi debt.

Apply for a SoFi credit card today!

FAQ

Does leasing affect your credit score?

Yes, leasing can affect your credit score, since activity is usually reported to the major credit bureaus in a very similar way to an auto loan. A lease will be reported as an installment loan, and your payment history will be included on your credit report. That means that regular and on-time payments can help improve your credit score, while late payments or delinquencies can hurt your credit score.

Can I lease a car with a low credit score?

Generally, potential lessors are looking for lessees with good or excellent credit. There are a variety of reasons for this, including a higher rate of delinquencies or car repossessions associated with less favorable credit. If you have a low credit score, you may not be able to qualify for a lease and may need to consider alternatives.

What is the minimum credit score I can lease a car with?

The exact minimum credit score that you’ll need to lease a car will depend on a variety of different factors. These include the specific lessor you’re working with, the car you’re considering leasing, and your overall financial situation. Many lessors are looking for people with good or excellent credit. If your credit is below that, you may not be able to qualify for a lease.

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Photo credit: iStock/EmirMemedovski

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.

The SoFi Credit Card is issued by SoFi Bank, N.A. pursuant to license by Mastercard® International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi cardholders earn 2% unlimited cash back rewards when redeemed to save, invest, a statement credit, or pay down eligible SoFi debt.

¹See Rewards Details at SoFi.com/card/rewards.

Members earn 2 rewards points for every dollar spent on purchases. No rewards points will be earned with respect to reversed transactions, returned purchases, or other similar transactions. When you elect to redeem rewards points into your SoFi Checking or Savings account, SoFi Money® account, SoFi Active Invest account, SoFi Credit Card account, or SoFi Personal, Private Student, or Student Loan Refinance, your rewards points will redeem at a rate of 1 cent per every point. For more details, please visit the Rewards page. Brokerage and Active investing products offered through SoFi Securities LLC, Member FINRA/SIPC. SoFi Securities LLC is an affiliate of SoFi Bank, N.A.

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

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If you’re looking to reduce the amount of income tax you’ll need to pay, there are numerous strategies to consider. Familiar moves include contributing to tax-deferred retirement and health-spending accounts, deducting certain taxes and interest, and making charitable donations. More complex maneuvers include timing investments to offset gains with losses.

Because each person’s situation is unique, be sure to check with your tax accountant to find out how a potential strategy might work for you. Note that some of the strategies included in this guide have income limits.

Keep reading to see how many of these 25 tactics you can implement.

25 Ways to Lower Your Taxable Income

As you look through this list of 25 ideas on how to pay less in taxes, you’ll note that some are broad, advising how to reduce either W-2 taxable income or self-employment income. Meanwhile, others are more targeted — for instance, applying only to the self-employed. Keep track of ideas that pertain to your situation, so you can explore them further.

1. Contribute to a Retirement Account

Many IRA contributions are tax deductible. If you’re covered by a plan at work, you can contribute up to $23,000 to a 401(k) plan in 2024, and an additional $7,500 if you’re over 50. You can also contribute $7,000 to an IRA ($8,000 if you’re over 50), though your deduction may be limited depending on income and other factors.

Self-employed individuals can contribute between 25% and 100% of net earnings from self-employment, up to $69,000 for 2024. Plans available to the self-employed include the Simplified Employee Pension (SEP) plan, solo-401(k), and Savings Incentive Match Plan for Employees (SIMPLE IRA).

2. Open a Health Savings Account

A health savings account (HSA) allows you to deposit money on a pre-tax basis. Contribution limits depend on your health plan, age, and other factors, but most individuals can contribute $4,150 for 2024.

Funds can be used to pay for qualified medical expenses or rolled over year to year. You must have a high deductible health plan (HDHP) to contribute to an HSA.

3. Check for Flexible Spending Accounts at Work

In lieu of an HSA, you can contribute up to $3,200 in pre-tax dollars to a flexible spending account (FSA). FSAs allow people with a health plan at work to deposit money and then use it to pay for qualifying health care costs. Unlike HSAs, FSAs don’t require an HDHP to qualify. The downside: Only a small portion of funds may be rolled over to the following year.

4. Business Tax Deductions

The IRS guidelines around business deductions change frequently, so it’s wise to watch out for their announcements throughout the year. Some business expenses apply only to self-employed people.

5. Home Office Deduction

When a self-employed person regularly uses a specific area of their home for business purposes, they may qualify to deduct costs associated with that part of the house. The home office deduction can be calculated in two ways (regular or simplified) up to the current gross income limitation. For more information, search for “IRS publication 587.”


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6. Rent Out Your Home for Business Meetings

If you’re self-employed, you can also rent out your home for business events and meetings, collect the income — and not have to pay income taxes on that rental income. To learn specifics, visit https://www.irs.gov/pub/irs-drop/rp-13-13.pdf.

7. Write Off Business Travel Expenses

Travel expenses, as defined by the IRS, are the “ordinary and necessary expenses of traveling away from home for your business, profession, or job. You can’t deduct expenses that are lavish or extravagant, or that are for personal purposes.” For IRS guidance for both W-2 employees and the self-employed, go to https://www.irs.gov/taxtopics/tc511.

8. Deduct Half of Your Self-Employment Taxes

When calculating your adjusted gross income (AGI) as a self-employed person, using Form 1040 or Form 1040-SR, you can deduct half the amount of your self-employment tax. The 2024 self-employment tax rate is 12.4% for Social Security and 2.9% for Medicare, based on your net earnings.

9. Get a Credit for Higher Education

This tax credit can go up to $2,500 based on tuition costs along with what you paid in certain fees and for course materials. As a first step, income tax owed is reduced dollar for dollar up to your limit. Then, if your tax credit is more than what you owe, you may be able to get up to $1,000 in a refund.

10. Itemize State Sales Tax

Currently, you can deduct a total of $10,000 for itemized state and local income taxes, sales taxes, and property taxes when you use Form 1040 or 1040-SR. If married but filing separately, the total is $5,000 per person. The IRS provides a calculator that you can use to figure out your deduction at https://apps.irs.gov/app/stdc/.

11. Make Charitable Donations

A taxpayer can typically deduct up to 60% of their AGI to qualified charities. But starting with contributions made in 2020, the IRS implemented a temporary suspension on limits. This means that a person can make qualified charitable contributions up to 100% of their AGI.

12. Adjust Your Basis for Capital Gains Tax

If you sell an asset, including but not limited to investments, a capital gains tax is levied on the difference between the purchase price and what it sells for. The adjusted basis also takes into account the costs of capital improvements made, minus decreases such as casualty losses. For more on the topic when selling a home, search for “IRS publication 523.”

Recommended: Should I Sell My House Now or Wait?

13. Avoid Capital Gains Tax by Donating Stock

You may be able to avoid paying capital gains tax if you transfer the ownership of your appreciated stock (held for more than one year). This is something that needs to be handled in exactly the right way; your tax accountant can help.

14. Invest in Qualified Opportunity Funds

If you invest in property through a Qualified Opportunity Fund, the IRS states that you can temporarily defer paying taxes on the gains. Taxes can be deferred (not reduced or canceled) up until December 31, 2026, or until an inclusion event occurs earlier than that date. This is a complex strategy and, again, you may want to get professional advice.

15. Claim Deductions for Military Members

You may be able to deduct moving expenses if you’re a member of the military on active duty who relocated because of a military order and permanent change of location. In this case, you can potentially deduct your unreimbursed moving expenses as well as those for your spouse and dependents. You can calculate relevant expenses on “IRS form 3903, Moving Expenses.”

16. Enroll in an Employee Stock Purchasing Program

In an employee stock purchase plan (ESPP), an employee who works at a company that offers this program can buy company stock at a discount. The company takes out money through payroll deductions and, on the designated purchase date, buys stock for participating employees. Note that only qualified plans have potential tax benefits.

17. Deduct the Student Loan Interest You’ve Paid

You may qualify to deduct student loan interest. Annual deduction amounts are the lesser between the amount of interest paid and $2,500. This deduction is lowered and eliminated when your modified adjusted gross income (MAGI) reaches a certain limit based on your filing status.

18. Sell Your Losing Stocks to Claim Capital Loss Carryover

If you sell stock at less than the purchase price, you’ve experienced a capital loss. You can use that loss to offset any capital gains that year. If you’ve lost more than you’ve gained, this can reduce your taxable income, which could reduce what you owe up to $3,000 for individuals and married couples, and $1,500 for someone married who filed separately.

Recommended: Tax Loss Carryforward

19. Deduct Mortgage Interest

You can deduct the money you paid on mortgage interest on the first $750,000 (or $375,000 if married, filing separately) of mortgage debt you owe. Higher limits exist ($1,000,000/$500,000) if the debt was taken on before December 16, 2017.

20. Deduct Medical Expenses

Under certain circumstances, you can deduct medical and dental expenses for yourself, your spouse, and dependents. You’ll need to itemize on your tax return and can only deduct qualifying expenses that exceed 7.5% of your AGI.

21. Delay IRA Withdrawal Upon Retirement

You can delay IRA withdrawals so that you don’t have more taxable income when you’re a high earner. For example, if you reach the age of 70 ½ in 2022 or later, you can wait until April 1 after you reach the age of 72.

22. Ask Your Employer to Defer Income

You pay income tax in the year the income is received. Although there are reasons why employers typically can’t postpone providing paychecks, they may be able to delay a bonus to the following year as long as this is standard practice for them. If self-employed, you can delay sending your end-of-year invoices to bump December payments to the following calendar year.

23. Open a 529 Plan for Education

A 529 plan allows you to save for future educational expenses. Although the contributions themselves aren’t deductible, interest that accrues in the account is tax-free, federally, as well as being tax-free in many states. In other words, when the money is withdrawn to pay college expenses, it is not taxed.

24. Buy Tax-Exempt Bonds

Interest you receive on muni bonds, for example, is not federally taxed (although there may be state and/or local taxes). These are typically very safe investments, although the interest rates may not be what you want.

25. Time Your Investment Gains or Losses

Known as tax loss harvesting, this strategy takes planning because you’ll want to ensure that any investment gains can be offset, as much as possible, by tax losses. So you may decide, as just one example, to hold on to a stock that’s lost significant value — selling it at a time when it can offset a stock sale with a sizable gain.


💡 Quick Tip: Income, expenses, and life circumstances can change. Consider reviewing your budget a few times a year and making any adjustments if needed.

The Takeaway

High earners looking to reduce taxable income have many avenues to explore — some you’ve likely heard of, with others perhaps new to you. For instance, investors may be able to take advantage of tax loss harvesting, tax loss carryover, or tax efficient investing. Consult your tax accountant about your specific situation. And to take advantage of tax reduction opportunities, it’s important to keep careful track of your financial transactions.

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

See exactly how your money comes and goes at a glance.

FAQ

How can I lower my taxable income?

If you’re wondering how to reduce your taxable income, there are numerous strategies that might work for your situation. A good place to start: Contribute to a retirement account, open a health savings account, and learn which taxes and interest you can deduct. Talk to your tax accountant about specific questions you may have.

What are the tax loopholes for the rich?

If you’re looking to reduce your taxable income, consider making charitable donations and investigating investment strategies that offset gains with losses.

Do 401(k) contributions reduce taxable income?

Said another way, are IRA contributions tax deductible? Retirements typically offer some tax benefits with specifics varying based on the type of retirement account. Traditional IRAs have different rules, for example, than Roth IRAs.

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Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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