What Is Mortgage Principal? How Do You Pay It Off?

What Is Mortgage Principal? How Do You Pay It Off?

Many homebuyers swimming in the pool of new mortgage terminology may wonder how mortgage principal differs from their mortgage payment. Simply put, your mortgage principal is the amount of money you borrowed from your mortgage lender.

Knowing how mortgage principal works and how you can pay it off more quickly than the average homeowner could save you a lot of money over the life of the loan. Here’s how it works and what you need to know about paying off the principal on a mortgage.

Mortgage Principal Definition

Mortgage principal is the original amount that you borrowed to pay for your home. It is not the amount you paid for your home; nor is it the amount of your monthly mortgage payment.

Each month when you make a payment, a portion goes toward the original amount you borrowed, a portion goes toward the interest payment, and some goes into your escrow account, if you have one, to pay for taxes and insurance.

Your mortgage principal balance will change over the life of your loan as you pay it down with your monthly mortgage payment, as well as any extra payments. Your equity will increase while you’re paying down the principal on your mortgage.

Mortgage Principal vs. Mortgage Interest

Your mortgage payment consists of both mortgage principal and interest. Mortgage principal is the amount borrowed. Mortgage interest is the lending charge for borrowing the mortgage principal. Both are included in your monthly mortgage payment, though you likely won’t see a breakdown of how much of your monthly mortgage payment goes to principal vs. interest.

When you start paying down principal, the mortgage amortization schedule will show that most of your payment will go toward interest rather than principal.

Hover your cursor over the amortization chart of this mortgage calculator to get an idea of how a given loan might be amortized over time if no extra payments were made.

Mortgage Principal vs. Total Monthly Payment

Your monthly payment is divided into parts by your mortgage servicer and sent to the correct entities. It includes principal plus interest.

Fees and Expenses Included in the Monthly Payment

Your monthly payment isn’t just made up of principal and interest. Most borrowers are also paying bits of property taxes and homeowners insurance each month, and some pay mortgage insurance. In the industry, this is often referred to as PITI, for principal, interest, taxes, and insurance.

A mortgage statement will break all of this down and show any late fees.

Among the many mortgage questions you might have for a lender, one is whether you’ll need an escrow account for taxes and insurance or whether you can pay those expenses in lump sums on your own when they’re due.

In the world of government home loans, FHA and USDA loans require an escrow account, and lenders usually require one for VA-backed loans.

Conventional mortgages typically require an escrow account if you borrow more than 80% of the property’s value. If you live in a flood zone and are required to have flood insurance, an escrow account may be mandatory.

Does the Monthly Principal Payment Change?

With a fixed-rate mortgage, payments stay the same for the loan term, but the amount that goes to your mortgage principal will change every month. An amortization schedule designates a greater portion of your monthly mortgage payment toward interest in the beginning. Over time, the amount that goes toward your principal will increase and the amount you’re paying toward interest will decrease.

Adjustable-rate mortgages (ARMs) are more complicated. Most are hybrids: They have an initial fixed period that’s followed by an adjustable period. They are also usually based on a 30-year amortization, but most ARM borrowers are interested in the short-term benefit — the initial interest rate discount — not principal reduction.

If you take out an ARM and keep it, you could end up owing more money than you borrowed , even if you make all payments on time.

Understanding mortgages and amortization schedules can be a lot, even for those who aren’t novices.

This Home Loan Help Center offers a wealth of information.

What Happens When Extra Payments Are Made Toward Mortgage Principal?

Making extra payments toward principal will allow you to pay off your mortgage early and will decrease your interest costs, sometimes by an astounding amount.

If you make extra payments, you may want to contact your mortgage servicer or notate the money to make sure it is applied to principal instead of the next month’s payment.

Could you face a prepayment penalty? Conforming mortgages signed on or after Jan. 10, 2014, cannot carry one. Nor can FHA, USDA, or VA loans. If you’re not sure whether your mortgage has a prepayment penalty, check your loan documents or call your lender or mortgage servicer.

Keeping Track of Your Mortgage Principal and Interest

The easiest way to keep track of your mortgage principal and interest is to look at your mortgage statements every month. The mortgage servicer will send you a statement with the amount you paid and how much of your principal was reduced each month. If you have an online account, you can see the numbers there.

How to Pay Off Mortgage Principal

Paying off the mortgage principal is done by making extra payments. Because the amortization schedule is set by the lender, a high percentage of your monthly payment goes toward interest in the early years of your loan.

When you make extra payments or increase the amount you pay each month (even by just a little bit), you’ll start to pay down the principal instead of paying the lender interest.

It pays to thoroughly understand the different types of mortgages that are out there.

And if you’re mortgage hunting, you’ll want to shop for rates and get mortgage pre-approval.

The Takeaway

Knowing exactly how mortgage principal, interest, and amortization schedules work can be a powerful tool that can help you pay off your mortgage principal faster and save you a lot of money on interest in the process.

Ready to dive in on a mortgage loan? You’ll want a competent partner. SoFi is an online mortgage lender that offers competitive fixed rates and a variety of terms. Qualifying first-time homebuyers can put just 3% down.

Find your rate in minutes.

FAQ

What is the mortgage principal amount?

The mortgage principal is the amount you borrow from a mortgage lender that you must pay back. It is not the same as your mortgage payment. Your mortgage payment will include both principal and interest as well as any escrow payments you need to make.

How do you pay off your mortgage principal?

You can pay off your mortgage principal early by paying more than your mortgage payment. Since your mortgage payment is made up of principal and interest, any extra that you pay can be taken directly off the principal. If you never make extra payments, you’ll take the full loan term to pay off your mortgage.

Is it advisable to pay extra principal on a mortgage?

Paying extra on the principal will allow you to build equity, pay off the mortgage faster, and lower your costs on interest. Whether or not you can fit it in your budget or if you believe there is a better use for your money is a personal decision.

What is the difference between mortgage principal and interest?

Mortgage principal is the amount you borrow from a lender; interest is the amount the lender charges you for the principal.

Can the mortgage principal be reduced?

When you make extra payments or pay a lump sum, you can designate the extra amount to be applied to your mortgage principal. This will reduce your mortgage principal and your interest payments over time.


Photo credit: iStock/PeopleImages

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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.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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Earnings Call: Definition, Importance, How to Listen

Understanding what’s going on with stocks can be tricky for both new and seasoned investors. It’s not always clear where you can turn for accurate information that will help with investment decisions.

One of the primary sources of information that investors can use is a company’s earnings reports. But an earnings report doesn’t tell the whole story. Therefore, companies will hold earnings calls to provide context and backstory behind the data in an earnings report to help investors make informed decisions. Here are some things to look out for when you join an earnings call — and ways to use that information.

What Is an Earnings Call?

An earnings call is a conference call between the management of a public company and any interested outside party — usually investors, analysts, and business reporters — to discuss the company’s financial results and future outlook. Earnings calls are generally held quarterly, in the form of a teleconference or webcast; anyone can listen to an earnings call.

The earnings call often comes on the heels of the release of an earnings report and covers a given reporting period, typically a fiscal quarter or fiscal year.

💡 Recommended: How To Know When to Buy, Sell, Or Hold a Stock

The Securities and Exchange Commission (SEC) requires that public companies disclose certain financial information regularly and on an ongoing basis. Companies must file Form 10-Q quarterly reports during the first three fiscal quarters of the year. A 10-Q includes unaudited financial statements and provides the government and investors with a continuing account of the company’s financial position throughout the year.

For the fourth quarter of the year, a company will file a Form 10-K, an annual report that shares audited financial statements, a look at the company’s business overall, and financial conditions over the previous fiscal year.

The financial information on these reports, like earnings per share, is discussed during an earnings call.

💡 Recommended: How to Read Financial Statements: The Basics

What Is the Importance of Earnings Calls?

An earnings call is important because it allows a company’s management to discuss pertinent financial information and a company’s outlook.

Publicly-traded companies are not required to hold earnings calls; they are only required to release the details of their financial performance in a Form 10-Q or Form 10-K. However, most public companies have quarterly conference calls to keep shareholders up to date with the latest financial developments and provide context beyond the earnings data.

Earnings calls are also important for investors, especially those practicing fundamental analysis. These calls help long-term investors decide whether or not to invest in or continue investing in a company. For short-term traders, earnings calls may be helpful to capitalize on short-term volatility in a stock’s price immediately following an earnings call.

💡 Recommended: How to Analyze a Stock

The Structure of an Earnings Call

A company will announce upcoming earnings calls several days or even several weeks before the event. The company will usually issue a press release containing dial-in or webcast access information for stakeholders interested in participating in the call.

Earnings calls are generally scheduled in the morning, before the stock market’s opening bell, or in the afternoon, following the end of the day’s trading. These calls occur shortly after an earnings report is made public.

Safe harbor statement

When the call begins, a company representative will likely share a safe harbor statement, which is a disclaimer about some of the comments executives will make. Specifically, some statements might be “forward-looking” and discuss future revenue, margins, income, expenses, and overall business outlook. Because no company can predict the future, the SEC requires that each warns investors that forward-looking statements may differ from actual results and trends.

Overview of financial results

The earnings call is usually led by the CEO, CFO, or other senior executives. During the call, these executives will deliver prepared statements covering financial results and the company’s performance for the reporting period.

This section of the call allows company leaders to give a more in-depth look at the company from their own eyes beyond the data found in the earnings reports. Executives may discuss market trends or even unpredictable factors that could influence how the company moves forward. Management will also likely share risks and their plans to take them on.

Question and answer session

At the end of the call, there may be a chance for investors and analysts to ask questions about the financial results the company presents. However, not everyone will get to ask a question. The company’s management may answer these questions, or they may decline or defer answering until they have the correct information to make an accurate response.

Preparing for an Earnings Call as a Shareholder

Before listening in on an earnings call, it may help to research the company and its earnings history and listen to previous earnings calls. Here’s additional information to know how to listen to an earnings call.

Where to Find Earnings Call Info?

Companies will send out a press release announcing when they will give an earnings call. Investors can also check the investor relations section of a company’s website for scheduled earnings calls. Additionally, NASDAQ and Yahoo Finance keep calendars of expected upcoming earnings reports and calls investors can check to stay current.

Many companies will post audio from the call on their website, making it available to investors and analysts for a few weeks. Companies also frequently offer transcripts of the call to read. This is especially useful for investors who may have missed an earnings call.

Much of the information discussed in conference calls, including Forms 10-Q and 10-K, are part of the public record and searchable on the SEC’s website. To find a company’s public filings, the SEC has a searchable Electronic Data Gathering, Analysis, and Retrieval system, or EDGAR .

How Long is an Earnings Call?

An earnings call usually lasts for less than an hour. However, there are no requirements for how long an earnings call should be.

What to Listen For

Investors should treat earnings calls as valuable information on a company but know that it doesn’t offer the complete picture of its potential performance.

Some key things investors should listen for in an earnings call are:

•   How the company performed compared to analysts’ expectations

•   What the company attributes its financial performance to

•   Any changes in guidance for the future

•   Any significant challenges or headwinds the company is facing

•   Questions from analysts and how management responds to them

💡 Recommended: The Ultimate List of Financial Ratios

Additionally, it may help to listen to the tone of the company’s executives when they are talking about the company’s performance. It isn’t quantifiable, but learning to pick up on the tone of management’s description of the company’s financials and the answers to analysts’ questions can help investors better understand the outlook for the company.

The Takeaway

Earnings calls provide investors with valuable insights into a company’s financial performance and outlook. These calls, paired with quarterly earnings reports, give investors a thorough understanding of the company, which helps with making investment decisions.

After reading an earnings report and listening to an earnings call, investors wishing to trade stocks online can do so with the SoFi app. With the SoFi Invest®, you can start investing with as little as $5.

Find out how to get started trading stocks with SoFi Invest.


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1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
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For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
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External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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What Is a Merchant Bank Account? How It Works

Guide to Merchant Bank Accounts

If you run a business, you may well need a merchant bank account, which is an account that allows you to make and accept credit cards and other forms of electronic payment. That’s because for those who are merchants today, the once-popular forms of payment, such as cash and checks, are often replaced by newer, seamless options. To keep pace and facilitate your business, you need to adapt and adopt the latest technologies.

But even if you are convinced that you need a merchant bank account, you may wonder:

•   What exactly are merchant bank accounts?

•   How do they work?

•   When and why might you need one?

•   What does an application involve?

This guide will answer these questions and much more.

What Is a Merchant Account?

As the name suggests, a merchant account is a specific type of business account, designed for those who sell products and/or services. This kind of account allows a company to accept credit cards and other forms of electronic payments when a customer is making a purchase. It differs from a basic business account in that the bank gets deeply involved in the payments. In fact, every single dollar that flows through their system on behalf of their client (the merchant) could wind up being charged back, which might mean the bank is responsible for refunds. So as you can see, it’s not at all your usual business account.

Recommended: How to Set Up and Use a Business Bank Account

How Do Merchant Accounts Work?

Let’s take a closer look at how merchant business accounts actually work. If a business wants to accept credit cards, debit cards, and/or electronic forms of payment, they must first apply to open an account with a bank that provides merchant services. When they get accepted by that merchant bank, they can begin their transactions. Among merchant banks, fees for conducting these transactions will vary, so it’s wise to comparison-shop before you decide which financial institution is your first choice.

Here’s a bit more detail on how merchant accounts actually work. Let’s say that Retailer A has chosen a merchant bank, been approved, and now accepts credit and debit cards in their store. When customers at Retailer A’s store use credit cards and other electronic payment forms to make their purchases, the dollar amounts of these purchases are credited to the retailer’s merchant account.

Funds may sit tight for a day or two while processing takes place. Once this is completed, the merchant services provider may place those funds into Retailer A’s bank account, making them available for the retailer to use. Processing fees are usually deducted from the amount deposited, which is how the merchant bank gets paid for their services.

Typically, the bank takes a per-transaction fee and the network processing the payment also gets a cut. A wide range of fees is possible, from 0.5% to 5.0% of the transaction, plus an additional 20 or 30 cents per transaction.

Documents Required for Opening a Merchant Account

If you decide that a merchant account is right for you, you’ll need to apply for one. You may be asked to provide the following pieces of information:

•   A completed application form that includes:

◦   Business name, contact information, and tax ID (EIN)

◦   Bank account information and a voided check to provide the account number and routing number

◦   Estimated monthly processing volume

◦   Authorized signer information

•   Valid IDs, such as a driver’s license and passport for each of the business owners

•   Current utility bill to verify the business address

•   Business banking statements (perhaps three months’ worth)

•   Credit card processing statements (perhaps three months’ worth) if the business has been using another merchant bank

Specifics can vary, so ask the merchant bank of choice what they require.

Merchant Acquiring Bank Services

If you are pursuing a merchant bank account, you are likely to hear the term “merchant acquiring bank,” “acquiring bank,” or “acquirer.” In all these cases, this language refers to the bank that is going to approve your account and handle the payment acceptance and processing. So an acquiring bank (or “acquirer”) is the financial institution that processes a business’s credit and debit card payments. In other words, these are the services being provided by a merchant bank.

How Merchant Transaction Processing Works

Curious about how these merchant bank accounts operate? Here’s a behind-the-scenes look at what happens as transactions are processed, step by step.

1.    The acquirer receives details about credit and debit card transactions from the merchant (Retailer A). This information is then sent to the card issuers—the financial institutions that issue credit cards to consumers — for authorization.

2.    Once that’s received, the credit card processing can continue.

3.    The acquirer will then typically forward funds to the merchant’s (Retailer A’s) business bank account according to the terms of their agreement. In other words, an acquirer facilitates this payment process.

4.   The bank that issued a credit card to a consumer, as part of this process, will add the charges made by an individual to their credit card balance.

Those steps give you an idea of how the process flows for transactions in a merchant bank account.

What Is Underwriting for a Merchant Account?

When you apply to open a merchant bank account, the process is considerably different than opening, say, a business bank account or personal checking account. Underwriting is part of the process. This process occurs when an acquirer reviews the application of a merchant/retailer who wants to accept credit and debit payments and so needs a merchant bank. The underwriter reviews the risks involved if they were to serve as a merchant bank for that retailer (which can involve their being on the hook for refunds for a period of time). They want to delve into your business to know that you are worth their taking on the risk of being your merchant bank. Once they’ve assessed a variety of factors and indicators, they then determines whether or not to approve your application.

Do I Need a Business Bank Account?

If you’re thinking about applying for a merchant bank account, you will also need a business bank account. Here’s why: That’s where the merchant bank can deposit your funds from electronic payments. This holds true even if you are a sole proprietor. In other words, you’ll need a merchant checking account that’s separate from a personal account. Hopefully, that account will grow along with your business’ value.

Ask your bank of choice about opening a business account, including about the documentation you’ll need to give them. Expect to provide them with an employer identification number (EIN).

Do I Need a Business License?

As you consider a merchant bank account, you may wonder if you need a business license, and the answer is usually yes. While there may be exceptions, you will likely need a business license for other reasons on your professional journey. So it can make sense to explore business structure options at your soonest opportunity. You might look into whether your business should be an LLC or if you should becoming incorporated.

If you’re just starting a business, you’ll probably want to delve into such matters as small business startup costs and small business loan fees, as well as debt financing. Educating yourself about the finances of running a business is an important step beyond getting your accounts and payments established.

Accepting Different Types of Payments

Merchant bank accounts are an important partner for businesses today. A key benefit of having a merchant bank account is that it makes it much easier for customers to transact with you, both in person and online. Nowadays, fewer people walk around with cash in their pockets or a checkbook in a wallet or purse. Allowing them to swipe a plastic card or enter their card numbers online can significantly expand the number of people who can shop with your business.

How Long Does It Take to Set Up a Merchant Account?

If you’re wondering how long it takes to set up a merchant bank account, the answer is honestly a not so helpful “It depends.” Situations differ — and so can timelines. That said, if everything on a retailer’s application is complete and acceptable to the merchant bank, the process can be quite fast. You might get up and running in perhaps just a day.

What Is PCI Compliance?

As you embark on your pursuit of a merchant bank account, you will probably encounter the initials PCI. Short for “payment card industry,” PCI compliance is required by credit card companies to ensure that electronic transactions are secure, operationally and technically. PCI standards. There are a variety of standards these businesses must adhere to in order to keep their business safe. If you are operating a business, you will probably see assurances of PCI compliance in your communications with credit card companies, reassuring you that they are following these guidelines.

Other Considerations for Merchant Accounts

Before we wrap up, let’s mention a few other terms and considerations you are likely to learn about as you pursue a merchant bank account. The industry uses the term “payments processor” in more than one way. Here’s a little intel to keep in mind:

•   An issuer processor focuses on helping banks to issue credit and debit cards to consumers and otherwise manage that process.

•   An acquiring processor, however, addresses the issues we’ve discussed above. An acquiring process also deals with customer requests for information about transactions, disputes made about them, and chargebacks.

Knowing the difference between these terms can be helpful as you understand how merchant banks conduct business.

The Takeaway

By exploring the questions “What is a merchant bank account?” and “How do merchant accounts work?” you’ll gain an understanding of what is involved if you are a business owner accepting credit card and online payments. These merchant accounts facilitate the handling and processing of payments so your company can thrive.

But business bank accounts aren’t the only ones to study. If you’re curious about just how good your personal accounts could be, take a look at what online banking with SoFi offers. If you join and set up direct deposit, you’ll earn a terrific APY, plus you’ll have access to your paycheck up to two days early, and you won’t pay any account fees, whether minimum-balance, monthly, or overdraft.

Better banking is here with up to 4.60% APY on SoFi Checking and Savings.

FAQ

Is a merchant account the same as a bank account?

A merchant account is a very specific type of business bank account. It allows a business to accept credit cards and other forms of electronic payments when selling products and services to consumers.

What is a merchant service account?

Merchant service accounts are a specific type of business account. They are used by business owners who want to accept credit cards and other electronic payment forms at their company. Businesses that will only accept cash and checks would not need this type of account.


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How Much Should I Spend On Rent?

The answer to the question, “How much should I spend on rent?” is a highly variable one, but, as a guideline, the number is typically 30% of your income.

Figuring out your “magic number” will require a little thought…and math. Individual situations certainly differ. Maybe you have a heavy monthly student-loan payment while your best friend has none. In other words, they have more disposable income than you and could likely pay a higher rent. Or perhaps you have a trust fund which gives you a degree of financial security but your best friend doesn’t: In this case, you might be comfortable putting more towards rent than your pal.

While 30% is a guideline, most Americans are paying more than that right now. The latest figures say that the typical citizen is paying closer to 32% of their income, or about $1,792 per month. Rents have been climbing, increasing by double digits year over year, so it’s not always possible to stick below that 30% guideline.

Here, we’ll take a look at how to budget for your rent, what a reasonable rent is for your income, and how to figure out different angles on what you can afford to pay for rent.

Budgeting: What Should You Spend on Rent?

Whether you rent or own, housing is typically the largest expense the average U.S. consumer must pay for every month.

Determining how much you pay is really a matter of better monthly budgeting. The question isn’t “How much can I spend on rent?” it’s “How much should I spend on rent?” It’s best not to max out your take-home money on rent and leave some wiggle room in your budget. You can take a look at your income after taxes and other deductions are taken out. Then you might look at what you’re spending now on rent, food, entertainment, transportation, clothes, and other costs. What can you afford to pay in rent that will allow you to live comfortably, do what you like (whether that means eating out often or affording vacations), pay your bills, get rid of any debt, and save some money, too?

No matter which rent formula you choose, it all comes back to your budget.

It’s a lot to figure out (and then to stay on top of) once you set your budget and determine how much to spend on rent.

And if you can reduce your rent payment, you’ll likely have a bit more flexibility in choosing where to allocate your money — whether that’s spending it, paying down debt, or saving for a future goal. Along with reducing small indulgences, sticking to a reasonable rent can be an effective way to free up more cash in your budget.

That’s a tall order in today’s hot housing market, for sure. But it can make a huge difference in terms of your overall financial health and your stress level. Wondering how to make rent every month can be a real source of anxiety. It may be better to, say, ward off “lifestyle creep” and rent a home with one or two fewer perks or amenities to keep the price down.

Recommended: Smart Debt Payoff Strategies

Strategies for Figuring Out How Much to Spend

Next, let’s dig into how to figure out the amount you can spend on rent every month. We mentioned a ballpark figure, but remember: There’s no single magic formula, and everyone’s situation is different.

That said, there are several formulas out there that you can use as a guide. Here are three:

The 30% Rule

We’ve already mentioned this rule of thumb — one that’s been around for decades — which puts the ideal housing costs at 30% of your after-tax income, no matter how much you earn.

That rather broad guideline dates back to the Brooke Amendment, which capped public housing rents at 25% of an individual’s income in 1969. Congress raised the cap to 30% in 1981, and eventually it became the go-to guide for determining “cost burden” — the amount of income a family could spend and still have enough left for other expenses — even those who aren’t in low-income households.

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Critics of this model advise using it as a starting point rather than a rule when determining a spending limit. Depending on how much you earn, 30% of your income could be more — or less — than you actually can afford to pay in rent.

Your location could also influence whether or not the 30% rule is realistic for you, since depending on where you live, accessibility may be a factor. Can a person who makes $40,000 even find a rental for $1,000 a month in most cities? It would likely be a challenge.

And, again, when you’re looking at renting a home, you’ll likely want to weigh what you’ll get vs. what you’ll give up. This isn’t just in money, but in time, safety, and happiness. Is the cool place downtown worth it if you can’t afford to go out and enjoy the nightlife? Is a longer commute or a roommate out of the question, or could those options open doors to your dream home?

Recommended: Price to Rent Ratio in the Top 50 Cities

The 50/30/20 Approach

If you’re a disciplined budgeter, you may already be familiar with this model, which was made popular by Sen. Elizabeth Warren’s book All Your Worth: The Ultimate Lifetime Money Plan.

The 50/30/20 budgeting method suggests dividing your after-tax income into three main categories, putting 50% toward needs (essential costs like housing, transportation, groceries, utilities, etc.), 30% toward wants, and 20% toward savings.

Following those guidelines, your rent would qualify as a need. But it remains up to you to decide how much of that 50% you want to — or feel you have to — spend on housing.

If your home is your castle, and your castle is in a major city or tech hub, it could be a lot. Which means you may have to make adjustments to other “essentials” in your budget or perhaps borrow from other categories (so …maybe fewer massages and dinners out).

The Budget Backwards Formula

Another way to budget is to look at your take-home pay and work backwards, deducting your expenses to see how much of a range you have for rent. Maybe you take home $4,000 a month. From that figure, deduct things like student loans and credit card debt you are paying down. Do you have a high-yield savings account where you are stashing some cash — say, are you putting money towards a vacation or new car fund? Subtract those too.

Then look at your typical monthlies in terms of food, utilities, transportation, gym memberships and subscription services, and the like. Take those off the remaining monthly amount and take a look at what is left. Of that sum, how much can you put towards rent, keeping aside some cash for discretionary spending? Once you know what number suits your finances, you can go hunting for a rental.

The Takeaway

Figuring out how much you can spend on rent involves some basic math. For instance, one common guideline says that 30% of your income (before taxes) can be allotted to rent. But everyone’s financial profile is different. Some people live in cities that are pricey; other people have student and car loans taking a big bite out of their money. Use the guidelines here to figure out the right number for you, and recognize where you may need to compromise. For instance, if you are paying off debts for the next couple of years, maybe it’s a good moment to consider having a roommate. There’s no one-size-fits-all answer.

Flexibility also matters when it comes to your personal banking, and SoFi understands that its clients have different needs. If you’re planning on opening a bank account online, consider our Checking and Savings. You can spend, save, and earn all in one place — complete with mobile transfers, photo check deposit, and customer service. Plus, when you sign up with direct deposit, you will earn a terrific APY and pay zero account fees.

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SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

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How to Invest in Carbon Credits

How to Invest in Carbon Credits

When a company reduces its greenhouse gas emissions, it can earn carbon credits which may then be traded to other companies which need to offset their own emissions. Individuals can invest in the carbon credit market in a few different ways, including direct investment in low-carbon companies, or via exchange-traded funds (ETFs).

The global carbon market is expanding quickly. The carbon commodities market increased from $270 billion to $851 billion between 2020 and 2021. The market is projected to reach $22 trillion by 2050.

Learn more about how to invest in carbon credits, and the pros and cons of this asset class, including portfolio diversification.

What Are Carbon Credits?

Carbon credits are a way of valuing or pricing how much a company is reducing its greenhouse gas emissions. Companies that directly reduce their own greenhouse gas emissions, including carbon (CO2) can earn credits for doing so.

These carbon credits can be valuable to other companies that aren’t able to meet greenhouse gas reduction targets. So they buy carbon credits from the companies that have them. Typically, companies that are in a position to sell carbon credits can make a profit. Each carbon credit represents one metric ton of carbon dioxide emissions. They are traded as transferable certificates or permits until they are actually used by a company and effectively retired.

For investors who are interested in ESG-centered strategies (i.e. companies that follow proactive environmental, social, governance policies) learning how to invest in carbon credits may be compelling.

What Is Cap and Trade?

An important dynamic to understand when deciding how to invest in carbon credits is the worldwide cap-and-trade market. Certain governments have put programs in place that place a limit or cap on the amount of greenhouse gases that companies can emit each year. Caps vary according to industry and company size.

Over time the cap can be reduced to force companies to invest in green technologies and reduce their emissions. Any emissions above the cap must be covered with the purchase of carbon credits (hence the term “cap and trade”), otherwise the company must pay a fine.

If a company is able to reduce their emissions, they can then sell those carbon credits to other companies, and make a profit on them. If they need to emit more than the cap, they buy additional carbon credits. As governments lower emissions caps, demand increases for carbon credits, and their price goes up.

Not every country has a cap-and-trade policy, but they have gained traction in the European Union, certain states in the U.S., the U.K., China, and New Zealand.

How Have Carbon Credits Become a Big Market?

For those interested in investing in carbon credits, consider this: Over one-fifth of global greenhouse gas emissions are now covered by carbon pricing initiatives, and even more are covered by voluntary carbon market purchases. This article focuses on the compliance carbon credit market created by governments, but it’s important to know the distinction between that and the voluntary carbon market.

In the voluntary market, companies choose to purchase carbon offsets as a way to cancel out their emissions. Carbon offset projects include emissions-reduction and removal initiatives such as tree planting and producing renewable energy.

In theory, this system allows certain companies to participate in the global system of reducing harmful emissions like carbon, even if those companies are still striving to attain low-emission goals in their own production or distribution systems. For example, some industries, such as cement and steel manufacturing, are unable to reach net zero emissions, so they can purchase carbon credits to help offset the emissions from their manufacturers.

3 Ways to Start Investing in Carbon Credits

Carbon markets are not as robust in the U.S. as they are in other countries, but this will likely change in the future. For now, there are a few ways investors can get started investing in carbon credits. This could be considered a form of impact investing.

1. Carbon Credit ETFs

An exchange-traded fund (ETF) is a pooled investment fund that tracks the performance of a certain group of underlying assets. There are carbon credit ETFs that track the performance of carbon markets. Some ETFs track a certain group of companies, while others track indices, futures contracts, or other asset groups.

2. Carbon Credit Futures

Another way to consider investing in carbon credits is through carbon credit futures contracts. Futures contracts are derivatives linked to underlying assets. A buyer and seller enter into an agreement to trade a particular asset for a certain price on a certain future date. With carbon credit futures, the underlying asset is the carbon credit certificate.

Carbon credits such as the European Union Allowances and the California Carbon Allowances have futures available on exchanges. However, carbon credit futures are complicated investments so they are only recommended for more experienced investors.

3. Individual Companies

A third way that investors can get involved in carbon markets is by investing in stocks of individual companies that generate or actively trade carbon credits. By investing in those companies investors can indirectly invest in carbon credits.

Other companies are investing significantly in decarbonization and decreasing their own carbon footprint. These are sometimes referred to as green stocks.

Also some companies have a business model focused on investing in carbon projects, so investing in those provides a targeted exposure to carbon credits.

Other Ways to Invest in Carbon Credits

There are also some newer private companies in the carbon credit space to keep an eye on. Although there isn’t a way for a retail investor to invest in private companies, it might be worth tracking these companies as they may go public in the future.

Additionally, new exchanges such as the trading platform LIBER have started offering retail investors exposure to portfolios of curated carbon credits. These credits may be grouped by region or by type, such as forestry or renewable energy projects.

💡 Recommended: 27 Ways to Invest in a Carbon-Free Future

Pros and Cons of Investing in Carbon Credits

While there are several benefits to investing in carbon credits, there are some risks and downsides as well.

Pros

•   Profitability: Investing in carbon credits can be very profitable, and the market is predicted to continue growing in the coming years.

•   Environmental and social benefits: Carbon pricing incentivizes companies to reduce their emissions, and as emissions caps tighten, and the price of carbon credits goes up, it gets more expensive for companies to pollute. By investing in carbon credits, investors can contribute to an emissions-reduction strategy that benefits both people and the environment.

•   Easy to invest: Investing in a carbon credit ETF is just as simple as investing in any other ETF. Investors can gain exposure to carbon markets without directly trading futures or researching individual companies.

•   Low supply and increasing demand: Currently there is a limited supply of carbon credits, and corporate demand for them is increasing. Companies are pre-purchasing them to cover emissions many years out, so their value is increasing.

•   Weak correlation to equity markets: Carbon credits can be a good way to diversify one’s portfolio because they don’t have a strong correlation with the rest of the stock market.

•   Price floor: Certain regions, such as Germany, are considering putting a lower limit on the price of carbon credits. This means their value could only go up from that price floor. California has a minimum carbon price that increases 5% plus inflation every year.

Cons

•   Potential risks: Certain carbon credit ETFs track carbon credit futures, which can be volatile and risky assets. Also, the carbon credit market is relatively new, so there is a limited amount of past performance data to refer to.

•   Narrow exposure: Carbon markets are limited to certain regions and are still a relatively small market, so investing in them doesn’t provide a lot of portfolio diversification.

•   Limited environmental impact: Cap-and-trade policies are designed to limit corporate emissions and reduce them over time, but they are also essentially permits to pollute. Rather than reducing emissions, companies can simply purchase more carbon credits. Therefore, the actual environmental benefit of investing in carbon credits is limited.

•   Not all carbon credits are the same: Some carbon credits are higher quality than others, and various factors go into determining their true value. It’s important to purchase through reputable ETFs or brokers to ensure the credits are legitimate and have value.

Risks and What to Watch For When Trading Carbon Credits

Investing in carbon credits may be profitable, but all commodities markets, including carbon markets, come with some risks investors should be aware of.

Carbon credit futures are speculative and can be very volatile, so ETFs that track them come with associated risks. Additionally, carbon credit ETFs only provide exposure to markets that have cap-and-trade programs, such as Europe and California. Therefore, they don’t provide investors with a broad exposure to carbon markets.

Also, carbon credit schemes are created by governments, and there is a risk at any time that a government could intervene and change the program or reduce the price by increasing the cap.

For this reason, carbon credit ETFs can be a good way to diversify one’s portfolio, but aren’t necessarily a place where investors should allocate a large portion of their money.

Steps to Start Investing in Carbon Credits

As an individual investor the way to invest in carbon credits is through ETFs and other pools. There are a few simple steps to start investing in carbon credits.

Step 1: Open a Trading Account

The first step is to open a brokerage account that offers ETFs. There are easy to use online trading platforms, such as SoFi Invest, where investors can buy ETFs, stocks, and other assets.

Step 2: Research and Decide on a Carbon Credit ETF

There are several different carbon credit ETFs to choose from. The next step is to research and choose one or more ETFs to invest in.

Step 3: Invest

The final step is to invest in the chosen carbon credit ETF using the trading account. Once the purchase has been made, the investor can track the ETF in the same way they would track any other stock or asset in their portfolio. Historically, carbon markets have shown volatility in the short term but have increased over the long term, so investors should keep that in mind when deciding how long to hold onto their investment.

Is Carbon Credit Investing Right for You?

Investing in carbon credits can be a profitable way to get involved in a growing market and support the transition to a low-carbon global economy. Since their launch, carbon credit ETFs have increased in value. However, they do come with risks, and past performance is not a predictor of future performance.

If an investor is looking to diversify their portfolio, allocating a small amount to carbon credit ETFs may be one good option.

The Takeaway

Carbon markets are growing quickly and predicted to be a huge industry in the coming years. There are several ways for retail investors to get involved by investing in carbon credits. Carbon credits are generated by companies that are able to reduce their own greenhouse gas emissions over and above what the company itself may need. This puts the carbon-credit-generating company in a position to sell their carbon credits for a profit, to the companies that need to offset their own emissions.

This system has some pros and cons from an environmental perspective, as well as from an investing perspective. Does trading carbon credits truly reduce global environmental pollution? While that remains open for debate, what does seem clear is that the demand for carbon credits is only growing, which is likewise spurring the growth of some investments, like carbon credit ETFs.

If you’re looking to start building an investment portfolio, one great way is using SoFi Invest®. The online trading platform lets you research, track, buy and sell ETFs, stocks, and other assets right from your phone. You can get started investing with just a few dollars.

Start investing today.

FAQ

How do you make money with carbon credits?

Carbon credits increase in value when demand for them increases and supply decreases. As regulated emissions caps decrease, demand increases, as does price. Investors can make money with carbon credits by purchasing carbon credits and selling them when their market value increases.

How much does it cost to buy a carbon credit?

By investing in carbon credit ETFs, investors can gain exposure to carbon markets with a small amount of capital. The value of an individual credit fluctuates based on various market factors.

How much is an acre of carbon credits worth?

The market price for carbon credits ranges from under $1 to over $150. The per-acre rate that suppliers make depends on the type of land and project as well as the current carbon credit market rate.


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