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How does a home equity loan work? First, it’s important to understand that the term home equity loan is simply a catchall for the different ways the equity in your home can be used to access cash. The most common types of home equity loans are fixed-rate home equity loans, home equity lines of credit (HELOCs), and cash-out refinancing.

What Are the Main Types of Home Equity Loans?

When folks think of home equity loans, they typically think of either a fixed-rate home equity loan or a home equity line of credit (HELOC). There is a third way to use home equity to access cash, and that’s through a cash-out refinance.

With fixed-rate home equity loans or HELOCs, the primary benefit is that the borrower may qualify for a better interest rate using their home as collateral than by using an unsecured loan — one that is not backed by collateral. Some people with high-interest credit card debt may choose to use a lower-rate home equity loan to pay off those credit card balances, for instance.

This does not come without risks, of course. Borrowing against a home could leave it vulnerable to foreclosure if the borrower is unable to pay back the loan. A personal loan may be a better fit if the borrower doesn’t want to put their home up as collateral.

How much a homeowner can borrow is typically based on the combined loan-to-value ratio (CLTV ratio) of the first mortgage plus the home equity loan. For many lenders, this figure cannot exceed 85% CLTV. To calculate the CLTV, divide the combined value of the two loans by the appraised value of the home. In addition, utilizing a home equity loan calculator can help you understand how much you might be able to borrow using a home equity loan. It’s similar to the home affordability calculator you may have used during the homebuying process.

Of course, qualifying for a home equity loan or HELOC is typically contingent on several factors, such as the credit score and financial standing of the borrower.

Fixed-Rate Home Equity Loan

Fixed-rate loans are pretty straightforward: The lender provides one lump-sum payment to the borrower, which is to be repaid over a period of time with a set interest rate. Both the monthly payment and interest rate remain the same over the life of the loan. Fixed-rate home equity loans typically have terms that run from five to 30 years, and they must be paid back in full if the home is sold.

With a fixed-rate home equity loan, the amount of closing costs is usually similar to the costs of closing on a home mortgage. When shopping around for rates, ask about the lender’s closing costs and all other third-party costs (such as the cost of the appraisal if that will be passed on to you). These costs vary from bank to bank.

This loan type may be best for borrowers with a one-time or straightforward cash need. For example, let’s say a borrower wants to build a $20,000 garage addition and pay off a $4,000 medical bill. A $24,000 lump-sum loan would be made to the borrower, who would then simply pay back the loan with interest. This option could also make sense for borrowers who already have a mortgage with a low interest rate and may not want to refinance that loan.

Recommended: What Is a Fixed-Rate Mortgage?

Home Equity Line of Credit (HELOC)

A HELOC is revolving debt, which means that as the balance borrowed is paid down, it can be borrowed again during the draw period (whereas a home equity loan provides one lump sum and that’s it). As an example, let’s say a borrower is approved for a $10,000 HELOC. They first borrow $7,000 against the line of credit, leaving a balance of $3,000 that they can draw against. The borrower then pays $5,000 toward the principal, which gives them $8,000 in available credit.

Unlike with a fixed-rate loan, a HELOC’s interest rate is variable and will fluctuate with market rates, which means that rates could increase throughout the duration of the credit line. The monthly payments will vary because they’re dependent on the amount borrowed and the current interest rate.

HELOCs have two periods of time that are important for borrowers to be aware of: the draw period and the repayment period.

•   The draw period is the amount of time the borrower is allowed to use, or draw, funds against the line of credit, commonly 10 years. After this amount of time, the borrower can no longer draw against the funds available.

•   The repayment period is the amount of time the borrower has to repay the balance in full. The repayment period lasts for a certain number of years after the draw period ends.

So, for instance, a 30-year HELOC might have a draw period of 10 years and a repayment period of 20 years. Some buyers only pay interest during the draw period, with principal payments added during the repayment period. A HELOC interest-only calculator can help you understand what interest-only payments vs. balance repayments might look like.

A HELOC may be best for people who want the flexibility to pay as they go. For an ongoing project that will need the money portioned out over longer periods of time, a HELOC might be the best option. While home improvement projects might be the most common reason for considering a HELOC, other uses might be for wedding costs or business start-up costs.

Home Equity Loan Fees

Generally, under federal law, fees should be disclosed by the lender. However, there are some fees that are not required to be disclosed. Borrowers certainly have the right to ask what those undisclosed fees are, though.

Fees that require disclosure include application fees, points, annual account fees, and transaction fees, to name a few. Lenders are not required to disclose fees for things like photocopying related to the loan, returned check or stop payment fees, and others. The Consumer Finance Protection Bureau provides a loan estimate explainer that will help you compare different estimates and their fees.

Home Equity Loan Tax Deductibility

Since enactment of the Tax Cuts and Jobs Act of 2017, interest on home equity loans and HELOCs is only deductible if the funds are used to substantially improve a home. Checking with a tax professional to understand how a home equity loan or HELOC might affect a certain financial situation is recommended.

Cash-Out Refinance

Mortgage refinancing is the process of paying off an existing mortgage loan with a new loan from either the current lender or a new lender. Common reasons for refinancing a mortgage include securing a lower interest rate, or either increasing or decreasing the term of the mortgage. Depending on the new loan’s interest rate and term, the borrower may be able to save money in the long term. Increasing the term of the loan may not save money on interest, even if the borrower receives a lower interest rate, but it could lower the monthly payments.

With a cash-out refinance, a borrower may be able to refinance their current mortgage for more than they currently owe and then take the difference in cash. For example, let’s say a borrower owns a home with an appraised value of $400,000 and owes $200,000 on their mortgage. They would like to make $30,000 worth of repairs to their home, so they refinance with a $230,000 mortgage, taking the difference in cash.

As with home equity loans, there typically are some costs associated with a cash-out refinance. Generally, a refinance will have higher closing costs than a home equity loan.

This loan type may be best for people who would prefer to have one consolidated loan and who need a large lump sum. But before pursuing a cash-out refi you’ll want to look at whether interest rates will work in your favor. If refinancing will result in a significantly higher interest rate than the one you have on your current loan, consider a home equity loan or HELOC instead.

The Takeaway

There are three main types of home equity loans: a fixed-rate home equity loan, a home equity line of credit (HELOC), and a cash-out refinance. Just as with a first mortgage, the process will involve a bank or other creditor lending money to the borrower, using real property as collateral, and require a review of the borrower’s financial situation. Keep in mind that cash-out refinancing is effectively getting a new mortgage, whereas a fixed-rate home equity loan and a HELOC involve another loan, which is why they’re referred to as “second mortgages.”

While each can allow you to tap your home’s equity, what’s unique about a HELOC is that it offers the flexibility to draw only what you need and to pay as you go. This can make it well-suited to those who need money over a longer period of time, such as for an ongoing home improvement project.

SoFi now offers flexible HELOCs. Our HELOC options allow you to access up to 90% of your home’s value, or $500,000, at competitively low rates. And the application process is quick and convenient.

Unlock your home’s value with a home equity line of credit brokered by SoFi.

FAQ

What is the downside of a home equity loan?

The primary downside of a home equity loan is that the collateral for the loan is your home, so if you found yourself in financial trouble and couldn’t make your home equity loan payment, you risk foreclosure. A second consideration is that a home equity loan provides you with a lump sum. If you are unsure about how much you need to borrow, consider a home equity line of credit (HELOC) as well.

How much does a $50,000 home equity loan cost?

The exact cost of a $50,000 home equity loan depends on the interest rate and loan term. But if you borrowed $50,000 with a 7.50% rate and a 10-year term, your monthly payment would be $594 and you would pay a total of $21,221 in interest over the life of the loan.

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SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

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.

*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.

^²SoFi Bank, N.A. NMLS #696891 (Member FDIC), offers loans directly or we may assist you in obtaining a loan from SpringEQ, a state licensed lender, NMLS #1464945.
All loan terms, fees, and rates may vary based upon your individual financial and personal circumstances and state.
You should consider and discuss with your loan officer whether a Cash Out Refinance, Home Equity Loan or a Home Equity Line of Credit is appropriate. Please note that the SoFi member discount does not apply to Home Equity Loans or Lines of Credit not originated by SoFi Bank. Terms and conditions will apply. Before you apply, please note that not all products are offered in all states, and all loans are subject to eligibility restrictions and limitations, including requirements related to loan applicant’s credit, income, property, and a minimum loan amount. Lowest rates are reserved for the most creditworthy borrowers. Products, rates, benefits, terms, and conditions are subject to change without notice. Learn more at SoFi.com/eligibility-criteria. Information current as of 06/27/24.
In the event SoFi serves as broker to Spring EQ for your loan, SoFi will be paid a fee.

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

Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.

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.

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

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If you own a home, you may be interested in tapping into your available home equity. One popular way to do that is with a home equity line of credit. This is different from a home equity loan, and can help you finance a major renovation or many other expenses.

Homeowners sitting on at least 20% equity — the home’s market value minus what is owed — may be able to secure a HELOC.Let’s take a look at what is a HELOC, how it works, the pros and cons and what alternatives to HELOC might be.

How Does a HELOC Work?

The purpose of a HELOC is to tap your home equity to get some cash to use on a variety of expenses. Home equity lines of credit offer what’s known as a revolving line of credit, similar to a credit card, and usually have low or no closing costs. The interest rate is likely to be variable (more on that in a minute), and the amount available is typically up to 85% of your home’s value, minus whatever you may still owe on your mortgage.

Once you secure a HELOC with a lender, you can draw against your approved credit line as needed until your draw period ends, which is usually 10 years. You then repay the balance over another 10 or 20 years, or refinance to a new loan. Worth noting: Payments may be low during the draw period; you might be paying interest only. You would then face steeper monthly payments during the repayment phase. Carefully review the details when apply

Here’s a look at possible HELOC uses:

•   HELOCs can be used for anything but are commonly used to cover big home expenses, like a home remodeling costs or building an addition. The average spend on a bath remodel in 2023 topped $9,000 according to the American Housing Survey, while a kitchen remodel was, on average, almost $17,000.

•   Personal spending: If, for example, you are laid off, you could tap your HELOC for cash to pay bills. Or you might dip into the line of credit to pay for a wedding (you only pay interest on the funds you are using, not the approved limit).

•   A HELOC can also be used to consolidate high-interest debt. Whatever homeowners use a home equity credit line or home equity loan for — investing in a new business, taking a dream vacation, funding a college education — they need to remember that they are using their home as collateral. That means if they can’t keep up with payments, the lender may force the sale of the home to satisfy the debt.

HELOC Options

Most HELOCs offer a variable interest rate, but you may have a choice. Here are the two main options:

•   Fixed Rate With a fixed-rate home equity line of credit, the interest rate is set and does not change. That means your monthly payments won’t vary either. You can use a HELOC interest calculator to see what your payments would look like based on your interest rate, how much of the credit line you use, and the repayment term.

•   Variable Rate Most HELOCs have a variable rate, which is frequently tied to the prime rate, a benchmark index that closely follows the economy. Even if your rate starts out low, it could go up (or down). A margin is added to the index to determine the interest you are charged. In some cases, you may be able to lock a variable-rate HELOC into a fixed rate.

•   Hybrid fixed-rate HELOCs are not the norm but have gained attention. They allow a borrower to withdraw money from the credit line and convert it to a fixed rate.

Note: SoFi does not offer hybrid fixed-rate HELOCs at this time.

HELOC Requirements

Now that you know what a HELOC is, think about what is involved in getting one. If you do decide to apply for a home equity line of credit, you will likely be evaluated on the basis of these criteria:

•   Home equity percentage: Lenders typically look for at least 15% or more commonly 20%.

•   A good credit score: Usually, a score of 680 will help you qualify, though many lenders prefer 700+. If you have a credit score between 621 and 679, you may be approved by some lenders.

•   Low debt-to-income (DTI) ratio: Here, a lender will see how your total housing costs and other debt (say, student loans) compare to your income. The lower your DTI percentage, the better you look to a lender. Your DTI will be calculated by your total debt divided by your monthly gross income. A lender might look for a figure in which debt accounts for anywhere between 36% to 50% of your total monthly income.

Other angles that lenders may look for is a specific income level that makes them feel comfortable that you can repay the debt, as well as a solid, dependable payment history. These are aspects of the factors mentioned above, but some lenders look more closely at these as independent factors.

Example of a HELOC

Here’s an example of how a HELOC might work. Let’s say your home is worth $300,000 and you currently have a mortgage of $200,000. If you seek a HELOC, the lender might allow you to borrow up to 80% of your home’s value:

   $300,000 x 0.8 = $240,000

Next, you would subtract the amount you owe on your mortgage ($200,000) from the qualifying amount noted above ($240,000) to find how big a HELOC you qualify for:

   $240,000 – $200,000 = $40,000.

One other aspect to note is a HELOC will be repaid in two distinct phases:

•   The first part is the draw period, which typically lasts 10 years. At this time, you can borrow money from your line of credit. Your minimum payment may be interest-only, though you can pay down the principal as well, if you like.

•   The next part of the HELOC is known as the repayment period, which is often also 10 years, but may vary. At this point, you will no longer be able to draw funds from the line of credit, and you will likely have monthly payments due that include both principal and interest. For this reason, the amount you pay is likely to rise considerably.

Difference Between a HELOC and a Home Equity Loan

Here’s a comparison of a home equity line of credit and a home equity loan.

•   A HELOC is a revolving line of credit that lets you borrow money as needed, up to your approved credit limit, pay back all or part of the balance, and then borrow up to the limit again through your draw period, typically 10 years.

   The interest rate is usually variable. You pay interest only on the amount of credit you actually use. It can be good for people who want flexibility in terms of how much they borrow and how they use it.

•   A home equity loan is a lump sum with a fixed rate on the loan. This can be a good option when you have a clear use for the funds in mind and you want to lock in a fixed rate that won’t vary.

Borrowing limits and repayment terms may also differ, but both use your home as collateral. That means if you were unable to make payments, you could lose your home.

Recommended: What are the Different Types of Home Equity Loans?

What Is the Process of Applying for a HELOC?

If you’re ready to apply for a home equity line of credit, follow these steps:

•   First, it’s wise to shop around with different lenders to reveal minimum credit score ranges required for HELOC approval. You can also check and compare terms, such as periodic and lifetime rate caps. You might also look into which index is used to determine rates and how much and how often it can change.

•   Then, you can get specific offers from a few lenders to see the best option for you. Banks (online and traditional) as well as credit unions often offer HELOCs.

•   When you’ve selected the offer you want to go with, you can submit your application. This usually is similar to a mortgage application. It will involve gathering documentation that reflects your home’s value, your income, your assets, and your credit score. You may or may not need a home appraisal.

•   Lastly, you’ll hopefully hear that you are approved from your lender. After that, it can take approximately 30 to 60 days for the funds to become available. Usually, the money will be accessible via a credit card or a checkbook.

How Much Can You Borrow With a HELOC?

Depending on your creditworthiness and debt-to-income ratio, you may be able to borrow up to 90% of the value of your home (or, in some cases, even more), less the amount owed on your first mortgage.

Thought of another way, most lenders require your combined loan-to-value ratio (CLTV) to be 90% or less for a home equity line of credit.

Here’s an example. Say your home is worth $500,000, you owe $300,000 on your mortgage, and you hope to tap $120,000 of home equity.

Combined loan balance (mortgage plus HELOC, $420,000) ÷ current appraised value (500,000) = CLTV (0.84)

Convert this to a percentage, and you arrive at 84%, just under many lenders’ CLTV threshold for approval.

In this example, the liens on your home would be a first mortgage with its existing terms at $300,000 and a second mortgage (the HELOC) with its own terms at $120,000.

How Do Payments On a HELOC Work?

During the first stage of your HELOC (what is called the draw period), you may be required to make minimum payments. These are often interest-only payments.

Once the draw period ends, your regular HELOC repayment period begins, when payments must be made toward both the interest and the principal.

Remember that if you have a variable-rate HELOC, your monthly payment could fluctuate over time. And it’s important to check the terms so you know whether you’ll be expected to make one final balloon payment at the end of the repayment period.

Pros of Taking Out a HELOC

Here are some of the benefits of a HELOC:

Initial Interest Rate and Acquisition Cost

A HELOC, secured by your home, may have a lower interest rate than unsecured loans and lines of credit. What is the interest rate on a HELOC? The average HELOC rate in mid-November of 2024 was 8.61%.

Lenders often offer a low introductory rate, or teaser rate. After that period ends, your rate (and payments) increase to the true market level (the index plus the margin). Lenders normally place periodic and lifetime rate caps on HELOCs.

The closing costs may be lower than those of a home equity loan. Some lenders waive HELOC closing costs entirely if you meet a minimum credit line and keep the line open for a few years.

Taking Out Money as You Need It

Instead of receiving a lump-sum loan, a HELOC gives you the option to draw on the money over time as needed. That way, you don’t borrow more than you actually use, and you don’t have to go back to the lender to apply for more loans if you end up requiring additional money.

Only Paying Interest on the Amount You’ve Withdrawn

Paying interest only on the amount plucked from the credit line is beneficial when you are not sure how much will be needed for a project or if you need to pay in intervals.

Also, you can pay the line off and let it sit open at a zero balance during the draw period in case you need to pull from it again later.

Cons of Taking Out a HELOC

Now, here are some downsides of HELOCs to consider:

Variable Interest Rate

Even though your initial interest rate may be low, if it’s variable and tied to the prime rate, it will likely go up and down with the federal funds rate. This means that over time, your monthly payment may fluctuate and become less (or more!) affordable.

Variable-rate HELOCs come with annual and lifetime rate caps, so check the details to know just how high your interest rate might go.

Potential Cost

Taking out a HELOC is placing a second mortgage lien on your home. You may have to deal with closing costs on the loan amount, though some HELOCs come with low or zero fees. Sometimes loans with no or low fees have an early closure fee.

Your Home Is on the Line

If you aren’t able to make payments and go into loan default, the lender could foreclose on your home. And if the HELOC is in second lien position, the lender could work with the first lienholder on your property to recover the borrowed money.

Adjustable-rate loans like HELOCs can be riskier than others because fluctuating rates can change your expected repayment amount.

It Could Affect Your Ability to Take On Other Debt

Just like other liabilities, adding on to your debt with a HELOC could affect your ability to take out other loans in the future. That’s because lenders consider your existing debt load before agreeing to offer you more.

Lenders will qualify borrowers based on the full line of credit draw even if the line has a zero balance. This may be something to consider if you expect to take on another home mortgage loan, a car loan, or other debts in the near future.

What Are Some Alternatives to HELOCs

If you’re looking to access cash, here are HELOC alternatives.

Cash-Out Refi

With a cash-out refinance, you replace your existing mortgage with a new mortgage given your home’s current value, with a goal of a lower interest rate, and cash out some of the equity that you have in the home. So if your current mortgage is $150,000 on a $250,000 value home, you might aim for a cash-out refinance that is $175,000 and use the $25,000 additional funds as needed.

Lenders typically require you to maintain at least 20% equity in your home (although there are exceptions). Be prepared to pay closing costs.

Generally, cash-out refinance guidelines may require more equity in the home vs. a HELOC.

Recommended: Cash Out Refi vs. Home Equity Line of Credit: Key Differences to Know

Home Equity Loan

What is a home equity loan again? It’s a lump-sum loan secured by your home. These loans almost always come with a fixed interest rate, which allows for consistent monthly payments.

Personal Loan

If you’re looking to finance a big-but-not-that-big project for personal reasons and you have a good estimate of how much money you’ll need, a low-rate personal loan that is not secured by your home could be a better fit.

With possibly few to zero upfront costs and minimal paperwork, a fixed-rate personal loan could be a quick way to access the money you need. Just know that an unsecured loan usually has a higher interest rate than a secured loan.

A personal loan might also be a better alternative to a HELOC if you bought your home recently and don’t have much equity built up yet.

The Takeaway

If you are looking to tap the equity of your home, a HELOC can give you money as needed, up to an approved limit, during a typical 10-year draw period. The rate is usually variable. Sometimes closing costs are waived. It can be an affordable way to get cash to use on anything from a home renovation to college costs.

SoFi now offers flexible HELOCs. Our HELOC options allow you to access up to 90% of your home’s value, or $500,000, at competitively low rates. And the application process is quick and convenient.

Unlock your home’s value with a home equity line of credit brokered by SoFi.

FAQ

What can you use a HELOC for?

It’s up to you what you want to use the cash from a HELOC for. You could use it for a home renovation or addition, or for other expenses, such as college costs or a wedding.

How can you find out how much you can borrow?

Lenders typically require 20% equity in your home and then offer up to 90% or even more of your home’s value, minus the amount owed on your mortgage. There are online tools you can use to determine the exact amount, or contact your bank or credit union.

How long do you have to pay back a HELOC?

Typically, home equity lines of credit have 20-year terms. The first 10 years are considered the draw period and the second 10 years are the repayment phase.

How much does a HELOC cost?

When evaluating HELOC offers, check interest rates, the interest-rate cap, closing costs (which may or may not be billed), and other fees to see just how much you would be paying.

Can you sell your house if you have a HELOC?

Yes, you can sell a house if you have a HELOC. The home equity line of credit balance will typically be repaid from the proceeds of the sales when you close, along with your mortgage.

Does a HELOC hurt your credit?

A HELOC can hurt your credit score for a short period of time. Applying for a home equity line can temporarily lower your credit score because a hard credit pull is part of the process when you seek funding. This typically takes your score down a bit.

How do you apply for a HELOC?

First, you’ll shop around and collect a few offers. Once you select the one that suits you best, applying for a HELOC involves sharing much of the same information as you did when you applied for a mortgage. You need to pull together information on your income and assets. You will also need documentation of your home’s value and possibly an appraisal.

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SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

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.

*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.

^²SoFi Bank, N.A. NMLS #696891 (Member FDIC), offers loans directly or we may assist you in obtaining a loan from SpringEQ, a state licensed lender, NMLS #1464945.
All loan terms, fees, and rates may vary based upon your individual financial and personal circumstances and state.
You should consider and discuss with your loan officer whether a Cash Out Refinance, Home Equity Loan or a Home Equity Line of Credit is appropriate. Please note that the SoFi member discount does not apply to Home Equity Loans or Lines of Credit not originated by SoFi Bank. Terms and conditions will apply. Before you apply, please note that not all products are offered in all states, and all loans are subject to eligibility restrictions and limitations, including requirements related to loan applicant’s credit, income, property, and a minimum loan amount. Lowest rates are reserved for the most creditworthy borrowers. Products, rates, benefits, terms, and conditions are subject to change without notice. Learn more at SoFi.com/eligibility-criteria. Information current as of 06/27/24.
In the event SoFi serves as broker to Spring EQ for your loan, SoFi will be paid a fee.

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

Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.

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 .

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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Getting an inheritance can usher in a wide range of emotions.

On one hand, you’ve just lost someone close to you, and that can be very difficult to process and deal with. On the other hand, inheritance money can change lives for the better. Who hasn’t dreamed of getting a chunk of change to put toward their financial dreams?

But receiving a sudden windfall can also be unexpectedly stressful. If you mismanage an inheritance, it could leave you back where you started financially, or even create new financial problems for you.

It’s crucial to think carefully about what to do with an inheritance, and to consider all your options before you act. From paying off debt to buying a home to investing the inheritance, there are many ways to use your inheritance that may help you get ahead financially.

Here are some ideas for what to do with an inheritance, including how to think about this new money and how to invest your inheritance in your financial goals.

First Steps After Receiving an Inheritance

If you receive an inheritance, first take a breath and just sit with the news for a bit. Don’t do anything rash or you might end up regretting it.

The Importance of Slowing Down

It’s wise to take it easy right now. You’ve just lost someone close to you and you are still dealing emotionally with that. Give yourself time to grieve before making any major decisions about what to do with an inheritance. In most cases, you don’t have to do anything about the inheritance immediately, so don’t feel pressured to act right away. Instead, take your time and be strategic.

For instance, you could put the money in a high-yield savings account for the time being. Then, when you’re ready, you can start mapping out a plan for the funds.

Paying Tribute: Honoring Their Legacy in Your Decisions

Your loved one worked hard to earn or accumulate the money you’ve inherited. Take some time to feel gratitude toward them and what they’ve done for you.

Think about how they might want you to spend the money. Would they want you to put it toward your retirement savings? Buy a house so you can finally stop renting? Keeping your loved one top of mind as you plan what to do with the money, might help give you purpose and hold you accountable so that you don’t spend the inheritance frivolously.

Building Your Support Team: Financial Advisors, Lawyers, and Accountants

Inheriting money can be confusing since you probably aren’t quite sure how the process works. And you may not know the best thing to do with the funds. That’s why having some support, such as estate lawyers, accountants, or financial advisors, might be wise, especially if you’re inheriting a large sum.

But be an active participant in the process. Ask these professionals for their input and suggestions and then carefully weigh the different options. You need to make the decisions that are best for you and your situation.


💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

Managing a Cash Inheritance

Receiving a cash inheritance is a great reason to sit down and review your financial situation and assess your current needs and priorities. Looking at your financial statements — including your income, expenses, assets, and liabilities — might be the easiest way to start.

Taking some time to think about your short-term and long-term financial goals may help define your values and guide you as you determine the best course of action for saving and investing the money. How you ultimately invest an inheritance will depend on your financial goals.

Strategies for Small, Medium, and Large Sums

What you do with your inheritance may depend on how much you inherit. If it’s a small sum, you may want to put it toward a downpayment on a house, for example. Or you could use it to build up an emergency fund.

If you inherit a medium-size sum, you may want to earmark it for your children’s college education. Or you could put it toward your own retirement savings.

And finally, if you inherit a large sum, you may want to do several different things with the money. For instance, you may decide to invest a chunk of it for your future. And you might use another portion if it to pay off your mortgage or other debts you have. Perhaps you want to donate some to charity. You could even use some of the money to take the vacation you’ve always dreamed of.

Balancing Savings, Debt Repayment, and Investments

It could be wise to make several financial moves with your inheritance to help secure your future. That way you can balance your different priorities.

Some of the money could go into your emergency savings fund so that you have a robust financial cushion in case you need it.

Another portion might go toward paying off debt, such as credit card or student loan debt. This can help free up your cash flow and even help you save more money for your future.

And you could invest the rest for retirement. You can explore the different types of retirement accounts that you may be eligible for to find the right options for you.

Retirement, Education, and Emergency Fund Priorities

Saving and investing for retirement could be an excellent use of inheritance money. As mentioned above, the first step is determining which type of account to open.

Because inherited money is not earned income, you cannot put it directly into a retirement account like a traditional or Roth IRA. However, you could open a brokerage account and build an investment portfolio for retirement. You may want to consider stocks, mutual funds, exchange-traded funds (ETFs), or a mix of all three in your portfolio.

Another priority for your inheritance might be your children’s college education. You could consider using your inherited money to fund a college savings account or invest towards your child’s future educational costs.

This can be done through a 529 plan, a prepaid tuition plan, or a Coverdell education savings account. A 529 plan allows for tax-free investment growth when the money is used for higher education expenses.

Each state has its own 529 plan, but you’re not required to use the plan for the state for which you live. Some states may offer a state income tax deduction if you use their state’s plan, so check with the plan (or your tax advisor) to be sure.

Another way you may want to use inherited money is building up an emergency fund. Just like it sounds, an emergency fund is cash, typically held in a savings account, that’s available in the event of an emergency, such as a sudden, unexpected expense like a car accident or a root canal. Having the cash available to cover such an expense may help you avoid going into credit card or other debt in the future.

While it’s ultimately up to you to determine how much money to keep in an emergency fund, you may want to consider having the recommended three to six months’ worth of expenses in the bank. This amount may help cover you in the event you are laid off from your job and need time to find a new opportunity.

Investment Opportunities for Inherited Wealth

Once you’ve paid off any debts you owe and allocated money to an emergency fund and possibly to your children’s college funds, you may want to invest the rest for your future financial goals.

Diversifying Investments: Stocks, Bonds, and Funds

Building a diversified, balanced portfolio with investments that have different degrees of risk is one strategy to consider. Diversification may help mitigate risk, though it’s important to remember that there is still risk involved with investing. Some investments with different levels of risk to explore are stocks, bonds, and mutual funds. Stocks are considered more volatile — they may potentially offer higher growth but also have higher risk — while bonds typically have lower risk and smaller returns. Mutual funds typically include a mix of stocks and bonds.

Tax-Advantaged Accounts and Minimizing Tax Burden

Inheritances are not considered taxable income for federal taxes. However, any earnings on your inherited assets are generally taxable.

Some of the most popular types of accounts that may offer tax advantages include IRAs and 401(k)s. Inheritance money per se cannot be invested in these accounts (because it’s not earned income). However, the additional money you get from an inheritance might give you the flexibility to use your income to open an IRA or contribute more to your 401(k) at work.

Here’s how: If you use inheritance money to pay down debt or pay bills, such as your mortgage, you may be able to afford to invest more of your earned income in a retirement account. Because some of these accounts are tax deferred, including traditional IRAs and 401(k)s, they may also help reduce your tax burden.

Real Estate Investments: Pros, Cons, and Considerations

If you’re thinking about investing your inheritance in real estate, you might want to consider a real estate investment trust (REIT). A REIT is a company that owns or operates properties that generate income. With a REIT, you can invest in real estate properties without having to buy actual properties and manage them yourself.

But REITS do come with risks. For instance, REITs tend to be very sensitive to changes in interest rates. When rates rise, the value of a REIT can fall. Also, commercial properties can be affected by trends. For instance, if a REIT focuses on a type of store that suddenly becomes less popular with consumers, your investment could take a hit.


💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

How to Handle Inherited Properties and Valuables

Part of your inheritance might include a house, a car, antiques, or jewelry. These can all be financially beneficial, depending on their value. But they can also pose challenges since you will need to decide what to do with them.

Decisions for an Inherited House: Sell, Rent, or Move In?

If you inherit a house, for instance, the big decision you’ll face is whether to move into it, rent it, or sell it.

Selling the house will provide you with a profit. You could then use that money to pay debt or invest for the future. There may also be a tax benefit. That’s because inherited homes have a step-up tax basis. That means you don’t pay taxes on the full amount of the home, but only on any amount it sold for that’s more than what the home was worth on the date your loved one died. So if the house was worth $300,000 at the time your relative died, and you sell it for $375,000, you only pay taxes on $75,000.

Just remember that you’ll have to empty out the house and get it ready to sell. You’ll also need to pay the utilities, mortgage, taxes, etc. until the house sells.

You can rent out the home instead, which could potentially give you steady rental income. However, you will need to manage the property and take care of maintenance and repairs. This could be tricky if you don’t live nearby. And even if you do, it can be time consuming. You’ll also need to figure out the tax implications of renting out the house, which may be complicated.

Finally, you may choose to move into the house. This might be a good option for you if you haven’t been able to afford buying a home of your own previously. Just remember that while you won’t have to pay a mortgage, you will have to pay such ongoing expenses as real estate taxes and homeowner’s insurance.

Inherited Vehicles and Heirlooms: Assessing Value and Sentiment

If you inherit a vehicle like a car, you’ll need to decide whether to keep it or sell it. Your decision will likely depend on the age of the vehicle and the shape it’s in. It will also hinge on whether you need or want a new car. You might be perfectly happy with your own current vehicle. In that case, you could sell the inherited car and make a profit from it.

Deciding what to do with inherited items that have sentimental value as well as monetary value — such as jewelry, antiques, or a relative’s prized collection — can be more difficult. You may feel an attachment to these items. Wait a bit before making a decision about them and give yourself time to think through the best course of action. For instance, you might want to hold onto a few items that have special meaning to you and sell the rest. Or perhaps you’ll decide you’re not ready to part with them and you’ll keep them all. Do what feels right to you.

Tax Implications of an Inheritance

There are two types of taxes related to an inheritance: estate taxes and inheritance taxes.

Estate and Inheritance Taxes: What You Need to Know

The federal government does not impose an inheritance tax. That means you won’t have to pay federal taxes on your inheritance. But keep in mind that any earnings you make from your inheritance are subject to taxes.

Some states have inheritance taxes that you may need to pay. To find out if your state is one of them, check with the state department of taxation. You might also want to consult a tax professional.

Estate taxes are a different matter. These taxes are not levied against you, the person inheriting money. Instead, they are levied against the estate of the deceased person. However, unless the estate is extremely large ($12.92 million or more in 2023, and $13.61 in 2024), the estate won’t have to pay federal estate taxes.

Capital Gains Tax: How It Affects Your Inherited Assets

Capital gains taxes are something you typically pay when you sell inheritance assets and make money on them. Thanks to what’s known as a step-up in basis, the value of the item you inherit is adjusted to its value on the date of your loved one’s death.

For example, if you inherit a house your mother bought for $100,000 and the house is worth $500,000 on her date of death, the value of the house is adjusted to $500,000. If you sell the house for that amount, there are no capital gains. If you sell the house for more than $500,000 you pay capital gains on anything over that amount.

In addition to real estate, this rule also generally applies to other things you inherit, such as stocks, mutual funds, bonds, and collectibles.

Capital gains taxes can be quite complicated, so you may want to consult a tax professional to make sure you report and pay these taxes properly.

Leveraging Professional Financial Advice

Dealing with an inheritance and all it involves can be overwhelming. A trusted advisor could help you decide what to do with the money in order to make the most of it.

Choosing the Right Advisor for Your Inheritance Needs

You may want to begin your search for an advisor with the person or people associated with the estate before it was passed along, such as the estate’s executor or a trustee.

That said, you’ll want to be certain that this person is a “fiduciary,” which means that they always act in your best financial interest.

Another option is to directly hire a financial advisor. When choosing a financial advisor, you can start by asking family, friends, and colleagues for recommendations. You can also consult industry associations such as the National Association of Personal Financial Advisors or the Financial Planning Association

The Role of Financial Planning in Estate Inheritance

A financial planner can help you create a financial plan for your inheritance based on your financial goals and your current situation.

A good financial plan can help you make the most of your money. It can allocate money to help you pay down debt and to create an emergency fund. It can also help you manage your inheritance assets. For instance, you might choose to put some of the money in investments to help reach future financial goals such as buying a house or saving for retirement.

Inheriting money requires careful decision making. That’s why having a solid financial plan in place can be so useful. It can help you stay on track to meet your goals.

Avoiding Common Mistakes with Inherited Wealth

When you receive an inheritance, it’s wise to take some time to decide the best course of action to take. This can help prevent you from doing something you may regret later. These are some common mistakes to avoid:

Failing to put together a solid financial plan. A good plan lays out your financial goals and priorities. It can help you pay off debt now and save money for your future. Without such a plan, you might end up frittering away a chunk of your inheritance before you realize it.

Making emotional decisions. Dealing with the loss of a loved one is difficult, and emotions could cloud your judgment about what to do with your inheritance. Don’t make rash decisions. Instead, put the money someplace safe for the time being, like a high-yield savings account, and give yourself time to grieve before making major decisions.

Spending too much. You may be tempted to use your windfall to purchase a boat or buy a luxury car. While these purchases are fun, they won’t help you in the long-term the way paying off debt or saving for your retirement will. Plus, cars and boats require ongoing maintenance — and even storage in the case of the boat — that you’ll need to keep paying for.

If you’re not careful, you could end up burning through your entire inheritance and not have a lot to show for it. Instead, create a financial plan as outlined above. In your plan you can set aside a small part of your inheritance for fun spending. For instance, maybe you dedicate 5% or 10% of the amount you inherited to taking that trip to Italy you’ve always dreamed of. That way you’ll be able to enjoy some of the money now and save and invest the rest for the future.

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