Dec
13
2024
Payday Loan vs. Installment Loan: What Are the Main Differences?

Payday Loan vs. Installment Loan: Which Is Right for You?

By | Financial Independence, personal_loan, Terminology | Comments Off on Payday Loan vs. Installment Loan: Which Is Right for You?

If you need cash to cover an emergency expense, like a car repair or medical bill, a payday loan or an installment loan are two options you may consider. However, these two loans are different in key ways that are important to understand before making a choice between them. Namely, a payday loan tends to have a short turnaround before you need to pay it off, and typically offers extremely high interest rates.

We’ll explain more about the features of each loan type, and why people choose payday loans vs installment loans.

Key Points

•   Installment loans provide a lump sum upfront, repaid in fixed payments over time, and can be secured or unsecured.

•   Payday loans are short-term, high-fee loans due on the next payday, often leading to debt cycles.

•   Personal loans, a type of installment loan, offer lower rates than payday loans and can be used for various purposes.

•   Eligibility for installment loans depends on credit score, income, and other factors, while payday loans require minimal qualifications.

•   Payday loans are considered predatory due to high fees, whereas installment loans offer more favorable terms if eligibility requirements are met.

Understanding Payday Loans

There is no set definition of a payday loan. Generally speaking, they are short-term loans that are due to be paid back on your next payday. Payday loans don’t charge interest per se, but they do charge high fees.

Payday loans are typically for relatively small amounts. In fact, many states limit the amount of a payday loan to $500. Borrowers usually repay the loan in a lump sum on their next payday. The specific due date is often between two and four weeks from when the loan was made.

To repay the loan, borrowers must make out a post-dated check to the lender for the full balance of the loan plus any fees. As an alternative, borrowers can give permission for the lender to electronically debit the funds from their bank account on a certain date. If the borrower doesn’t repay the loan by the due date, the lender can cash the check or debit the funds. Either way, the lender gets paid.

In some states, borrowers may be able to roll over the amount of the loan, paying only the fees when it comes due, while the lender pushes out the due date.

To qualify for a payday loan, you generally need to be 18 years or older and have proof of income, a valid ID, and an active bank, credit union, or prepaid card account.

Risks of a Payday Loan

The risks of payday loans include sky-high fees and the potential for falling into a cycle of debt. Many states set a limit on payday loan fees, but they can still run from $10 to $30 for every $100 borrowed. Consider that a $15 fee for $100 is the equivalent of a nearly 400% APR.

By comparison, the average personal loan interest rate as of December 2024 is 12.33%, according to the Federal Reserve of St. Louis.

Pros and Cons of Payday Loans

Before signing on for a payday loan, carefully consider the advantages and disadvantages.

Pros of Payday Loans

 Cons of Payday Loans
Provide quick access to cash, often with same-day turnarounds. Very expensive, with fees equivalent to a 400% APR.
No credit check required. To qualify, you typically need to be 18 years old, have a government I.D., bank account, and regular source of income. Lenders don’t consider your ability to repay the loan, and the loan doesn’t help you build credit. As a result, these lenders are considered “predatory.”
Unsecured: Borrowers are not required to put up property as collateral. Borrowers can get trapped in a cycle of debt. If they are unable to pay back the loan, borrowers will pay expensive fees each time they roll over or renew their loan.

Exploring Installment Loans

When a borrower receives an installment loan, their lender will give them a lump sum upfront, which the borrower has to repay in fixed payments with interest over a set period of time.

Personal loans are a good example of an installment loan.

They can range in size from a few hundred dollars to $100,000, and the money can be used for any reason, from covering unexpected expenses or consolidating debt to remodeling a home. Repayment terms may stretch from a few months to a few years.

How Installment Loans Work

During the loan application process, lenders will consider factors such as a borrower’s credit score and reports, their income, and the amount and length of the loan.

Typically, borrowers with good credit scores will receive the best terms and interest rate options. These loans may have variable interest rates or fixed, meaning they don’t change over the life of the loan.

Installment loans may be secured or unsecured. Unsecured loans, such as unsecured personal loans, do not use collateral to back the loans. Secured loans do require collateral and may offer borrowers a lower interest rate since they present less risk to the lender.

Pros and Cons of Installment Loans

Personal installment loans tend to offer borrowers the option of borrowing at lower rates than are available through revolving credit or payday loans. However, it’s still important to consider disadvantages in addition to benefits.

Pros of Installment Loans

 Cons of Installment Loans
Borrowers can finance a big purchase over 2-12 years. Interest rates may be higher than other alternatives, such as a home equity line of credit.
Payments typically remain fixed over the life of the loan, unless the borrower chooses a variable interest rate. May be subject to fees, such as closing costs.
Secured loans don’t require collateral, while unsecured loans may offer lower interest rates. Missed payments can damage credit scores. Defaulted loans may be sent to collections.

Pros and Cons of Installment Loans

Eligibility requirements vary by lender, but generally speaking, you’ll need:

•   Proof of identity

•   Proof of income

•   Proof of address

Your credit score is an important factor, as it helps determine the interest rate you’re offered.

Key Differences Between Payday Loans and Installment Loans

By now you’ve likely got a good sense that installment loans and payday loans differ in some important ways. Here’s a side-by-side comparison.

Payday Loans

 Installment Loans
Repayment terms Payment is due on the borrower’s next payday, usually two to four weeks from the date the loan was taken out. Loan is repaid in regular installments, often monthly, typically over 2 to 7 years. Large personal loans can be repaid over 12 years.
Loan amounts Often limited to $500. Can range between a few hundred dollars and $100,000.
Interest rates Payday loans don’t charge interest, but they do charge costly fees that can be the equivalent of up to 400% APR. Interest rates vary, depending on a borrower’s credit history, among other factors. The average personal loan interest rate is 12.33%.
Use cases Payday loans are typically targeted to borrowers with poor credit and few other lending options. Loan money can be used for any reason. Some installment loans, such as auto loans or mortgages, are limited in how they can be used. Personal loans can be used for any purpose.
Risk Payday loans are predatory loans that can trap borrowers in a cycle of debt. Lenders don’t consider a borrower’s ability to repay the loan, and the loan won’t help build credit. Failure to repay an installment loan on time can damage credit. Defaulting on secured loans may result in loss of property.
Credit requirement None. The application process for installment loans requires a credit check.

Choosing the Right Loan for Your Needs

As you can see, there are important differences between payday and installment loans. Not sure which sort of loan is right for you? A good place to start is to determine what your short- and long-term financial goals are and which type of loan best aligns with them. Interest rates, terms, fees, and repayment options are all factors to consider.

You’ll also want to assess your repayment capabilities. Can your income cover your normal expenses plus the loan debt? Finally, check your credit score and the eligibility requirements of potential lenders to see where your application is more likely to be approved.

The Takeaway

Payday loans and installment loans both provide quick cash to cover emergency expenses. However, because of their astronomical fees — equivalent to a 400% APR — payday loans fall under the heading of “predatory lending.” On the other hand, installment loans vary in their terms but generally are a much better deal, provided that you meet eligibility requirements.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.


SoFi’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.

FAQ

Are payday loans installment loans?

No, payday loans usually require you to pay off the loan amount in full on your next payday, usually two to four weeks from when the loan was made.

What is an installment loan?

When you take out an installment loan, you immediately receive the money you’re borrowing. You then pay it back to your lender in a series of regular fixed payments known as installments.

Are personal loans installment loans?

Personal loans are one type of installment loan. Money from the loan can be used for any purpose, such as debt consolidation or a home remodel.

Photo credit: iStock/Prostock-Studio
SoFi Loan Products
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.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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.

SOPL-Q424-052

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Dec
11
2024
Guide to Reopening a Closed Bank Account

Guide to Reopening a Closed Bank Account

By | Budgeting & Goals, Financial Independence, money | Comments Off on Guide to Reopening a Closed Bank Account

You can sometimes reopen a closed bank account depending on the bank’s policies and the reasons for the closure. Accounts that you closed or that were closed due to inactive status tend to be easier to reopen than those that were terminated due to problems like frequent overdrafts. This guide will help you navigate having a closed bank account that you’d like to reopen.

Key Points

•   Bank accounts can be closed by the owner or the bank for various reasons, including dissatisfaction, relocation, or financial issues.

•   Closed accounts might be reopened depending on the bank’s policies and the reasons for closure.

•   Dormant accounts require reactivation, which can often be resolved by making a transaction.

•   Accounts closed due to excessive overdrafts may be reopened after settling outstanding balances.

•   Fraudulent activities leading to account closure generally prevent reopening with the same bank.

Why Might You Need to Close a Bank Account?

Account holders may decide to close a bank account for a variety of reasons, including the following:

•   No longer needing the account

•   Moving to a new location

•   Lack of convenience

•   Dissatisfaction with the account

•   Issues meeting minimum requirements

Here’s more about each.

No Longer Needing the Account

Sometimes, you simply might not need a bank account anymore. For example, if you’d set up a separate savings account to save enough money for a down payment on a house or for a vacation, after you’ve accomplished those goals, you might decide that you don’t need multiple bank accounts anymore.

Moving to a New Location

If you’re moving to a new community that doesn’t have a branch of your financial institution nearby, you may decide to close your bank account and open a new one that’s more readily accessible in your new town. Moving doesn’t create a problem when someone banks solely online, but it can lead someone to switch banks if they prefer in-person options.

Lack of Convenience

Another potential reason someone might switch banks is due to a lack of convenience, such as a bank’s hours being incompatible with their schedule or the bank not having a widespread enough network of ATMs so they wind up paying many ATM fees. When banking becomes inconvenient through a certain financial institution, that could spur someone to seek a more practical solution.

Dissatisfaction With the Account

Whether it’s poor customer service, a lack of desired services, or fees that are too high, customers sometimes close their accounts and go elsewhere because they aren’t satisfied with their current financial institution. If, for instance, you see an offer for a savings account that earns more interest and charges lower fees, you might decide to make a switch.

Issues Meeting Minimum Requirements

If a bank requires you to maintain a certain balance to keep the account open or to avoid hefty fees, an account holder may opt to close the account if they’re struggling to meet those requirements. By closing a savings account with a minimum balance that’s just out of reach, for instance, someone could avoid incurring fees each month when they don’t make the minimum balance requirement.

Is It Bad When a Bank Closes Your Account?

Whether it’s bad when a bank closes your account depends on why the bank closed it — and situations can vary. According to the governmental agency, the Office of the Comptroller of the Currency , banks typically can close accounts for nearly any reason without providing notice.

That being said, common reasons why a bank may close an account can include:

•   Low or no activity: Banks may place an account in a dormant status after a certain period elapses with no transactions. With a dormant account, it’s not technically closed, but the account owner is no longer able to make transactions. How long it might take for an account to go dormant depends on both state laws and a particular bank’s policies.

   After an account has been dormant for a period of time, a traditional or online bank may close the account and, if you can’t be reached, forward the funds to the proper state government, labeling them as “unclaimed property.” At this point, you’d need to submit a claim to your state’s treasury office to obtain that money.

   Recommended: How to Find a Lost Bank Account

•   Suspicious activity: A bank will close an account if it has proven the account to be involved in fraudulent activity. When the bank initially suspects fraudulent behavior (whether the account holder was the perpetrator or the victim), the bank will likely freeze the account to investigate. Red flags can include large transactions, frequent account activity (especially if that activity is new or different), and transfers to overseas accounts.

•   Excessive overdrafts: If an account holder regularly spends more from an account than what’s available, this leads to negative balances and bounced checks. A bank can charge overdraft fees and require that the account holder bring in sufficient funds to return the account back to the minimum balance required. If that happens frequently or if funds are not restored, however, the bank may close the account.

Worth noting: If your bank account is closed due to a negative balance or suspicion of fraudulent activity, this may make it difficult for you to open a new bank account. Those issues will be on your record with ChexSystems, an industry reporting agency. You might need to explore what are known as second chance checking accounts in order to open a bank account again.

Get up to $300 when you bank with SoFi.

No account or overdraft fees. No minimum balance.

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Do You Get Your Money If a Bank Closes Your Account?

By law, a bank must refund to you any money in a closed account after subtracting fees that are due. Typically, a check will be sent to the account holder. There is a possibility that the bank might move the money into a different type of account.

If the bank cannot reach you about this matter, your funds could be sent to the state as unclaimed money.

How Long Do Banks Keep Closed Accounts?

For deposit accounts of $100 or more, a bank must retain records for at least five years. However, this doesn’t necessarily mean that you can reopen the account within that time frame.

You’ll learn more about how you might reopen a closed account below.

Can You Reopen a Closed Bank Account?

There isn’t a simple yes/no answer to “Can a closed bank account be reopened?” You may be able to reopen a closed bank account in some situations. It will depend, however, on why the account was closed and your financial institution’s policies.

Usually, it’s a wise move to contact the bank, find out why your account has been closed, and see if it’s possible to use it again. You might be able to reactivate a dormant account simply by making a withdrawal or depositing funds (see below for more details). But if a bank account has been closed due to, say, suspicions of fraud, you may not be able to reinstate it.

Next, you’ll learn the steps involved if you do try to reopen a closed bank account.

How Do You Reopen a Closed Bank Account?

If you’ve closed your account (rather than a bank doing so), you can typically submit a request to reopen, say, your checking account. This can be done online, over the phone, or by visiting a branch in person, with the exact process varying depending on the specific financial institution.

Another option you have in this situation is to simply open a new bank account, whether at your previous financial institution or at another one of your choice. When choosing your account, it’s worth exploring the different types of savings accounts you might consider.

On the other hand, if your bank account gets closed by a bank, whether or not you can reopen it largely depends on the reason for the closure as well as your bank’s policies.

In general, the first step in reinstating a troubled account is to talk to your financial institution about why your account was frozen, put into dormant status, or closed. Ask what you need to do to address the issues. You can also review your account agreement. If you believe that a bank wrongfully closed your account, you can file a written complaint .

Here’s guidance on how to reopen a closed bank account in three scenarios.

Reopening a Dormant/Inactive Account

This is one of the simplest issues to address. If you receive a notification that your account is considered inactive or dormant, contact your bank to find out how to make it active again. The bank may allow you to make a deposit to the old account, or they may have you open a new bank account.

💡 Recommended: What Do You Need to Open a Bank Account?

Reopening an Account After Closure Due to Excessive Overdraft

Financial institutions need to monitor their levels of risk. If they close a bank account for excessive overdrafts, the account holder would likely need to talk to the bank to see if they are willing to reopen the old account or if they’d allow them to open a new one. Different banks will have different policies. You may be required to pay off your negative balance, sometimes within a specified timeframe, before you can reopen your account.

Reopening an Account Closed for Suspicious or Fraudulent Activities

If a bank believes that a customer is engaged in fraudulent behavior (rather than being a victim of it), then it may be difficult to reopen an account or to open a new one with the institution. Contact the financial institution, and be prepared to demonstrate how any activity in your account that appeared suspicious was, in fact, not fraudulent or not your fault.

How to Prevent Bank Account Closures

In order to avoid your bank account being closed, it’s a good idea to:

•   Use it regularly so it doesn’t go dormant.

•   Set up alerts for a low balance. That way, you can remedy a situation which could lead to closure due to your overdrafting.

•   Review communication from your bank. You might get a notice that your account has issues, but if you don’t read it, you can’t take steps to prevent closure.

Recommended: APY Calculator

The Takeaway

Whether or not you can reopen a closed bank account largely depends on why it was closed in the first place. Sometimes, an account holder in good standing decides to close a bank account and later changes their mind. In that case, the financial institution will almost certainly allow them to have an account there again. Other times, the bank closed the account, perhaps because of excessive overdrafts, suspicious activity, or lack of use. In those instances, talk to the financial institution to see what steps you need to take.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.00% APY on SoFi Checking and Savings.

FAQ

Can a bank close your account?

Yes, it can. According to a governmental agency that oversees financial transactions, banks can close accounts for virtually any reason without notice.

Is it bad when a bank closes your account?

Whether it’s bad depends upon the reason why the bank closes your account. Sometimes, a bank account is closed because of inactivity. Other times, it can be a more concerning situation, one that can make it harder to open an account in the future. For instance, the bank may have flagged the account for suspicious or fraudulent activity. Another reason why a bank may close an account is excessive overdrafts.

Can you reopen a closed account?

Whether you can reopen a closed account depends on who closed the account (you or the bank), the reasons why the account was closed, and the bank’s policies. Talk to your financial institution to find out what steps you would need to take in order to reopen your account.

How do I prevent my bank account from being closed?

To prevent your bank account from getting closed, use the account regularly and set up low balance alerts so you can avoid overdrafting. If your account is troubled, talk to your financial institution. Explore what solutions might exist to keep your account open and return it to good standing. It might also be beneficial to brush up on your financial habits and the basics, such as how savings accounts work.

Will a direct deposit reopen a closed account?

No. If an account is closed, the direct deposit funds will have nowhere to be deposited and so the transaction will not go through. To address this situation, talk to your bank about reopening the account and let the payer know that there is an issue with the account tied to your direct deposit.

Photo credit: iStock/Delmaine Donson

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2024 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

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.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

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

This content is provided for informational and educational purposes only and should not be construed as financial advice.

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.

SOBNK-Q424-101

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Dec
07
2024
Refinancing Student Loans Without a Cosigner: Is It Possible?

Refinancing Student Loans Without a Cosigner: A Comprehensive Guide

By | Debt Payoff, Fresh Out of School, Student Loans, student_loan | Comments Off on Refinancing Student Loans Without a Cosigner: A Comprehensive Guide

You may be able to finance student loans without a cosigner as long as you meet specific lender requirements. Refinancing is when a private lender like a bank, credit union, or online lender pays off some or all of your existing student loans and replaces them with a new loan.

A cosigner is an individual with good credit who agrees to repay the loan if you, the primary borrower, cannot. A cosigner may give a student without a strong credit history a better chance of being approved for refinancing and also help them secure a better interest rate on the loan. However, it is possible to refinance loans with no cosigner if you meet certain conditions.

Read on for more information about student loan refinancing without a cosigner and what it involves.

Key Points

•   Refinancing student loans without a cosigner requires a good credit score, a solid credit history, and a stable income.

•   A lower debt-to-income ratio increases the chances of qualifying for student loan refinancing.

•   Refinancing student loans can potentially result in a lower interest rate. It also streamlines student loan payments by consolidating multiple loans into one.

•   Refinancing federal student loans turns them into private loans and results in the loss of federal benefits like federal loan forgiveness programs.

•   Alternatives to refinancing include income-driven repayment plans and loan forgiveness programs.

Understanding Student Loan Refinancing

With student loan refinancing, a private lender pays off your existing student loans, whether they are private student loans, federal student loans, or a mixture of both. The lender then issues you a new loan with a new interest rate and loan terms.

Ideally, refinancing student loans allows you to get a lower interest rate or more favorable loan terms. The loan interest rate, which is a percentage of your principal amount borrowed, is the amount you pay to your lender in exchange for borrowing money. A lower interest rate can help you save money on your monthly student loan payments.

When you refinance, you may be able to change the repayment terms of the loan. For instance, if you need more time to repay the loan and smaller monthly payments, you may be able to get a longer loan term. However, this means that you will likely pay more in interest overall since you are extending the life of the loan. Alternatively, if you are refinancing student loans to save money, you might be able to get a shorter loan term so that you can repay the loan faster, helping you save on interest payments.

Refinancing can also help you manage your student loan payments by streamlining the process. Instead of having to keep track of multiple loans with different due dates and balances, with refinancing you have just one loan to repay.

You can refinance both federal and private student loans, but be aware that refinancing federal student loans means that you’ll lose access to federal benefits such as federal loan forgiveness and income-driven repayment plans. Clearly, it’s important to consider when to refinance student loans for the best possible outcome.

Recommended: Guide to Student Loan Refinancing

Refinancing Student Loans Without a Cosigner

Refinancing student loans without a cosigner means you’ll have full control over your loan and the responsibility of repaying it will be all yours. No one else will be financially liable for it.

However, to qualify for student loan refinancing on your own you will need to meet specific requirements. These eligibility requirements include:

Qualifying With Your Own Credit

To get approved for student loan refinancing, you typically need a good credit score and a solid credit history. FICO®, the credit scoring model, considers a good credit score to be between 670 to 739. Different lenders have different credit score requirements — some have a minimum credit score that’s slightly lower than 670 — but a higher score is usually better not only for approval but also to get the best rates and terms.

If your credit score needs some work, there are ways to build your credit over time. First, make all your payments in full and on time. Payments account for 35% of your FICO score, so this is critical. In addition, keep your credit utilization — the amount of debt you owe vs. the available credit you have — as low as you can. This can help show that you’re not overspending. And have a balanced mix of credit, such as credit cards and loans, to demonstrate that you can successfully deal with different types of debt.

In addition to your credit score, lenders will also check your credit history — meaning the age of your credit accounts. Having some older active credit accounts shows that you have a track record of borrowing money and repaying it.

Debt-to-Income Ratio

The lender will also look at your debt-to-income (DTI) ratio. This is a percentage that indicates how much of your money goes toward your monthly debts versus how much money you have coming into your household each month.

You can calculate your DTI by adding up your monthly debts and dividing that figure by your gross monthly income (your income before taxes). Multiply the resulting number by 100 to get a percentage, and that’s your DTI. The lower your DTI is, the less risk you are to lenders because it indicates that you have enough money to pay your debts, including the new loan.

If your DTI is high, above 50%, say, work on paying down the debt you owe before you apply for student loan refinancing. You can also work to boost your income by applying for a promotion or taking on a side hustle.

Employment Status

Generally, lenders look for borrowers who are currently employed and have a steady income, or, in some cases, those who have an offer of employment to start within the next 90 days, in order to approve them for student loan refinance. Check with your lender to learn their specific employment and income criteria.

Recommended: Student Loan Refinancing Calculator

Alternatives to Refinancing

If you can’t qualify for student loan refinancing without a cosigner, there are some other options to explore to help manage your student loan payments.

Income-driven Repayment Plans

With an income-driven repayment (IDR) plan, your monthly student loan payments are based on your income and family size. Your monthly payments are typically a percentage of your discretionary income, which usually means you’ll have lower payments. At the end of the repayment period, which is 20 or 25 years, depending on the IDR plan, your remaining loan balance is forgiven.

Loan Forgiveness Programs

You might qualify for student loan forgiveness through a state-specific or federal program. For instance, borrowers with federal student loans who work in public service may be eligible for the Public Service Loan Forgiveness (PSLF) program. If you work for a qualifying employer such as a not-for-profit organization or the government, PSLF may forgive the remaining balance on your eligible Direct loans after 120 qualifying payments are made under an IDR plan or the standard 10 year repayment plan. There is also a federal Teacher Loan Forgiveness program for student loan borrowers who teach in low-income schools or educational service agencies.

Be sure to check with your state to find out what loan forgiveness programs may be available. Some state programs even offer forgiveness to private student loan holders.

Federal Student Loan Consolidation

A federal Direct Consolidation loan allows you to combine all your federal loans into one new loan, which can lower your monthly payments by lengthening your loan term. The interest rate on the loan will be a weighted average of the combined interest rates of all of your consolidated loans. Consolidation can simplify and streamline your loan payments, and your loans remain federal loans with access to federal benefits and protections. However, a longer loan term means you’ll pay more in interest over the life of the loan.

How SoFi Can Help You Refinance

If you opt to refinance your student loans, you may want to consider refinancing your loans with SoFi. You’ll get competitive fixed or variable interest rates on refinanced student loans, no fees, flexible repayment options, and member benefits such as financial advice.

You can refinance online with SoFi and the process is quick and easy. You can view your rate in just two minutes, and it won’t affect your credit score. Then, you can choose a term and payment that makes sense for you. Just remember that refinancing federal student loans makes them ineligible for federal benefits such as income-driven repayment plans.

With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.

FAQS

Can I refinance my student loan without my cosigner?

If you can qualify for refinancing on your own, you typically won’t need to include the cosigner on the new loan which will have new loan terms. By qualifying on your own, you are essentially demonstrating to the lender that you have what it takes to make your loan payments. To qualify for refinancing without a cosigner, you’ll generally need a strong credit score and solid credit history, a low debt-to-income ratio, and a stable income

Is there any way to get a student loan without a cosigner?

Your ability to get a student loan without a cosigner depends on the type of loan it is and your financial situation. Most federal student loans, including Direct Subsidized and Unsubsidized loans, don’t require you to have good credit or to prove you have income, so you won’t need a cosigner for those loans. However, if you’re taking out a Direct PLUS loan and you have adverse credit, such as a recent loan default, you will likely need a cosigner for the loan.

If you’re interested in private student loans, private lenders generally have strict qualification requirements regarding your credit score and income. As a student without much of a credit history or a steady income, you may need a cosigner to qualify for a private student loan.

How easy is it to refinance student loans?

Refinancing student loans is quite easy today because in most cases you can do virtually all of it online. Here’s how: Research different lenders that offer refinancing and compare their loan terms and interest rates. Get a rate estimate from a few lenders to see what rate you may be eligible for (this process involves a soft credit check that does not affect your credit score), and then choose the lender that makes the most sense for you. You can typically complete the entire loan application online (just be aware that you will need to supply documentation to prove your financial situation).

Photo credit: iStock/paulaphoto

SoFi Student Loan Refinance
SoFi Student Loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891. (www.nmlsconsumeraccess.org). SoFi Student Loan Refinance Loans are private loans and do not have the same repayment options that the federal loan program offers, or may become available, such as Public Service Loan Forgiveness, Income-Based Repayment, Income-Contingent Repayment, PAYE or SAVE. Additional terms and conditions apply. Lowest rates reserved for the most creditworthy borrowers. For additional product-specific legal and licensing information, see SoFi.com/legal.


SoFi Loan Products
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.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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 .

This article is not intended to be legal advice. Please consult an attorney for advice.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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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Dec
07
2024

Why Are Student Loan Interest Rates So High?

By | Debt Payoff, Fresh Out of School, Student Loans, student_loan | No Comments

Student loan interest rates are rising. In July 2024, interest rates rose to their highest level in 16 years. Rates for undergraduate loans have increased almost 19% over last year and 44% over the past five years. Some loan rates for graduate students have never been as high as they are now.

Why are student loan interest rates so high? Some of it comes down to perception: Interest rates are up after a decade of historical lows. But other factors also come into play.

Read on to learn how student loan interest rates are set, why interest rates are going up, and the different options available for managing high-interest student loans.

Key Points

•   Federal student loan interest rates have risen to their highest levels in years, and rates for some loans for graduate students are at record highs.

•   Interest rates on federal student loans are set annually by Congress, influenced by the 10-year Treasury note rate plus a fixed increase. Rates are capped at specific limits.

•   Private lenders determine interest rates on private student loans, using benchmarks such as the prime rate. Borrowers’ credit scores and credit history also impact private loan rates.

•   Students who don’t have a strong credit history may need a cosigner on a private student loan to qualify for more favorable rates.

•   Methods to help pay off student loans include paying any accruing interest while in school, using an income-driven repayment plan after graduation, and refinancing student loans.

Understanding Student Loans

There are two main types of student loans — federal and private student loans. Federal loans are offered by the Department of Education (DOE) and they include Direct Subsized and Unsubsidized student loans for undergraduate students, and Direct Unsubsidized loans and Direct PLUS loans for graduate or professional students.

•   Direct Subsidized loans are for undergraduates who have financial need. You fill out the Free Application for Student Aid (FAFSA), and your school determines how much you can borrow. The interest on the loan is paid by the DOE while you’re in school and for a six-month grace period after graduation.

•   Direct Unsubsidized loans are available for undergrads and graduate students. A borrower does not have to prove financial need for these loans. Again, your school determines the amount you can borrow. However, unlike Direct Subsidized loans, the interest on Direct Unsubsidized loans begins to accrue as soon as the loan is disbursed.

•   Direct PLUS loans are for eligible parents (typically called a parent PLUS loan) and grad students. To be approved for one of these loans, a borrower must undergo a credit check and cannot have an adverse credit history. Interest accrues on Direct PLUS loans while the student is in school.

Here’s a look at how the interest rates on these federal loans have increased over the last four years:

School Year 2021 – 2022

 School Year 2022 – 2023

 School Year 2023 – 2024

 School Year 2024 – 2025
Direct Subsidized and Unsubsidized Loans for Undergrads 3.73% 4.99% 5.50% 6.53%
Direct Unsubsidized Loans for Graduate or Professional Students 5.28% 6.54% 7.05% 8.08%
Direct PLUS Loans for Graduate or Professional Students or Parents of Undergrads 6.28% 7.54% 8.05% 9.08%

There are several different repayment plans for federal student loans, including the standard 10-year plan; graduated repayment in which your monthly payments gradually increase over 10 years; extended payment, which gives you up to 25 years to repay your loans; and income-driven repayment plans that base your monthly payments on your income and family size. Federal loans come with benefits such as federal loan forgiveness.

Private student loans are issued by private lenders, such as banks, credit unions, and online lenders. Their interest rates and loan terms differ from lender to lender. The interest rates on private student loans may be fixed or variable, and the rate you get depends on your credit history. You can use student loan refinancing later on for potentially better interest rates and terms on your private loans, if you’re eligible. (Federal loans can be refinanced as well, but they then become private loans and lose the federal benefits mentioned above.)

By using our student loan refinance calculator, you can check the interest rate and repayment terms you could qualify for — and find out if refinancing makes sense for your situation.

Take control of your student loans.
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Factors Contributing to High Interest Rates

Congress sets federal student loan interest rates, while private loan rates depend on the credit rating of the borrower (or their student loan cosigner, if they have one). But that’s not the whole story.

The federal government adjusts federal student loan rates every year based on 10-year Treasury notes, plus a fixed increase. Rates are also capped, so they can’t rise above a certain limit. Here are the formulas:

•   Direct Unsubsidized Loans for Undergraduates: 10-year Treasury + 2.05%, capped at 8.25%

•   Direct Unsubsidized Loans for Graduates: 10-year Treasury + 3.60%, capped at 9.50%

•   PLUS Loans to Graduate Students and Parents: 10-year Treasury + 4.60% Capped 10.50%

The rates for Treasury notes are set based partly on global market conditions and the state of the economy. When market conditions are in flux, the rates for Treasury notes tend to rise.

Federal student loan interest rates are fixed over the life of the loan. That means, if you get a federal student loan for your freshman year, the rate it was issued with won’t change despite Congress setting a new rate every year. If you need to take out another federal student loan for your sophomore year, however, you’ll then get the new rate, not the previous one.

Private student loan rates vary by lender and fluctuate with market trends. A borrower’s credit history also determines the rate they get for a private student loan.

Another factor is that student loans are unsecured. Unsecured loans are not tied to an asset that can serve as collateral. Secured loans, by comparison, are backed by something of value, such as a car or house, which can be seized if you default. But lenders can’t seize a degree. So student loan interest rates may be higher than secured loan rates because the lender’s risk is higher.

Comparison of Federal and Private Student Loan Interest Rates

Why are student loan interest rates so high? As noted above, private student loan rates will fluctuate with market trends and from lender to lender. They also depend on a borrower’s credit score. As of November 2024, some private student loan rates start at about 4% and go up to around 17%.

Private student loan rates for 10-year loans may be higher than the federal interest rate when you are comparing rates concurrently on offer. The rates may be lower for a loan that has a shorter term length than the standard 10 years of federal loans.

What’s more, private student loan rates and student loan refinance rates that are currently on offer can very well be lower than the federal interest rate you received at the time of getting your loan. And you can shop around with private lenders for the best interest rates.

Recommended: Student Loan Refinancing Guide

Pros and Cons of Federal and Private Student Loans

Both federal and private student loans have advantages and drawbacks.

Pros of federal student loans include:

•   Interest rates for federal loans are fixed over the life of the loan

•   The rates for federal loans may be lower than the rates you might get for private student loans

•   Depending on the type of federal loan you have, the government may pay your interest while you are in school and during the six-month grace period after graduation

•   Federal loans have federal programs and protections such as income-driven repayment plans and federal deferment options

Cons of federal student loans include:

•   You can’t shop around for interest rates

•   If you take out a new loan in subsequent years, you may get a higher rate than you got with your initial loans

•   Borrowing limits may be lower compared to private student loans

Pros of private student loans include:

•   You can shop around with different private lenders for lower rates

•   Borrowers (or cosigners) with very good or excellent credit can get lower interest rates

•   May offer higher borrowing limits than federal loans, spending on what a borrower is eligible for

Cons of private student loans include:

•   Borrowers with poor credit will get higher interest rates or may not be able to qualify for a loan

•   If the loan has a variable interest rate, it may rise over time

•   Private loan student holders don’t have access to the same programs and protections that federal student loan borrowers do

•   Deferment and forbearance options (if any) depend on the lender

Interest Rates for Graduate and Professional Degrees

For graduate students and those pursuing advanced professional degrees, interest rates on federal Direct PLUS loans and Direct Unsubsidized Loans for graduate and professional students are substantially higher than the interest rate for Direct Subsidized and Unsubsidized loans for undergrads.

For the 2024-2025 school year, the interest rates are:

Direct PLUS loan: 9.08%
Direct Unsubsidized loans for graduate and professional students: 8.08%
Direct Subsidized and Unsubsidized loans for undergraduate students: 6.53%

The higher rates on loans for graduate and professional students add significantly to the cost of borrowing. Not only that, the interest on these loans begins accruing immediately and while the borrower is in school, which also adds to the overall amount they’ll need to repay.

It’s worth noting that loans for graduate students have much higher borrowing limits than federal loans for undergrads. Graduate students can usually borrow up to $20,500 each year, with a lifetime cap of $138,500. Undergrad borrowers can typically borrow $5,500 for the first year, $6,500 for the second year, and $7,500 for the next two years, up to a total of $31,000.

Credit Score Impact on Private Student Loan Interest Rates

Private lenders will look at your creditworthiness when determining your interest rate. This involves considering such factors as:

•   Credit score: Lenders have different requirements when it comes to credit scores for private student loans, but many look for a score of at least 650. As a student, you may not have that high a score, and in that case, you may need a cosigner on the loan in order to be approved.

•   Credit history: When entering college, most students have little to no credit history. That means the lender could be unsure of their ability to repay the loan since students don’t typically have a history of paying any loans. This can lead to a higher interest rate.

•   Your cosigner’s finances: Since many private student loan applicants are relatively new to debt and have no credit history, they might be required to provide a cosigner, as previously mentioned. A cosigner shares the burden of debt with you, meaning they’re also on the hook to pay it back if you can’t. A cosigner with a strong credit history can potentially help secure a lower interest rate on private student loans.

To help build your credit as a student, having student loans can help. Managing your student loans responsibly is a good way to help establish credit.

In addition, you might consider getting a credit card with a lower line of credit and use it to cover a few small expenses such as groceries and transportation. Be sure to pay your bill on time each month and in full if you can. Strategies like these can help you build credit over time.

Strategies to Pay Off Student Loans Faster

Whether you’re still in school or you’ve just graduated, you have options that may save you money. But it’s important to be proactive. Here are some potential actions you could take:

If You’re Still in College or Grad School

Borrowers with Direct Unsubsidized loans are responsible for the interest that accrues while they’re in school and immediately after. They don’t have to make payments while enrolled, but not making payments means that, in certain situations, interest may “capitalize” — that is, it will be added to the principal. In other words, a borrower would be paying interest on the interest.

To save yourself money on interest, consider making interest-only payments during school until your full repayment period begins after graduation. It will take a small bite out of your budget now, but it can save you money in the long run.

If you have Direct Subsidized loans, no interest will accrue until your grace period ends.

If You Graduated

Borrowers are automatically placed on the standard repayment plan, unless they select another option. The standard repayment plan spreads repayment over 10 years. Other options, such as the extended plan, extend the repayment term, which can make payments more manageable in the present, but that means you may pay more in interest over the life of the loan.

With an income-driven repayment (IDR) plan, your monthly student loan payments are based on your income and family size. Your monthly payments are typically a percentage of your discretionary income, which usually means you’ll have lower payments. At the end of the repayment period, which is 20 or 25 years, depending on the IDR plan, your remaining loan balance is forgiven.

Federal Student Loan Forgiveness

You could also explore student loan forgiveness through a state or federal program. Borrowers with federal student loans who work in public service may be eligible for the Public Service Loan Forgiveness (PSLF) program. If you work for a qualifying employer such as a not-for-profit organization or the government, PSLF may forgive the remaining balance on your eligible Direct loans after 120 qualifying payments are made under an IDR plan or the standard 10 year repayment plan.

In addition, check with your state to find out what loan forgiveness programs they may offer.

Refinancing Student Loans

Refinancing is one way to deal with high-interest student loan debt if you don’t qualify for federal protections. You can potentially lower your interest rate or your monthly payments.

If you’re considering refinancing to save money, you could be a strong candidate if you’ve strengthened your credit since you first took out your loans. Unlike when you were first headed to college, you may now have a credit history for lenders to take into account. If you’ve never missed a payment and have continually built your credit, you might qualify for a lower interest rate.

Having a stable income can also help. Being able to show a consistent salary to a private lender may help make you a less risky investment, which in turn could also help you secure a more competitive interest rate.

Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.


With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.

SoFi Student Loan Refinance
SoFi Student Loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891. (www.nmlsconsumeraccess.org). SoFi Student Loan Refinance Loans are private loans and do not have the same repayment options that the federal loan program offers, or may become available, such as Public Service Loan Forgiveness, Income-Based Repayment, Income-Contingent Repayment, PAYE or SAVE. Additional terms and conditions apply. Lowest rates reserved for the most creditworthy borrowers. For additional product-specific legal and licensing information, see SoFi.com/legal.


SoFi Loan Products
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.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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 .

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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

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Dec
06
2024
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Should You Borrow Money in a Recession?

By | Credit, Debt Payoff, personal_loan | Comments Off on Should You Borrow Money in a Recession?

Figuring out how to prepare for a recession — or any crisis — can be difficult. When facing a potential recession, financial decisions take on a new weight. After all, financial policy may change during a recession, which can leave consumers with questions. For example, if the Federal Reserve lowers interest rates, should you borrow money during a recession?

While lower recession interest rates might sound appealing, there are lots of things to consider before borrowing money during a recession.

Key Points

•   Recession involves economic decline, reduced spending, and increased unemployment.

•   Lower interest rates during recessions can make borrowing attractive, but risks must be considered.

•   Borrowing risks include job loss and potential credit score damage.

•   Borrowing may help consolidate high-interest debts or cover unexpected expenses.

•   Weigh risks and benefits, consider consolidation loans, and seek professional advice.

Understanding Recessions

A recession is a period of time when economic activity significantly declines. In the U.S., the National Bureau of Economic Research defines a recession as more than a few months of significant decline across different sectors of the economy. We see this decline in changes to the gross domestic product, unemployment rates, and incomes.

In essence, a recession is a period of time when spending drops. As a result, businesses ramp down production, lay off staff, and/or close altogether, which in turn causes a continued decrease in spending.

There are many possible causes of the recession. Usually, recessions are caused by a wide variety of factors — including economic, geopolitical, and even psychological — all coinciding to create the conditions for a recession.

For example, a recession could be caused by a major disruption in oil access due to global conflict, or by the bursting of a financial bubble created by artificially depressed interest rates on home loans during a financial boom (as was partially the case with the 2008 financial crisis in the U.S.). A recession also could be caused in part by something like a pandemic, which could create supply chain disruptions, force businesses into failure, and change spending habits.

As for how psychology plays a role in recessions, financial actors might be more likely to invest in a new business or home renovation during boom years when the market seems infallible. But when an economic downturn or recession starts, gloomy economic forecasts could make people more likely to put off big purchases or financial plans out of fear. In aggregate, these psychological decisions may help control the market.

In the case of a recession, for example, many people choosing not to spend out of fear could cause a further contraction of the market, and consequently further a recession.

Financial Policy During a Recession

Economic policy might temporarily change in an effort to keep the market relatively stable amid the destabilization a recession can bring. The Federal Reserve, which controls monetary policy in the U.S., often takes steps to curb unemployment and stabilize prices during a recession.

The Federal Reserve’s first line of defense when it comes to managing a recession is often to lower interest rates. The Fed accomplishes this by lowering the interest rates for banks lending to other banks. That lowered rate then ripples throughout the rest of the financial system, culminating in reduced interest rates for businesses and individuals.

Lowering the interest rate could help to stem a recession by decreasing costs for businesses and allowing consumers to take advantage of low interest rates to buy things using credit. The increase in business and purchasing might in turn help offset a recession.

The Federal Reserve also may take other monetary policy actions in an attempt to curb a recession, like quantitative easing. Quantitative easing, also known as QE, is when the Federal Reserve creates new money and then uses that money to purchase assets like government bonds in order to stimulate the economy.

The manufacturing of new money under QE may help to fight deflation because the increase in available money lowers the value of the dollar. Additionally, QE can push interest rates down because federal purchasing of securities lowers the risks to lending institutions. Lower risks can translate to lower rates.

Recommended: Federal Reserve Interest Rates, Explained

Downsides to Borrowing Money During a Recession

How do you prepare for a recession? It might seem smart to borrow during this time, thanks to those sweet recession interest rates. But there are other considerations that are important when deciding whether borrowing during a recession is the right move. Keep in mind the following potential downsides:

•   There’s a heightened risk of borrowing during a recession thanks to other difficult financial conditions. Disruptive financial conditions like furloughs or layoffs could make it more difficult to make monthly payments on loans. After all, regular monthly expenses don’t go away during a recession, so borrowers could be in a tough position if they take on a new loan and then are unable to make payments after losing a job. Missed payments could negatively impact a borrower’s credit score and their ability to borrow in the future.

•   It may be harder to find a bank willing to lend during a recession. Lower interest rates may mean that a bank or lending institution isn’t able to make as much money from loans. This may make lending institutions more hesitant.

•   Lenders could be reluctant to lend to borrowers who may be unable to pay due to changes in the economy. Most forms of borrowing require borrowers to meet certain personal loan requirements in order to take out a loan. If a borrower’s financial situation is more unstable due to a recession, lenders may be less willing to lend.

When to Consider Borrowing During a Recession

Of course, there are still situations where borrowing during a recession might make sense. If you’re hit with unexpected expenses or have the opportunity to buy quality stocks for a lower price, for instance, it could make sense to have extra funds available.

Another scenario where it might be a good idea is if you’re consolidating other debts with a consolidation loan.

If you already have debt, perhaps from credit cards or personal loans, you may be able to consolidate your debt into a new loan with a lower interest rate, thanks to the changes in the Fed’s interest rates. Consolidation is a type of borrowing that doesn’t necessarily increase the total amount of money you owe. Rather, it’s the process by which a borrower takes out a new loan — with hopefully better interest rates and repayment terms — in order to pay off the prior debts.

Why trade out one type of debt for another? Credit cards, for example, often have high interest rates. So if a borrower has multiple credit card debts with high interest rates, they may be able to refinance credit card debt with a consolidation loan with a lower interest rate. Trading in higher interest rates loans for a consolidation loan with potentially better terms could save borrowers money over the life of the loan. It also streamlines bill paying.
When considering consolidation, borrowers may want to focus on consolidating only high-interest loans or comparing the interest rates between their current debts and a potential consolidation loan.

Note that interest rates on consolidation loans can be either fixed or variable. A fixed rate means a borrower may be able to lock in a lower interest rate during a recession. With a variable interest rate, the loan’s interest rate could go up as rates rise following a recession.

Additionally, just like many other types of loans, consolidation loans require that borrowers meet certain requirements. Available interest rates may depend on factors like credit score, income, and creditworthiness.

Recommended: How to Apply for a Personal Loan

The Takeaway

It can be challenging to navigate any economic downturn, and it’s natural to wonder how to prep for a recession. Deciding whether to borrow, including taking out a personal loan, is a decision that depends on your specific circumstances. There are downsides to consider, such as the general economic uncertainty that can increase risk and heightened risk-aversion from lenders. But if you have high-interest debt, or can secure a lower rate by consolidating, then taking out a consolidation loan during a recession could make sense. It’s a good idea to weigh the risks and benefits carefully and seek out professional advice before making a decision.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.


SoFi’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.

FAQ

Is it good to have money in the bank during a recession?

The general consensus is that banks are a safe place to keep your cash during a recession. If your account is insured by the Federal Deposit Insurance Corporation (FDIC), then individual deposits up to $250,000 are protected. Banks also protect funds against theft or loss.

Is it better to have cash in a recession?

It’s a good idea to have some of your money in cash during a recession. That’s because if you’re laid off from your job or an emergency arises, it can be helpful to have a cushion of readily accessible money.

Should I withdraw all my money during a recession?

If you’re thinking about how to prepare for the recession, it can be tempting to want to take out all of your money from a bank. But there’s good reason to reconsider. Many banks are FDIC insured, which means deposits up to $250,000 are protected.

SoFi Loan Products
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.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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

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