Dec
19
2022
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Second Mortgage, Explained: How It Works, Types, Pros, Cons

By | Budgeting & Goals, Home Ownership, mortgage | No Comments

For many homeowners who need cash in short order, a second mortgage in the form of a home equity loan or home equity line of credit is a go-to answer.

What’s the point of a second mortgage? It’s a way to fund everything from home improvements to credit card debt payoff, and for some, a HELOC serves as a security blanket.

You can probably think of many things you could use a home equity loan or HELOC for, especially when the rate and terms may be more attractive than those of a cash-out refinance or personal loan.

Just know that you’ll need to have sufficient equity in your home to pull a second mortgage.

What Is a Second Mortgage?

A second mortgage is one typically taken out after your first mortgage. Less commonly, a first and second mortgage may be taken out at the same time in the form of a “piggyback loan.”

Your house serves as collateral.

An “open end” second mortgage is a revolving line of credit that allows you to withdraw money and pay it back as needed, up to an approved limit, over time.

A “closed end” second mortgage is a loan disbursed in a lump sum.

It’s not called a second mortgage just because you probably took it out in that order. The term also refers to the fact that if you can’t make your mortgage payments and your home is sold as a result, the proceeds will go toward paying off your first mortgage and then toward any second mortgage and other liens (if anything is left).

How Does a Second Mortgage Work?

A home equity line of credit (HELOC) and a home equity loan, the two main types of second mortgages, work differently but have a shared purpose: to allow homeowners to borrow against their home equity without having to refinance their first mortgage.

Rates

HELOCs may have lower starting interest rates than home equity loans, although HELOC rates are usually variable — fluctuating over time.

Home equity loans have fixed interest rates.

In general, the choice between a fixed- vs variable-rate loan has no one universal winner.

Costs

Home equity loans and HELOCs come with closing costs and fees of about 2% to 5% of the loan amount, but if you do your research, you may be able to find a lender that will waive some or all of the closing costs.

Some lenders offer a “no-closing-cost HELOC,” but it will usually come with a higher interest rate.

Example of a Second Mortgage

Let’s say you buy a house for $400,000. You make a 20% down payment of $80,000 and borrow $320,000. Over time you whittle the balance to $250,000.

You apply for a second mortgage. A new appraisal puts the value of the home at $525,000.

The current market value of your home, minus anything owed, is your home equity. In this case, it’s $275,000.

So how much home equity can you tap? Often 85%, although some lenders allow more.

Assuming borrowing 85% of your equity, that could give you a home equity loan or credit line of nearly $234,000.

After closing on your loan, the lender will file a lien against your property. This second mortgage will have separate monthly payments.

Types of Second Mortgages

To qualify for a second mortgage, in addition to seeing if you meet a certain home equity threshold, lenders may review your credit score, credit history, employment history, and debt-to-income ratio when determining your rate and loan amount.

Here are details about the two main forms of a second mortgage.

Home Equity Loan

A home equity loan is issued in a lump sum with a fixed interest rate.

Terms may range from five to 30 years.

Recommended: Exploring the Different Types of Home Equity Loans

Home Equity Line of Credit

A HELOC is a revolving line of credit with a maximum borrowing limit.

You can borrow against the credit limit as many times as you want during the draw period, which is often 10 years. The repayment period is usually 20.

Most HELOCs have a variable interest rate. They typically come with yearly and lifetime rate caps.

Second Mortgage vs Refinance: What’s the Difference?

A mortgage refinance involves taking out a home loan that replaces your existing mortgage. Equity-rich homeowners may choose a cash-out refinance, taking out a mortgage for a larger amount than the existing mortgage and receiving the difference in cash.

Taking on a second mortgage leaves your first mortgage intact. It is a separate loan.

To determine your eligibility for refinancing, lenders look at the loan-to-value ratio, in part. Most lenders favor an LTV of 80% or less. (Current loan balance / current appraised value x 100 = LTV)

Even though the rate for a refinance might be lower than that of a home equity loan or HELOC, refinancing means you’re taking out a new loan, so you face mortgage refinancing costs of 2% to 5% of the new loan amount on average.

Homeowners who secured a low mortgage rate will not benefit from a mortgage refinance when the going rate exceeds theirs.

Pros and Cons of a Second Mortgage

Taking out a second mortgage is a big decision, and it can be helpful to know the advantages and potential downsides before diving in.

Pros of a Second Mortgage

Relatively low interest rate. A second mortgage may come with a lower interest rate than debt not secured by collateral, such as credit cards and personal loans. And when rates are on the rise, a cash-out refinance becomes less appetizing.

Access to money for a big expense. People may take out a second mortgage to get the cash needed to pay for a major expense, from home renovations to medical bills.

Mortgage insurance avoidance via piggyback. A homebuyer may take out a first and second mortgage simultaneously to avoid having to pay private mortgage insurance (PMI).

People generally have to pay PMI when they make a down payment on a conventional loan of less than 20% of the home’s value.

A piggyback loan, or second mortgage, can be issued at the same time as the initial home loan and allow a buyer to meet the 20% threshold and avoid paying PMI.

Cons of a Second Mortgage

Potential closing costs and fees. Closing costs come with a home equity loan or HELOC, but some lenders will reduce or waive them if you meet certain conditions. With a HELOC, for example, some lenders will skip closing costs if you keep the credit line open for three years. It’s a good idea to scrutinize lender offers for fees and penalties and compare the APR vs. interest rate.

Rates. Second mortgages may have higher interest rates than first mortgage loans. And the adjustable interest rate of a HELOC means the rate you start out with can increase — or decrease — over time, making payments unpredictable and possibly difficult to afford.

Risk. If your monthly payments become unaffordable, there’s a lot on the line with a second mortgage: You could lose your home.

Must qualify. Taking out a second mortgage isn’t a breeze just because you already have a mortgage. You’ll probably have to jump through similar qualifying hoops in terms of home appraisal and documentation.

Common Reasons to Get a Second Mortgage

Typical uses of second mortgages include the following:

•   Paying off high-interest credit card debt

•   Financing home improvements

•   Making a down payment on a vacation home or investment property

•   As a security measure in uncertain times

•   For a blow-out wedding (or funeral) with a HELOC chunk

•   College costs

Can you use the proceeds for anything? In general, yes, but each lender gets to set its own guidelines. Some lenders, for example, don’t allow second mortgage funds to be used to start a business.

The Takeaway

What’s the point of a second mortgage? A HELOC or home equity loan can provide qualifying homeowners with cash fairly quickly and at a relatively decent rate.

If you’re looking for a way to put some of your home equity to use, see what SoFi has to offer.

In addition to a cash-out refinance, SoFi offers a brokered home equity line of credit, allowing access to 95%, or $500,000, of your home’s equity.

It’s easy to find your rate.

FAQ

Does a second mortgage hurt your credit?

Shopping for a second mortgage can cause a small dip in a credit score, but the score will probably rebound within a year if you make on-time mortgage payments.

How much can you borrow on a second mortgage?

Most lenders will allow you to take about 85% of your home’s equity in a second mortgage. Some allow more.

How long does it take to get a second mortgage?

Applying for and obtaining a HELOC or home equity loan takes an average of two to six weeks.

What are alternatives to getting a second mortgage?

A personal loan is one alternative to a second mortgage. A cash-out refinance is another.

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

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Nov
07
2022
How Do Interest Rates Impact Stocks?

How Do Interest Rates Impact Stocks?

By | Growing Wealth, invest, Investing | Comments Off on How Do Interest Rates Impact Stocks?

The impact of interest rates and their fluctuations are a fact of life for investors. And there are several ways interest rates can affect the stock market, like how higher interest rates raise the cost of borrowing for consumers and corporations, which can ultimately affect public companies’ earnings. The reality for stock market investors is that even minor adjustments to interest rates can significantly impact their portfolios.

Below is a deeper dive into the effects interest rates may have on stock prices. For context, interest rates are rising to levels the economy hasn’t experienced in decades, thanks in part to the Federal Reserve’s attempts to fight rising prices. Here’s how that could affect stocks.

Interest Rates 101

Who controls interest rates? While many market factors come into play to determine interest rates, the short answer is that the Federal Reserve, or the U.S. central bank, influences rates.

The Fed has a “dual mandate”:

•  Create the best environment for maximum employment.

•  Stabilize prices, or keep inflation in check

One of the tools the Fed has in its toolkit to try to achieve these twin goals is controlling short-term interest rates. This is done by the Federal Open Market Committee (FOMC)–made up of 12 Fed officials–which meets eight times a year to set the federal funds rate, or the target interest rate.

The federal funds rate is the rate banks charge each other to lend funds overnight.

Other factors influence general interest rates, like consumers’ demand for Treasuries, mortgages, and other loans. But when the Fed adjusts the federal funds rate, it has sweeping ripple effects on the economy by broadly changing the cost of borrowing.

💡 Recommended: What Is the Federal Funds Rate?

How the Fed Reacts to Slow Economy

When economic activity in the U.S. is slow or contracting, the Fed may cut the federal funds rate to boost growth. This move, known as loose monetary policy, is one way the Fed attempts to hit the mandate of creating the best environment for maximum employment.

Lower interest rates make it easier for consumers, businesses, and other economic participants to borrow money and get easier access to credit. When credit flows, Americans are more likely to spend money, create more jobs, and more money enters the financial markets.

Recent history bears this strategy out. In 2008, when the global economy cratered, and both employment and spending were in free fall, the Fed slashed rates to near zero percent to make credit easier to get and restore confidence among consumers and businesses that the economy would stabilize. The Fed again cut interest rates in March 2020 to near zero percent to stimulate the economy during the initial waves of shutdowns due to the coronavirus pandemic.

How the Fed Reacts to Hot Economy

Alternatively, if the U.S. economy is growing too fast, the Fed might hike interest rates to get a grip on rising inflation, which makes goods and services more expensive. This is to make borrowing and getting credit more expensive, which curbs consumer and business spending, reduces widespread prices, and hopefully gets the economy back on an even keel.

For instance, in the early 1980s, Fed Chair Paul Volcker jacked up interest rates to above 20% in order to tame runaway inflation; prices were rising by more than 10% annually during the period. Volcker’s interest rate moves were a big reason why the average 30-year mortgage rate was above 18% in 1981.

More recently, the Fed started to raise interest rates rapidly through 2022 to combat rising prices, with inflation rates hitting the highest levels since the early 1980s.

Interest Rates and Markets

Most analysts note that interest rate changes, or the expectation of rate changes, can significantly affect the stock market beyond how rates may impact business and household finances.

Generally, higher interest rates tend to be a headwind for stocks, partly because investors will prefer to invest in lower-risk assets like bonds that may offer an attractive yield in a high-interest rate environment.

But lower rates may make the stock market more attractive to investors looking to maximize growth. Because investors cannot get an attractive yield from lower-risk bonds in a low rate environment, they will put money into higher-risk assets like growth stocks to get an ideal return.

💡 Recommended: Bonds vs. Stocks: Understanding the Difference

When it comes to stock market sectors or industries, the most obvious beneficiary of higher interest rates would be financial services companies. That’s because higher interest rates would mean banks and other loan providers would earn more for the money that they lend out.

Protecting Your Investments From Higher Rates

Fortunately, there are strategies you can use to protect your portfolio – and possibly – add value to it, when interest rates change.

•  Monitor the Federal Reserve and its rates policy. The FOMC meets eight times a year to discuss economic policy strategy. Even if they don’t result in an interest rate change, announcements from the meetings can significantly impact the stock market.

•  Diversify your portfolio. Investors can aim to protect their assets by diversifying their portfolio up front. A portfolio with a mix of investments like stocks, bonds, real estate, commodities, and cash, for example, may be less sensitive to interest rate moves, thus minimizing the impact of any volatile interest rate fluctuations.

•  Look into TIPS. Investing in Treasury Inflation Protected Securities (TIPS) can fortify a portfolio against interest rate swings. TIPS are a form of Treasury bonds that are indexed to inflation. As inflation rises, TIPS tend to rise. When deflation is in play, TIPS are more likely to decrease.

How Interest Rates Affect Consumers

In a period of high interest rates, publicly-traded companies face a potential indirect threat to revenues, which could hurt stock prices.

That’s due to the reduced levels of disposable income in a high-rate environment. Higher rates make it more expensive for consumers to borrow money with credit cards, mortgages, or personal or small-business loans.

Consumers’ tighter grip on their pocketbooks may negatively affect companies, who find it more challenging to sell their products and services. With lower revenues, companies can’t reinvest in the company and may experience reduced earnings.

How Interest Rates Impact Companies

Businesses that are publicly traded can experience significant volatility depending on interest rate fluctuations. For instance, changes in interest rates can impact companies through bank loan availability.

When rates rise, companies may find it more difficult to borrow money, as higher interest rates make bank loans more expensive. As companies require capital to keep the lights on and products rolling, higher rates may slow capital borrowing, which can negatively impact productivity, cut revenues, and curb stock growth.

Correspondingly, companies can borrow money more freely in a lower interest rate environment, which puts them in a better position to raise capital, improve company profitability, and attract investors to buy their stock.

The Takeaway

Changes in interest rates can have far-reaching effects on the stock market. In general, higher interest rates tend to have a dampening impact on stocks, while lower interest rates tend to boost market prices. Higher interest rates effectively mean higher borrowing costs that can slow down the economy and companies’ balance sheets and drag down stock prices. Additionally, higher interest rates can boost the appeal of bonds relative to equities, which also acts as a drag on stocks.

But changes in interest rates don’t have to be daunting. If you want to create a well-diversified portfolio, SoFi can help. With a SoFi Invest® investment account, you can trade stocks, exchange-traded funds (ETFs), and fractional shares with no commissions for as little as $5.

Take a step toward reaching your financial goals with SoFi Invest.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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Oct
12
2022
financial chart lines

How to Invest During a Recession

By | Financial Independence, Growing Wealth, Investing | No Comments

The first half of 2022 caused many investors to be worried about how to invest during a recession. With inflation at levels not seen in 40 years, stocks falling into bear market territory, and the U.S. economy contracting for two straight quarters, investors were searching for strategies to invest during these volatile times.

Looking at your brokerage or 401(k) account may cause a sense of dread when the economy or stock market looks to be on shaky footing. You may wonder how you can navigate the moment. Just because your investments may be trending downward, don’t let fear lead you to make impulsive decisions like pulling your money out of the market and locking in losses. Read on to learn why staying the course during a recession can have an upside, and sometimes entering the market even in the depths of a downturn might offer some long-term rewards.

What You Need to Know About Investing in a Recession

A recession describes a contraction in economic activity, often defined as a period of two consecutive quarters of decline in the nation’s real Gross Domestic Product (GDP) — the inflation-adjusted value of all goods and services produced in the United States. However, the National Bureau of Economic Research, which officially declares recessions, takes a broader view — including indicators like wholesale-retail sales, industrial production, employment, and real income.

The point is that the markets tend to price in those indicators, so much so that you may see the prices of stocks start to drop (and bond prices start to rise) even before a recession is officially called. For example, the S&P 500 Index declined about 57% from October 9, 2007, through March 9, 2009, a bear market that started two months before the Great Recession, which lasted from December 2007 through June 2009.

From those lows in March 2009, the S&P 500 delivered a return of 400% through February 2020, surpassing the previous peak in April 2013. Those that stayed in the market despite unprecedented economic declines were still able to experience a positive return.

But that stock volatility can give investors the jitters — and that emotional state that can be contagious.

Behavioral finance experts have dubbed this tendency “herd mentality,” which means you’re more likely to behave similarly to a larger group than you realize. Combine that behavioral bias with another common one — loss aversion — and you can see how emotions can lead some investors to make impulsive choices in a moment of panic or doubt.

However, there is some good news: history shows that most recessions don’t last as long as you might think — about 17 months, according to the National Bureau of Economic Research (NBER). So while an economic downturn can be scary while it lasts, it’s likely that time is on your side.

By staying the course and sticking with your investment strategy (and not yielding to emotion), the market recovery could help you recoup any losses and possibly see some gains — especially if you buy the dip (when prices are low).

As investors witnessed firsthand during the market swoon that accompanied the arrival of the pandemic in March of 2020, sometimes declines don’t last very long. The pandemic-related bear market lasted for about a month, while the recession lasted about two months.

💡 Need more recession help? Check out our recession survival guide.

Investing Strategies for a Recession

The following are a few investment strategies that may help investors weather a recession:

Dollar-Cost Averaging

While it’s critical for investors to stay true to their long-term strategy during a recession, what about investing new money? This is where the concept of dollar-cost averaging is important for investors to keep in mind.

Dollar-cost averaging, simply put, is a systematic way of investing a fixed amount of money regularly. It’s often used to describe the way most people invest, on a paycheck-by-paycheck basis, through workplace 401(k) and 403(b) plans.

This approach spreads the cost basis out over a long period of time and a wide range of prices. By doing so, it provides a degree of insulation against market fluctuations. During times of rapidly rising share prices, the investor will have a higher cost basis than they otherwise would have had. During times of collapsing stock prices, the investor will have a lower cost basis than they otherwise would have had.

Taken together, then, dollar-cost averaging can help you pay less for your investments on average over time and help to improve long-term returns.

Buy and Hold

Because most investors invest with a long-term time horizon, it’s best to employ a buy and hold investment strategy. This strategy can often be paired with a dollar-cost averaging strategy.

In short, a buy and hold strategy is a passive strategy in which investors buy stocks, exchange-traded funds, and other securities and hold on to them for a long time.

By buying and holding, investors believe that they are likely to earn long-term investment returns despite whatever short-term market volatility may come their way. They think an extended time horizon allows them to ride out short-term dips in the market.

This strategy can also help investors avoid emotional investing or trying to time the market.

Rebalancing

Investors try to gauge how close or far they are from their goals because your time horizon determines how you invest. For instance, a younger investor may have a portfolio that’s heavier in growth stocks and lighter when it comes to bonds and cash.

For an investor nearing an important goal, like retirement, the priority may be safety and security or investments like high-quality (but lower-yielding) bonds. Over time, investors need to rebalance their portfolios, shifting the allocation of different asset classes. A younger investor may start with an allocation of 70% stocks and 30% bonds and cash. As you near retirement, that equity allocation would likely shift toward 50% stocks or even lower.

Tax-Loss Harvesting

A recession can also be a chance to sell out of a mix of investments, owing to tax considerations. Investors can take advantage of tax-loss harvesting by selling stocks or mutual funds that have appreciated alongside those that have lost value. This strategy allows investors to use investments that have declined in value to offset investment gains and potentially reduce their annual tax bill.

When an investor wants to reduce capital gains taxes they owe on investments they’ve sold, tax-loss harvesting can allow an investor to deduct $3,000 in losses per year. As such, the strategy can be the silver lining on investments that didn’t work out.

Potential Investments During a Recession

It’s worth remembering some investments do better than others during recessions. Recessions are generally bad news for highly leveraged, cyclical, and speculative companies. These companies may not have the resources to withstand a rocky market.

By contrast, the companies that have traditionally survived and even outperformed during a downturn are companies with very little debt and strong cash flow. If those companies are in traditionally recession-resistant sectors, like essential consumer goods, utilities, defense contractors, and discount retailers, they may deserve closer consideration.

💡 Recommended: What Types of Stocks Do Well During Volatility?

Some investors might also seek out even more defensive positions during a recession by buying real estate, precious metals (e.g., gold), or investing in established, dividend-paying stocks.

Additionally, some investors may look to move some money out of riskier investments like stocks, bonds, or commodities and into cash and cash equivalents. For some investors, having adequate cash on hand or having money invested in certificates of deposit (CDs) and money market funds may be a good option for a portfolio during a recession.

Bear in mind that every recession impacts different sectors in different ways. During the Great Recession of 2008-09, financial companies suffered — because it was a financial crisis. In 2020, biotech companies tended to thrive, but investments in energy companies have been hit harder owing to fluctuating oil prices.

As an investor, you must do the math on where the risks and opportunities lie during a recession.

What to Avoid In a Recession

During a recession, it’s important to remember two key tenets that will help you stick to your investing strategy. The first is: While markets change, your financial goals don’t. The second is: Paper losses aren’t real until you cash out.

The first tenet refers to the fact that investors go into the market because they want to achieve certain financial goals. Those goals are often years or decades in the future. But as noted above, the typically shorter-term nature of a recession may not ultimately impact those longer-term financial plans. So, most investors want to avoid changing their financial goals and strategies on the fly just because the economy and financial markets are declining.

The second tenet is a caveat for the many investors who watch their investments — even their long-term ones — far too closely. While markets can decline and account balances can fall, those losses aren’t real until an investor sells their investments. If you wait, it’s possible you’ll see some of those paper losses regain their value.

So, investors should generally avoid panicking and making rash decisions to sell their investments in the face of down markets. Panicked and emotional selling may lead you into the trap of “buying high and selling low,” the opposite of what most investors are trying to do.

Should Investors Expect a US Recession in 2023?

There is a possibility that the U.S. will be in or enter a recession in 2023, but it is not guaranteed. Factors that could lead to a recession include decreased consumer spending, rising unemployment, and decreased business investment.

In the first two quarters of 2022, the Bureau of Economic Analysis reported that GDP in the U.S. declined. To some, this indicated that the U.S. economy was in a recession. The stock market seemed to agree, with the S&P 500 down 25% in the year’s first three quarters.

However, others argued that the economy was not in a recession and that the GDP figures didn’t tell the whole story. After all, unemployment was still low, hiring was still robust, and consumer spending was growing.

Nonetheless, there is a chance that a recession will occur. Around the world, inflation is running high, so the Federal Reserve and other central banks are raising interest rates to try to cool economies to bring prices under control. But this hawkish monetary policy, along with factors like a volatile energy market and the Russia-Ukrainian War, may lead to a global recession that ultimately affects the U.S.

The Takeaway

Investing during a recession is really what you make of it. While market volatility can spark investor worries, it’s possible to manage your emotions, stay in control of your investment strategy, and possibly come out ahead.

Certainly, you could start investing today by opening an account with SoFi Invest® so that you lay the groundwork for your financial plans sooner rather than later. With a SoFi online brokerage account, you can trade stocks and ETFs with no commissions for as little as $5. Then you could be better positioned to take advantage of new opportunities if and when another recession comes along.

Take a step toward reaching your financial goals with SoFi Invest.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

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Oct
10
2022
colorful rollercoaster

What Is Your Risk Tolerance?

By | Growing Wealth, invest, Investing | No Comments

Investing is a lot like riding a roller coaster. Some love the thrill of taking big risks with the possibility of getting even bigger rewards. Others get anxious with every market dip and downturn.

Knowing yourself and your risk tolerance is an essential part of investing. Of course, it’s good to have a diversified portfolio built with your financial goals in mind. Still, the products and strategies you use should ideally fall within guidelines that make you feel comfortable—emotionally and financially—when things get rough.

Otherwise, you might resort to knee-jerk decisions—selling at a loss or abandoning your plan to save—that could cost you even more.

What is Risk Tolerance?

balancing risk involves tolerance, capacity, and need

Risk tolerance is the amount of risk an investor is willing to take to achieve their financial goals. Risk tolerance level comprises three different factors: risk capacity, need, and emotional risk.

Recommended: What Every New Investor Should Know About Risk

Risk Capacity

Risk capacity is the ability to handle risk financially. Unlike your emotional attitude about risk, which might not change as long as you live, your risk capacity can vary based on your age, your personal financial goals, and your timeline for reaching those goals. To determine your risk capacity, you need to determine how much you can afford to lose without affecting your financial security.

For example, if you’re young and have plenty of time to recover from a significant market loss, you may decide to be aggressive with your asset allocation; you may invest in riskier assets like stocks with high volatility or cryptocurrency. Your risk capacity might be larger than if you were older and close to retirement.

For an older investor nearing retirement, you might be more inclined to protect the assets that soon will become part of your retirement income. You would have a lower risk capacity.

Additionally, a person with a low risk capacity may have serious financial obligations (a mortgage, your own business, a wedding to pay for, or kids who will have college tuition). In that case, you may not be in a position to ride out a bear market with risky investments. As such, you may use safer investments, like bonds or dividend stocks, to better protect your portfolio.

On the other hand, if you have additional assets (such as a home or inheritance) or another source of income (such as rental properties or a pension), you might be able to take on more risk because you have something else to fall back on.

Recommended: Savings Goals by Age: Smart Financial Targets by Age Group

Need

The next thing to look at is your need. When determining risk tolerance, it’s important to understand your financial and lifestyle goals and how much your investments will need to earn to get you where you want to be.

The balance in any investment strategy includes deciding an appropriate amount of risk to meet your goals. For example, if you have $100 million and expect that to support your goals comfortably, you may not feel the need to take huge risks. When looking at particular investments, it can be helpful to calculate the risk-reward ratio.

But there is rarely one correct answer. Following the example above, it may seem like a good idea to take risks with your $100 million because of opportunity costs — what might you lose out on by not choosing a particular investment.

Emotional Risk

Your feelings about the ups and downs of the market are probably the most important factor to look at in risk tolerance. This isn’t about what you can afford financially — it’s about your disposition and how you make choices between certainty and chance when it comes to your money.

Conventional wisdom may suggest “buy low, sell high,” but emotions aren’t necessarily rational. For some investors, the first time their investments take a hit, fear might make them a little crazy. They may lose sleep or be tempted to sell low and put all their remaining cash in a savings account or certificate of deposit (CD).

On the flip side, when the market is doing well, investors may get greedy and decide to buy high or move their safe investments to something much more aggressive. Whether it’s FOMO trading, fear, greed, or something else, emotions can cause any investor to make serious mistakes that can blow up their plan and forestall or destroy their objectives. A volatile market is a risk for investors, but so is abandoning a plan that aligns with your goals.

And here’s the hard part: it’s difficult to know how you’ll feel about a change in the market — especially a loss — until it happens.

Three Levels of Risk Tolerance

Generally, investors fall into one of three categories regarding investment risk tolerance: aggressive, moderate, and conservative.

While the financial industry tends to use labels like conservative, moderate, or aggressive to describe risk in the context of investments and investors, those terms are subjective. What they mean to you may differ from what they mean to someone else.

It can put things into better perspective to think of a potential loss in terms of dollars, not percentages. A 15% loss might not sound so bad, but if you think of it as having $10,000 one month and $8,500 the next, that’s a little more daunting.

Aggressive Risk Tolerance

People with aggressive risk tolerance tend to focus on maximizing returns, believing that getting the largest long-term return is more important than limiting short-term market fluctuations. If you follow this philosophy, you will likely see periods of significant investment success that are, at some point, followed by substantial losses. In other words, you’re likely to ride the full rollercoaster of market volatility.

Moderate Risk Tolerance

An investor with a moderate risk tolerance balances the potential risk of investments with potential reward, wanting to reduce the former as much as possible while enhancing the latter. This investor is often comfortable with short-term principal losses if the long-term results are promising.

Conservative Risk Tolerance

A person with conservative risk tolerance is usually willing to accept a relatively small amount of risk, but they truly focus on preserving capital. Overall, the goal is to minimize risk and principal loss, with the person agreeable to receiving lower returns in exchange.

Assessing Your Risk Tolerance for Retirement Investing

Risk Tolerance Quiz

Take this 9 question quiz to see what your risk tolerance is.

⏲️ Takes 1 minute 30 seconds

There are steps you can take and questions to ask yourself to determine your risk tolerance for retirement investing. Once you know your risk preference, you can open a retirement account with confidence. Both low risk tolerance and high risk tolerance investors may want to walk through these steps to ensure they know what retirement investment style is right.

Matching your 401(k) risk amount to your personality traits can help you stick to your strategy over the long haul.

1.    What will your income be? If you expect your salary to ratchet higher over the coming years, then you may want to have a higher 401(k) risk level, as time in the market can help you recover from any losses. If you are in your peak-earning years and will retire soon, then toning down your risk could be a prudent move, since you don’t want to risk your savings this close to retirement.

2.    What will your expenses look like? If you anticipate higher expenses in retirement, that might warrant a lower risk level since a sharp drop in your assets could result in financial hardship. If your expenses will likely be low (and your savings rate is high), then perhaps you can afford to take on more retirement investing risk.

3.    Do you get nervous about the stock market? Those who cannot rest easy when stocks are volatile are likely in a lower-risk, lower-return group. But if you don’t pay much attention to the swings of the market, you might be just fine owning higher-risk, higher-return stocks.

4.    When do you want to retire? Your time horizon is a major retirement investing factor. The more time you have to be in the market, the more you should consider owning an aggressive 401(k) risk portfolio. Those in retirement and who draw income from a portfolio are likely in the low risk-tolerance bucket, since their time horizon is shorter.

The Takeaway

Each investor may have a unique level of risk tolerance, though generally, the levels are broken down into conservative, moderate, and aggressive. The fact is, all investments come with some degree of risk—some greater than others. No matter your risk tolerance, it can be helpful to be clear about your investment goals and understand the degree of risk tolerance required to help meet those goals.

Investors may diversify their investments into buckets — some safer assets, some intermediate-term assets, and some for long-term growth — based on their personal goals and timelines.

Ready to take steps toward your financial future? With SoFi Invest®, investors can set up an online brokerage account to trade stocks and exchange-traded funds (ETFs) with no commissions.

Find out how to get started with SoFi Invest.

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1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

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Sep
26
2022
Cash Back vs Low-Interest Credit Card: Key Differences

Cash-Back vs Low-Interest Credit Cards: Key Differences

By | Credit, credit card, Family Finances | Comments Off on Cash-Back vs Low-Interest Credit Cards: Key Differences

With average credit card annual percentage rates (APR) topping 15% as of the second quarter of 2022, according to the Federal Reserve, savvy cardholders are looking for ways to reduce the cost of using a card. Some ways consumers achieve this is through a cash-back rewards credit card or a low-interest credit card.

The distinction between a cash-back vs. low interest credit card is that cash-back cards help you earn a small percentage of your spending back. Conversely, a low-interest credit card tends to charge less interest each month than a high-interest card, which is helpful for cardholders who roll a balance into the next month.

Recommended: Can You Buy Crypto With a Credit Card

What Are Cash-Back Credit Cards?

Credit cards that offer cash-back rewards are designed as an incentive to encourage spending on the card. For every eligible purchase you charge to your card, you’ll receive a small percentage of cash back. Some cards offer 1% cash back, while others offer as much as 8% or more, depending on the program’s rules. You might earn a flat rate across all purchases, or you might earn more in certain spending categories, such as groceries or gas.

You then can redeem your earned cash-back rewards. Redemption options may include a cash payment or a statement credit toward your next bill, or you may be able to redeem the rewards for travel, merchandise, gift cards, and more.

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

What Are Low-Interest Credit Cards?

Low-interest credit cards incur a lower borrowing cost compared to a high-interest credit card. A credit card that charges low interest allows you to pay less for using the card if you carry a balance. This card feature is beneficial for cardholders who repay their monthly balance in increments over time, instead of in full.

The interest rate you qualify for highly depends on your creditworthiness, including your past borrowing habits and credit score. Consumers with strong credit might qualify for promotional no-interest credit cards that charge 0% APR for a limited period. After this period is over, the card’s interest rate increases, based on the cardholder’s credit and qualifications. As such, there are both advantages and disadvantages of no-interest credit cards.

Recommended: How to Avoid Interest On a Credit Card

Differences Between Cash-Back and Low-Interest Credit Cards

Below are the key differences between low-interest vs. cash-back credit cards to keep in mind when choosing a card:

Cash-Back Credit Cards Low-Interest Credit Cards
You’ll generally need good credit to qualify. Cash-back rewards offer an incentive for spending.
Cash-back rates vary by issuer. Advantageous for those who don’t carry a balance.
Savings may be negated when a balance carries over. Lowest APR offers are reserved for those with strong credit.
Advantageous for those who carry a balance. Some cards offer a promotional 0% APR for a limited period.
Lowers the borrowing cost for carried-over balances. Perks may be inconsequential when monthly balances are paid in full.

Factors to Consider When Choosing Between Rates and Rewards

Your unique financial situation, borrowing habits, and the features and benefits of a particular card are what you should consider when comparing your options.

Average Balance You’ll Be Carrying Monthly

How credit cards work is that they give you purchasing power up to a limited amount, even when you don’t have the cash upfront. You can choose to repay the debt in one lump payment by your statement due date, which allows you to avoid paying interest charges. Alternatively, you can make installment payments over multiple months, in which case you’ll accrue interest charges.

Not carrying a monthly balance is one of the common credit card rules to try to stick to, but it’s not always possible. For example, you might have had an unexpected injury that resulted in a medical bill that exceeded your cash savings. In this scenario, putting some of that cost on your credit card and making small, monthly payments to repay it might be necessary.

If you don’t have sufficient cash savings or income to confidently repay your monthly balance in full each month, a low-interest card might offer an advantage over a cash-back card.

Recommended: When Are Credit Card Payments Due

Your Average Monthly Spending

Look back at your monthly expenses and think about the total amount you’ll likely put on your credit card each month. For example, you might choose use a credit card to cover everyday expenses, like dining, groceries, and gas. Cardholders who rack up high monthly balances can benefit from a cash-back credit card that offers money back from purchases you’re already making.

The caveat, however, is if you charge more expenses to your card than you can realistically pay back in full by the statement due date. If you roll over any portion of your outstanding balance into the next month, you’ll get charged interest on that amount, which cancels out any cash-back rewards you may have earned.

Recommended: Tips for Using a Credit Card Responsibly

Annual Fees

Some cards — particularly rewards cards that extend high-value benefits and incentives — might charge an annual fee. For example, a cash-back card might offer an annual $300 travel credit and 5% cash back on flight purchases, but charge an annual fee of $550.

If you don’t travel enough to use up the credits and earn more cash back than the annual fee costs, that card might not be the best fit for your lifestyle. You’ll need to assess the total potential dollar value that a card’s benefits, credits, and other incentives offer in comparison to the upfront cost of the card’s annual fee.

Recommended: What is a Charge Card

Interest Rate Difference Between Cards

Although all credit card issuers check your credit to determine your interest rate, each card company has its own underwriting criteria. You might receive an interest rate offer for 13.99% APR for one card, and an offer from another card issuer at 11.99% APR, for example. To gauge interest rates, it can be helpful to look at the current average credit card interest rates for a point of comparison.

Regardless of whether you end up with a cash-back credit card vs. low interest credit card, it’s always a good idea to shop around for the lowest interest rate you can get. That way, if you ever need to carry a balance, you can minimize the amount of interest you end up paying.

Guide to Lowering Your Credit Card Interest Rate

Whether you’re shopping around for a new credit card or have an existing card with a high APR, here are some ways to lower your interest rate:

•   Contact your card issuer. If you’ve been a loyal customer and have kept your account in good standing, or if your credit score has improved since you opened the account, your credit card issuer may be willing to reduce your rate.

•   Raise your credit score. Even if you already have good credit, strengthening your credit score can help you secure the most competitive interest rate in the future. Good borrowing habits — like making on-time payments and keeping your credit utilization low — are just some ways that may help your score.

•   Consider a low-interest balance transfer card. If you have a high-interest card with a balance on it, and you have strong credit, a balance transfer card can allow you to move your original balance onto a low-interest card. Before proceeding, always compare the balance transfer fee against your potential savings to confirm that it’s worth it.

Remember, what’s considered a good APR for a credit card is subjective, based on your creditworthiness and other factors. Securing the lowest APR that you qualify for can help you avoid heavy interest charges if you roll over a monthly balance.

Explore SoFi’s Credit Card With Rewards

Ultimately, whether you opt for a cash-back credit card or a low-interest card depends on how you plan to use the card and whether you practice responsible credit card habits. But why choose one or the other when you can explore credit cards with low interest rates and cash-back rewards?

A SoFi Credit Card offers the advantages of a cash-back rewards credit card with the opportunity to lower your APR through responsible credit usage.

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



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

FAQ

When is a lower annual interest rate better than a low annual fee?

A lower APR is better if you typically carry a balance from one billing cycle to the next. When you roll over a balance, old and new balances accrue daily interest charges that can cost you more money out of pocket. A low annual fee is something to look for when you’re using a card to earn incentives, like credit card rewards.

Are there credit cards with low interest and cash back?

Yes, there are credit card options that offer a low interest rate to qualified applicants, as well as cash-back rewards. However, you’ll generally need to have good credit in order to qualify for the most competitive rates offered by low-interest rewards credit cards.

How can I choose between low APR and rewards?

Consider your credit history and score to determine whether you meet the minimum qualifications for a credit card’s lowest APR. Also, examine your general credit card habits, like whether you often roll over a balance and what your monthly spending habits are like. Compare those details against the costs of carrying a card, like annual fees and the APR you’re offered.

Is it better to find a credit card with low or high interest?

Finding a credit card that offers a low interest rate is always the better move. The lower your APR, the less you’ll pay for borrowing on credit if you decide to carry a balance month to month.

Photo credit: iStock/AsiaVision

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

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

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

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 .

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

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