Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
Another way to invest in real estate is through buying or selling real estate options. With an options contract, a buyer is granted the right to purchase a property for a specific price by a specific date, but they are not obligated to buy it.
In order to purchase this option, the buyer of the contract pays the seller a premium.
This is a flexible and typically less expensive way to enter the real estate market that may also help reduce risks involved in single property investment.
What Are Real Estate Options?
Real estate options are contracts between a potential buyer and seller. They grant the buyer the exclusive right to purchase a particular property within terms set in the contract. But the buyer doesn’t have to purchase the property.
However, if the buyer decides to exercise the option and purchase the property, the seller is obligated to sell the property at the agreed-upon price. Once the agreement is entered into, the property owner can’t sell to anyone else within the time period set in the option.
An options contract for a purchase is also known as a call option, whereas an option to sell would be called a put option.
Generally, real estate options set a particular purchase price and are valid for anywhere from six months to one year. The buyer doesn’t have to purchase the property, but if they want to, the seller is obligated to sell to them even if the market price has gone up.
The buyer pays what is known as a “premium” in options terminology to enter into the contract. If they decide not to buy the property, the property owner (the seller) keeps that premium.
Real estate options are most often used in commercial real estate, but they can be used by retail investors as well. They aren’t sold on exchanges, and each contract is specific for the property it represents. Usually a contract is only for a single property, not multiple properties.
Real estate options are similar to stock options in that they set a specific price, premium, and period of time for a contract related to an underlying asset. Options can be exercised early or at the expiration date. They can also be sold to another investor.
• Most of the benefits involved in real estate options tilt in the buyer’s favor.
• If the property value goes up a few months into the contract, the buyer can exercise the contract and purchase the property, and sell it for a profit.
• If the property value drops, the buyer can simply let the option expire — thus losing only the premium they paid, which is typically a small percentage of the value of the underlying asset or property in this case.
If the buyer decides not to exercise the contract, they can sell it to another buyer at a potentially higher premium (and pocket the difference).
For a seller, there is the potential for them to make a profit if the buyer exercises their option to purchase the property. They may also profit if the buyer doesn’t exercise the option — at which point they can keep the premium amount, and then sell the contract (or the property) to someone else.
💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.
Lease Options
In addition to real estate options for purchases, there are also lease options. These are rent-to-own agreements between a buyer and seller. They let someone lease a property with the option to buy it after a certain amount of time, but not the obligation.
Generally with a lease option, some or all of the rental payment goes towards the purchase. Some lease options lock in a particular price, but others just give the buyer the exclusive right to buy at whatever the market price is.
Although lease options can be great for buyers, they are also more expensive than simply renting a property since they involve a premium. For this reason, it’s important for a buyer to carefully consider the contract and their future plans before entering into a lease option agreement.
2 Advantages of Real Estate Options for Buyers
Options are a common investing strategy for commercial real estate investors. There are several reasons a buyer might enter into a real estate option contract with a seller.
It Can Allow Time for the Buyer to Amass Funds
One might choose a real estate option if they want to secure a piece of land or property at a certain price but they need some time to get funds in order for the purchase.
A Real Estate Option Locks in a Price
If a buyer thinks the price of a property might go up, they can purchase an option to lock in the current market price. However, some real estate options are not completely set in their sale prices. There may be clauses in the contract to determine what the final sale price will actually be.
2 Advantages of Real Estate Options for Investors
Real estate investors can also use options to their advantage.
It’s a Lower-Risk Way to Develop Property
For example, let’s say an investor finds a property they’re interested in developing into housing. The investor needs to create a plan for the property and get other investors involved before they can buy it, so they purchase a real estate option to give them the exclusive right to buy the land.
The investor can make a profit by bringing in investors at a higher rate than the option. They can then buy the land and sell it to the developers they brought in to make a profit.
If they aren’t able to get developers and investors involved before the contract expires then they simply don’t buy the land.
An Investor Can Buy and Sell Real Estate Options
Investors can also make a profit just on buying and selling real estate options contracts rather than the properties themselves. This is a much less capital-intensive way to get involved in real estate investing.
For instance, an investor might find a property they expect will increase in value in the coming months. They purchase a real estate option to buy the land at the current market rate within the next year, pay a premium, and wait.
At any point during the period of the agreement the investor can either act on the contract and buy the property, or they can sell the contract to someone else. Let’s say the value of the property increases three months into the contract. The investor can find another investor who wants to purchase the contract for them for a higher price than the premium the original investor paid.
Whether any investor buys the property or not, the seller of the property keeps the premium.
The Takeaway
Real estate options are a way for investors to get involved in real estate investing without directly buying properties. As with any other kind of options, the investor buys the right to buy or sell at a certain price, but is not obligated to do so.
SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.
With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.
🛈 SoFi does not offer real estate options trading at this time.
Photo credit: iStock/Melpomenem
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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.
Buying a house for the first time is a major life moment, both emotionally and financially. For many people, it’s the biggest investment they will ever make. With the median price of a house hitting $436,800 in 2023 (ka-ching), it’s not a purchase to be made lightly.
If you’re buying your first home, you may expect it to be the same as those quick, fun-and-done experiences portrayed on reality TV shows. In truth, however, it’s a process with a steep learning curve and many moving parts, from figuring out your home-shopping budget to satisfying your final mortgage contingencies. There can be minor hiccups and major missteps along the way.
There are so many things to know as a first-time homebuyer, it’s better to educate yourself in advance rather than learn as you go. To that end, this guide will cover the 10 most common first-time homebuyer mistakes to avoid, including:
• Not knowing how much house you can afford
• Failing to include other factors, like insurance and repairs, in your budget
• Waiving an inspection because you’ve found your dream house
10 Home-Buying Mistakes to Avoid
Home-buying mistakes are easy to make, especially when buying a house for the first time. Review these 10 common first-time homebuyer mistakes before searching for your dream home — so you can ensure you’ll avoid them.
First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.
Why? You may not qualify for a mortgage if your credit score is too low. For most types of mortgage loans, you’ll need a 620, though lenders also consider other factors, like your down payment and your debt-to-income (DTI) ratio. You’ll get better rates if you wait to apply for a mortgage until your score is 740 or above.
The lesson? Don’t let a low credit score rule out buying your first home, but if it’s on the lower side, maybe consider taking some time to build your credit score before shopping for a house.
Before you start looking at listings online or working with a real estate agent — and certainly before you try to get preapproved for a mortgage — calculate how much house you can afford.
Once you know the number, avoid looking at houses above your limit.
So how do you calculate how much house you can afford? There are a few easy methods:
• DTI: Think about your debt-to-income ratio (your debts divided by your gross income). When adding a monthly mortgage payment into your current DTI calculation, the percentage shouldn’t pass 43%. That’s typically the highest ratio mortgage lenders will accept.
• 28/36 rule: With this method, your max mortgage payment should be 28% of your gross income, and your total debts — mortgage and otherwise — should be no more than 36% of your gross income.
• 35/45 rule: Spend no more than 35% of your gross income on debt and no more than 45% of your after-tax income on debt.
• 25% after-tax rule: After adjusting for taxes, your mortgage should not account for more than 25% of your income.
💡 Quick Tip: You deserve a more zen mortgage. SoFi Mortgage Loan Officers are dedicated to closing your loan on time — backed by a $5,000 guarantee offer.‡
3. Putting Too Much or Too Little Down
In their eagerness to become homeowners, many first-time buyers make the mistake of going overboard and directing every bit of money they have to the purchase.
If you have to drain your emergency savings to manage the down payment on a home, you might want to dial down the amount or wait and save up a bit more. Consider what could happen if the home needs a costly repair or, worse, if you or someone in your family suddenly has an expensive medical bill. That’s a good example of when to use an emergency fund.
Conventional wisdom says to put 20% down (and it does help you to avoid paying private mortgage insurance (PMI). But with housing costs so high, that’s all but impossible for most homebuyers. Instead, focus on the minimum down payments required for the type of loan you’re considering:
• Conventional loan: As low as 3%
• FHA loan: As low as 3.5%
• VA loan: As low as 0%
Remember, though, that if you put down very little, you’ll need to borrow more. Your monthly payments will be higher, and you could pay more interest over the life of the loan.
4. Forgetting About Homeowners Insurance and Property Taxes
Your monthly mortgage loan payment is more than just the cost of your home. You’ll also need to cover the cost of homeowners insurance and property taxes, which are often paid into an escrow account. Depending on the type of mortgage and how much you’ve paid, you may also have to pay for PMI. Together, these all increase your monthly payment — sometimes substantially. When you look at a home, the real estate agent should be able to show you property tax history so you can get an idea of what you’d pay each year. You can also work with an insurance agent to simulate insurance quotes for various homes you’re considering.
Property taxes will change from year to year, and you can always change your homeowners insurance to lower the cost, even if you pay for it through the escrow account. It may be a good idea to bundle home and auto policies together to take advantage of a discount.
5. Failing to Budget for Home Repairs and Maintenance
Forgetting to budget for homeowners insurance and property taxes is one of the most common first-time homebuyer mistakes — but those expenses aren’t the only ones people forget to budget for when buying a house for the first time.
If you’ve been accustomed to calling a landlord whenever something breaks in a rental, reset your expectations. Now, you’ll have to take care of basic home maintenance — like replacing air filters, cleaning the gutter, resealing wood decks, and cleaning the chimney — and repairs. When the air conditioner is blowing hot air, the oven stops working, or your roof starts leaking, you’re on the hook for the repairs.
Some issues may be covered by homeowners insurance (but there’s still a deductible!), but other issues caused by general wear and tear are solely your responsibility. And then there are other possible costs, like higher utility bills and homeowners association fees, that can eat into your budget.
6. Not Hiring a Qualified Home Inspector
It may be tempting to waive the home inspection when you’re trying to buy the home of your dreams — especially if you have some stiff competition to be the winning bidder for an in-demand property.
Sorry to say, this is a risky strategy. A home inspection might reveal critical information about the condition of a home and its systems, from electrical problems to hidden mold; from a failing septic system to a leaky roof. What you learn in an inspection could reveal that your dream home is actually a money pit.
What’s more, your inspection report might serve as a useful negotiating tool: You could use it to ask for repairs or to work out a better price from the seller. And if you really aren’t happy with the inspection results, you may be able to use it to cancel the offer to buy.
And in the grand scheme of things, an inspection isn’t too expensive. The average home inspection costs $300 to $500.
7. Overlooking the Neighborhood and Surrounding Area
You may have fallen in love with a specific home, but when you buy a house, you’re also buying the neighborhood that comes with it, so to speak.
How are the surrounding properties maintained? Do the people seem friendly? If you have kids or are planning on having them, do you see other families with young children? How are the schools in the area? What’s the traffic like? How’s the noise level? What restaurants and stores are nearby?
Think about your ideal community — and then try to find a dream home in that type of community.
8. Letting Your Emotions Get the Best of You
Buying your first home or any home thereafter can be a roller coaster, so it’s important to prepare yourself psychologically as well as financially. If you’ve ever talked to someone buying a house, you know there are potential pitfalls all through the purchasing process.
You might fall in love with the perfect house and find it’s way over your budget. You might get annoyed with the sellers or their real estate agent, especially during the negotiation process. You might disagree with your partner about priorities.
All of these scenarios can cause a person to behave emotionally. It might make you want to walk away from a great deal. It might lead you to barrel ahead with a purchase, even when warning lights are flashing.
Our advice to a first-time homebuyer? Recognizing that this will be a challenging and, at times, stressful process (especially because you are new to it), take a deep breath, and proceed calmly. Find tools that help you move ahead with patience and a sense of calm, best as you can. With your eye on the prize — namely, your first home — you’ll get there.
Houses are more than a place to live — they’re an investment. While you certainly want to prioritize buying a home you’ll be happy in, it’s also a good idea to think about how much the property might be worth in five, 10, 15 years and beyond.
It’s impossible to predict the market, but you can feel more confident about strong future resale value by choosing a house with multiple bedrooms and bathrooms, a well-appointed kitchen, and a yard. Other features, like a finished basement or a garage, may also make it easier to sell the home in the future.
10. Not Having an Emergency Fund
One of the basic tenets of personal finance is building an emergency fund. And here’s some blunt advice for first-time homebuyers: You’re going to need an emergency fund.
House emergencies can happen at any time: A tree falls on your roof, a toilet starts to leak, your dog destroys the carpet, you name it. Having money socked away to cover these expenses is crucial when buying a home.
6 Smart Moves for First-Time Homebuyers
We’ve covered some of the most common first-time homebuyer mistakes, so let’s shift gear to smart moves you can make when buying your first home.
1. Get Paperwork Moving ASAP
What do first-time homebuyers need when getting a mortgage? Here are some of the most common docs to start putting together:
• Proof of income: Lenders will often want to see two months’ worth of pay stubs or bank statements that confirm your income. They’ll also want your tax returns from the previous two years.
• Proof of funds: To take you seriously, lenders want to know you have enough money to cover a down payment andclosing costs.
• Proof of identification: This could include a government ID, a passport, or your driver’s license.
Early in the process, you can furnish this basic information to get prequalified at various lenders. They’ll also run a credit check during the prequalification process.
Being prequalified simply allows lenders to give you an idea of what types of mortgages (fixed rate vs. variable rate, 15-year vs. 30-year, etc.) you might get approved for. It’s not a promise of approval, but it does help set expectations as you start to browse listings.
💡 Quick Tip: Your parents or grandparents probably got mortgages for 30 years. But these days, you can get them for 20, 15, or 10 years — and pay less interest over the life of the loan.
2. Check Out First-Time Homebuyer Programs
It’s wise to shop around for a few different mortgage quotes, but it would be a rookie mistake to overlook some great, government-sponsored programs that make buying a house more affordable. These include:
• FHA loans: These mortgages are designed for those with low to moderate incomes. They typically offer low down-payment requirements, low interest rates, and the ability to get approval even if you have a fair credit score.
• USDA loans: These provide affordable mortgages to those with a lower income who are planning on buying a home in a qualifying rural area.
• VA loans: These mortgages help those on active military duty, veterans, and eligible surviving spouses become homeowners. If you can check one of those boxes, you may be eligible for a home loan with no down payment requirement and no PMI.
3. Consider Additional Costs Beyond the Mortgage
As we’ve discussed above, the actual monthly house payment is not your only cost. Your full mortgage payment includes property taxes, homeowners insurance, and, potentially, PMI.
But before you even get to the point of making monthly payments, consider these upfront costs of buying a house:
• Closing costs, which are traditionally paid for by the buyer.
• Home inspections, which we highly recommend.
• Moving costs, whether just renting a truck or hiring movers.
4. Get Preapproved
Mortgage prequalification isn’t a commitment for the lender or buyer — it’s just a first step. If you appear to meet a lender’s standards, you could move on to the preapproval stage.
Getting preapproved for a home loan involves submitting additional income and asset documentation for a more in-depth review of your finances.
Once the lender approves these aspects of your loan application, you’ll receive a conditional commitment for a designated loan amount — called a preapproval letter — and have a better idea of what your loan terms will be.
Mortgage preapproval can help demonstrate to sellers that you’ve completed the first step in getting a mortgage because your credit, income, and assets have already been reviewed by an underwriter. This can smooth the bidding process and could give you an edge over others in a competitive situation with multiple offers.
You may qualify for various types of mortgage loans. Spend some time researching the different types so you have a better understanding of how they’ll impact your payments for the next several decades.
For instance, you’ll want to know the difference between a fixed-rate mortgage and an adjustable-rate mortgage (ARM). You’ll also want to understand how a 15-year term affects your monthly payments when compared to a 30-year term — but also how a longer term increases the amount you’ll pay in interest.
Finally, remember that you don’t have to go with the first mortgage offer you get. It’s worth your while to get multiple offers so you can compare interest rates, down payment requirements, terms, and more.
The Takeaway
Buying a house for the first time can be a stressful experience, but remember: At the end of it all, you’ll have a place you can call yours. You’ll build equity over time, and the house may increase in value. Just make sure you research the most common first-time homebuyer mistakes so you know how to avoid them.
Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.
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FAQ
What are some common mistakes first-time homebuyers make?
Some common home-buying mistakes for first-time homebuyers include forgetting to check (and improve) their credit, not calculating how much home they can actually afford, and forgetting to consider additional expenses, like inspections, homeowners insurance, property taxes, closing costs, and increased utilities. First-timers may also forget to consider the neighborhood as a whole or the future resale of the home.
What are the two largest obstacles for first-time homebuyers?
Two large obstacles for first-time homebuyers include rising housing prices and credit score requirements. Those who don’t already have equity in a current home may have more trouble coming up with a down payment on a new home. First-time homebuyers may also lack the credit score needed to get the best possible rate on a new mortgage.
What are three common mortgage mistakes?
Three common mortgage mistakes are 1) buying up to the limit you’re approved for rather than calculating how much you’re comfortable paying; 2) skipping the home inspection to expedite the process or make your offer more appealing to buyers; and 3) not considering related expenses you’ll have to budget for, including homeowners insurance, property taxes, and repairs and maintenance.
What are the most common mistakes that homebuyers make?
Homebuyers make a number of common mistakes, such as making an unnecessarily large down payment, forgetting to budget for related costs, buying more house than they can afford, and not shopping around for the best mortgage loans.
Photo credit: iStock/Drazen Zigic
*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.
‡SoFi On-Time Close Guarantee: If all conditions of the Guarantee are met, and your loan does not close on or before the closing date on your purchase contract accepted by SoFi, and the delay is due to SoFi, SoFi will give you a credit toward closing costs or additional expenses caused by the delay in closing of up to $10,000.^ The following terms and conditions apply. This Guarantee is available only for loan applications submitted after 04/01/2024. Please discuss terms of this Guarantee with your loan officer. The mortgage must be a purchase transaction that is approved and funded by SoFi. This Guarantee does not apply to loans to purchase bank-owned properties or short-sale transactions. To qualify for the Guarantee, you must: (1) Sign up for access to SoFi’s online portal and upload all requested documents, (2) Submit documents requested by SoFi within 5 business days of the initial request and all additional doc requests within 2 business days (3) Submit an executed purchase contract on an eligible property with the closing date at least 25 calendar days from the receipt of executed Intent to Proceed and receipt of credit card deposit for an appraisal (30 days for VA loans; 40 days for Jumbo loans), (4) Lock your loan rate and satisfy all loan requirements and conditions at least 5 business days prior to your closing date as confirmed with your loan officer, and (5) Pay for and schedule an appraisal within 48 hours of the appraiser first contacting you by phone or email. This Guarantee will not be paid if any delays to closing are attributable to: a) the borrower(s), a third party, the seller or any other factors outside of SoFi control; b) if the information provided by the borrower(s) on the loan application could not be verified or was inaccurate or insufficient; c) attempting to fulfill federal/state regulatory requirements and/or agency guidelines; d) or the closing date is missed due to acts of God outside the control of SoFi. SoFi may change or terminate this offer at any time without notice to you. *To redeem the Guarantee if conditions met, see documentation provided by loan officer. 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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SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
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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.
If you have multiple loans or credit cards with high interest rates, you might feel like you are continually paying interest and not making much headway on the principal of the debt. By consolidating those debts into one loan — ideally with a lower interest rate — you may be able to reduce your monthly payments or save on interest. Using a personal loan to consolidate debt can be one way to accomplish this goal.
This guide tells you everything you need to know about how loan consolidation works, what types of loans benefit from consolidation, and when to start the consolidation process.
• Loan consolidation is the process of combining multiple debts into one, usually using a new loan or line of credit to pay off existing debts.
• Types of loan consolidation include student loan consolidation, credit card consolidation, and general loan consolidation.
• Loan consolidation can help simplify finances, lower interest rates, and shorten the time until debt is paid off.
• Downsides to loan consolidation include potentially high interest rates, fees, and the possibility of adding to debt if credit cards are used again.
• Using a personal loan for loan consolidation can be a financially savvy move if you have a good credit history and score.
What Is Loan Consolidation?
Loan consolidation, at its most basic, is the process of combining multiple debts into one. Usually, this means using a new loan or line of credit to pay off your existing debts, consolidating multiple payments into one.
For example, imagine you have the following debt:
• $5,000 on a private student loan
• $10,000 in credit card debt on Card A
• $10,000 in credit card debt on Card B
Your private student loan may have a high interest rate, and your credit card interest rates probably aren’t much better. Each month you’re making three different payments on your various debts. You’re also continuing to rack up interest on each of the debts.
When you took out those loans, maybe you were earning less and living on ramen you bought on credit. But now you have a steady job and a good credit score. Your new financial reality means that you may qualify for a better interest rate or more favorable terms on a new loan.
A personal loan, sometimes called a debt consolidation loan, is one way to help you pay off the $25,000 you currently owe on your private student loan and credit cards in a financially beneficial way.
Using a debt consolidation loan to pay off the three debts effectively condenses those debts into one single debt of $25,000. This avoids the headache of multiple payments with, ideally, a lower interest rate or more favorable repayment terms.
There are different types of loan consolidation. Which one is right for you depends on your financial circumstances and needs.
Student Loan Consolidation
If you have more than one federal student loan, the government offers Direct Consolidation Loans for eligible borrowers. This program essentially rolls multiple federal student loans into one. However, because the new interest rate is the weighted average of all your loans combined, it might be slightly higher than your current interest rate.
You may also be able to consolidate your student loans with a personal loan. If you’re in a healthy financial position with a good credit score and a strong income (among other factors), a personal loan might give you more favorable repayment terms, including a lower interest rate or a shorter repayment period.
Consolidating federal student loans may not be right for every borrower. There are some circumstances in which consolidating some types of federal student loans may lead to a loss of benefits tied to those loans. By the way, you don’t have to consolidate all eligible federal loans when applying for a Direct Consolidation Loan.
Credit Card Consolidation Loan
If you’re carrying balances on multiple credit cards with varying interest rates — and those interest rates are fairly high — a credit card consolidation loan is one way to better manage that debt.
Credit card loan consolidation is the process of paying off credit card debt with either a new, lower interest credit card or a personal loan that has better repayment terms or a lower interest rate than the credit cards. Choosing to consolidate with a personal loan instead of another credit card means potential balance transfer fees won’t add to your debt.
General Loan Consolidation
Let’s say you have multiple debts from various lenders: some credit card debt, some private student loan debt, and maybe a personal loan. You may be able to combine these debts into a single payment. In this case, using a personal loan to consolidate those debts would mean you would no longer have to deal with multiple monthly payments to multiple lenders.
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Why Consider Loan Consolidation?
There are many reasons to consider loan consolidation, but here are some of the most common:
• You’re a minimalist. Did you join in the “pandemic purge”? If your home looks less cluttered and you’d like your finances to match, you might be thinking about financial decluttering by consolidating some of your high-interest debt into one personal loan that has a lower interest rate or terms that work better for your budget.
• Your financial circumstances have improved. Maybe you spent some time living off student loans to finish your degree, and now you’ve started your dream job. You have a steady salary, and you’ve taken control of your finances. Because of your financial growth, you may be able to qualify for lower interest rates than when you first took out your loans. Loan consolidation can reward all that hard work by potentially saving you money on interest payments.
• Your credit card interest rates are super high. If thinking about the interest rate on your current credit cards makes you want to hide under your desk, consolidating those cards with a personal loan may be just what you’re looking for. High interest rates can add up over the time it takes to pay off your credit card. Using a personal loan to consolidate those cards can potentially reduce your interest rate and help you get your debt paid off more quickly.
Are There Downsides to Loan Consolidation?
Using a personal loan to consolidate debt may not be the right move for everyone. Here are some things to think about if you’re considering this financial step.
Potentially High Interest Rate
Not everyone can qualify for a personal loan that offers a lower interest rate than the credit cards you want to pay off. Using a credit card interest calculator will help you compare rates and see if consolidating credit cards with a personal loan is worth it for your financial situation.
Fees May Apply
Looking for a lender that offers personal loans without fees can help you avoid this potential downside. Keep an eye out for application fees, origination fees, and prepayment penalties.
If you choose a secured personal loan, you pledge a particular asset as collateral, which the lender can seize if you don’t pay the loan according to its terms.
Possibility of Adding to Your Debt
The general idea behind consolidating debt is to be able to pay off your debt faster or at a lower interest rate — and then have no debt. However, continuing to use the credit cards or lines of credit that have zero balances after consolidating them into a personal loan will merely lead to increasing your debt load. If you can get to the root of why you have debt it may make it easier to remain debt free.
The Takeaway
Using a personal loan to consolidate debt can be a financial savvy move — especially if you have the credit history and score to qualify for a low interest rate and favorable loan terms. Consolidating multiple credit cards and loans with a single personal loan can help simplify your finances, lower the interest you pay, and shorten the time until you’re debt free.
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Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
The binomial option pricing model is a valuation tool that predicts the price of an asset for selected future points in time then uses an iterative approach to work backwards to determine the present value of options on that underlying asset.
The binomial option pricing model has the benefit of being relatively easy to implement and provides visibility into the linkages between the underlying asset price and the option prices as the expiration date approaches.
What Is the Binomial Option Pricing Model?
The binomial option pricing model is a widely used option pricing formula. There are multiple versions of the model, depending on what assumptions the trader wishes to make and what types of options are to be priced.
Fundamentally, the model involves a three-step process:
1. Generate the binomial price tree for the underlying asset.
2. Calculate the options values based on the asset prices for each final node.
3. Calculate the option value at each preceding node.
The binomial option pricing model assumes two possible outcomes: an up or down change in the stock price. While it’s simple in a one-period approach, the model can quickly turn complex over multiple time frames. However, constructing the pricing tree illustrates how an asset’s price changes from period to period.
Another advantage is that the binomial option pricing model can be used to value American, European, and Bermuda-style options. There are adjustments needed to use the binomial model based on which options are being priced. For this discussion, we will focus on American options only.
Other assumptions in the model discussed herein include that the underlying asset pays no dividends, the interest rate is constant, there are no transaction costs, there are no taxes, and that the risk-free rate is constant.
💡 Quick Tip: If you’re an experienced investor and bullish about a stock, buying call options (rather than the stock itself) can allow you to take the same position, with less cash outlay. It is possible to lose money trading options, if the price moves against you.
How Does the Binomial Model Work?
The binomial option tree is used for finding the current value of an option. This value is equal to the present value of the probability-weighted future payoffs.
Binomial Option Pricing Model Calculations
Let’s dive into calculations for calls and puts. In order to understand how these calculations are made it helps to know the basics of options trading strategies.
Call Options
A call option gives the holder the right but not the obligation to purchase a security at a specific price at a specific time. A call option is in the money when the stock price is above the strike price. A binomial tree’s nodes will value an option at the maximum of zero or its calculated value.
When the underlying asset moves up in price, the call option’s payoff (Cup) is the maximum of zero and the stock price (S) multiplied by the up factor (u) and reduced by the exercise price (Px).
When the underlying asset moves down in price, the call option’s payoff (Cdown) is the maximum of zero and the stock price (S) multiplied by the down factor (d) and reduced by the exercise price (Px).
The binomial model calculates all possible payoffs, based on these calculations. The final outcomes are then discounted back to calculate the present value.
Put Options
Put options give the holder the right but not the obligation to sell a security at a specific price at a specific time. A put option is in the money when the stock price is below the strike price.
When the underlying asset moves up in price, the put option’s payoff (Pup) is the maximum between zero and the exercise price (Px) minus the stock price (S) multiplied by the up factor (u).
When the underlying asset moves down in price, the put option’s payoff (Pdown) is the maximum between zero and the exercise price (Px) minus the stock price (S) multiplied by the down factor (d).
Binomial Model Example
Assumptions
XYZ stock is currently trading at $100 and you wish to calculate the value of a call option with a $105 strike price that will expire in two weeks.
You expect that each week the stock may increase by 10% or decrease by 15%. The risk-free rate is currently 5% and you will be looking for cash settlement rather than delivery of shares. Additionally, XYZ is not expected to pay dividends over the two-week holding period.
You want to view how the option price will move weekly up until expiration and calculate the option value today.
Generate the Binomial Tree
We construct the binomial tree for the prices of XYZ stock.
At the end of one week (1/52 of a year or 0.02 years) the stock will be priced at either $110 or $85.
After two weeks, (0.04 years) the price will increase to $121 if the price moves up twice in a row. The stock price will be $93.50 if the price moves up then down, or down then up. Finally, if the stock moves down twice in a row the stock will drop to $72.25.
Note that we can create a binomial tree for any time period size and include many more steps at the cost of greater complexity in the calculations.
Calculate Final Option Values
Having forecast the stock price two weeks into the future we can calculate the value of the $105 strike price call option at that time.
The call option will only have value if the stock moves up twice in a row. At that time the shares will be worth $121 and the option will be worth $16.
Stock price – Strike price = $121 – $105 = $16
Work Backward to Calculate Present Values
Before we can perform the present value calculations we need to determine the probability that the stock price, and the call option price, will move along the upward path in the binomial tree during each week.
Fortunately we have all the information we need to calculate the probability based on our initial assumptions. The probability for an up move is:
Where:
• t = the time period in years (1 week = 0.02 years)
• r = the risk-free rate (5%)
• u = up factor ($110 / $100 = 1.1)
• D = down factor ($85 / $100 = 0.85)
Substituting into the equation:
Because there are only two paths at each node the the probability of a down move is:
Given the probabilities and the potential option values at the end of week two, we use the present value calculation to determine the option value for the end of week one.
We repeat this process until we arrive at the value of the call option today.
At each step we weigh the final values by their respective probabilities and discount by the risk-free rate using the following equation:
Finally, we arrive at the present value of the call option of $5.82.
Finally, user-friendly options trading is here.*
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Difficult to predict future prices and probabilities
Can be used on American options
Assumes conditions that are not seen in real-world markets
Can be used over multiple periods
Complexity grows as more periods are considered
Binomial Option Pricing Model vs Black-Scholes Model
The Black-Scholes model comes to a deterministic result based on the inputs. Its inputs are option variables such as the strike price, the current stock price, the time to expiration, the risk-free rate, and the volatility. While the binomial model is considered path dependent, the Black-Scholes model is path independent.
Widely used in practice and considered accurate, the Black-Scholes model makes assumptions that sometimes arrive at options prices that are different from those seen in the real world.
The Black-Scholes model is considered the standard when valuing European options since the model does not allow for options to be exercised early.
Binomial Option Pricing Model
Black-Scholes Model
Probabilistic approach
Deterministic approach
Path dependent with two possible outcomes at each node
Usually accurate, but output prices sometimes deviate from those seen in the real world
Helpful for American options
Helpful for European options
Binomial Option Pricing Model vs Monte Carlo Model
The Monte Carlo model runs thousands of computer simulations to arrive at a solution. Monte Carlo simulation often includes an array of possible paths — some that show higher ending prices and others that show lower prices.
The computer simulations are only as good as the assumptions used. Analysts can tailor the inputs. Often, historical data is used in Monte Carlo simulations which may lead to results that aren’t applicable.
Binomial Option Pricing Model
Monte Carlo Model
An iterative approach that is path dependent
Based on computer simulations
Less computer intensive
You can tailor the inputs and scenarios
Uses future assumptions, not historical data
Output only as good as the assumptions used
The Takeaway
The binomial option pricing model is a valuation tool that predicts the price of an asset for selected future points in time then uses an iterative approach to work backwards to determine the present value of options on that underlying asset.
Due to its relative simplicity and speed, traders often prefer it to the Black-Scholes and Monte Carlo models.
SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.
With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.
The binomial options pricing model was first suggested by William Sharpe in 1978, but the model’s development is associated with work done by John Cox, Stephen Ross, and Mark Rubinstein in 1979.
Are the Black-Scholes and binomial option pricing models the same?
No, these are two different models. The Black-Scholes model provides a numerical result based on inputs. The binomial options pricing model prices an asset based on a range of possible results. The binomial model is considered an iterative calculation since there is a range of possible outcomes to value options. The Black Scholes model uses fixed inputs to arrive at an option’s value.
How is the binomial option pricing model different from the Monte Carlo model?
The Monte Carlo model runs thousands of computer simulations to eventually arrive at an options price. The model first generates a random number based on a probability distribution. That number then uses additional option inputs like volatility and time to expiration to generate a stock price. The stock price at expiration is then used to calculate the value of the option. The result is only as good as the inputs used.
The model runs that process thousands of times, using different variables from the probability functions. To determine option pricing, the Monte Carlo model uses the average of all the calculated results.
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SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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.
Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
An iron butterfly spread is a type of options trade involving four separate options contracts. It’s a complicated and advanced options trade, meaning that many beginner investors will likely never use it — they may not have even heard of it.
Iron butterfly spreads can be used as a part of a larger options trading strategy, however, so long as investors understand the ins and outs of how it works, and most importantly, the risks involved.
What Is an Iron Butterfly?
An iron butterfly spread, sometimes called an “Iron Fly” or a “Butterfly Spread” is a trade involving four separate options contracts.
As a strategy that earns investors money when stocks or futures prices make moves within a defined range, it’s especially popular with traders who expect a decrease in implied volatility. To succeed with an iron butterfly spread, traders will try to forecast when option prices will likely decline, usually when the broader markets are in a holding pattern, or gradually moving upwards.
How Does an Iron Butterfly Trade Work?
An Iron Butterfly is a four-legged options spread, since an investor buys four options contracts, two calls and two puts. The call options allow the investor to buy a stock at a given price, and the put options allow the investor to sell a stock at a given price.
In the trade, the calls and puts have three strike prices, but the same expiration date.
In a put or call option, the strike price is the price an investor can sell the underlying security when it is exercised. With a call option, the strike price is the price at which the investor can buy the security. With a put, the strike price is the value at which they can sell the security.
The three strike prices consist of one in the middle, called the options straddle, and two other strike prices, called the strangle, positioned above and below that price. As a trade, the Iron Butterfly has the propensity to deliver profits when the option’s underlying stock hits its expiration date at the middle strike price.
For the strategy to work, the call and put options that sit on either side of the target stock price should be far enough apart that they can still make money regardless of the unexpected price movement of the stock between the time when the trade is executed, and the expiration of the options.
As an example, you’re an investor with a sense that a stock would reach $50 in the next month, and that it would be at least within a range of $10 above or below the target price. To make an Iron Butterfly trade, you’d buy a call and a put option with a strike price of $50. Then you’d buy a call option ten dollars higher, followed by a put option ten dollars lower than the target price, or saddle price, of $50.
The theory behind the Iron Butterfly strategy is that there’s a high likelihood that the eventual price of the stock targeted in the strategy will trade within a profitable range by the time the strike price of the options arrives.
Pros and Cons of Iron Butterfly Spreads
There is a limit to the maximum profit that an investor can earn by using the Iron Butterfly. That’s because of the cost of the options they have to buy to make money on their bet, as well as the cost of the options they purchase to protect themselves in the event that their hunch is wrong.
In the strategy, the most money the investor can make becomes possible when the underlying stock reaches the stock price at which they’ve purchased the saddle options. But even in this best-case scenario, at least half of the options expire worthless.
While this limited return may seem like a downside, it also comes with limited risk. As long as the stock rises or falls — at the time of the options’ expiration — between the target price and the strike prices of the outlying call and put options, then the trade will not lose money. But the closer it is to the target price, the more money it will make.
The biggest risk in an Iron Butterfly strategy is that the stock trades outside of the strangle, making all of the options worthless.
The investor will have at least one option that is in the money, and possibly two options that are in the money, when the options expire. They will exercise those options, and make money on the trade.
Traders realize that it’s unrealistic that any given trade will reach its expiration date exactly at the strike price, or straddle price, that they choose. But with a smart spread on the outer range of the call and put options in the trade, the strategy can deliver returns on the capital put at risk that are consistently in the 15-20% range.
What Is the Difference Between Iron Condor and Iron Butterfly?
An Iron Butterfly is similar to another option strategy known as an Iron Condor. The strategies differ in terms of their strike prices and premiums. In an Iron Condor the strike prices are different and in an Iron Butterfly they’re the same. The premiums are higher in an Iron Butterfly than an Iron Condor.
💡 Quick Tip: In order to profit from purchasing a stock, the price has to rise. But an options account offers more flexibility, and an options trader might gain if the price rises or falls. This is a high-risk strategy, and investors can lose money if the trade moves in the wrong direction.
The Takeaway
The Iron Butterfly is a trading strategy that investors use when they believe that a stock price will trade within a specific range. Rather than buying the stock itself, an Iron Butterfly involves purchasing four options based on the investor’s price prediction for a certain security.
Again, trading options is an advanced investment strategy that requires a good amount of background knowledge and market experience. It may not be a good idea for beginning investors to wade into options, or advanced moves like the Iron Butterfly. However, speaking with a financial professional may help get you prepared for trading options.
SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.
With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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