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Looking for affordable loans and access to bank accounts may not be as easy for some people, especially those of lower income and in rural or underserved areas. That’s where Community Development Financial Institutions, or CDFIs, step in. These organizations aim to serve economically disadvantaged communities.

Here, take a closer look, including:

•   What a CDFI is and how they work?

•   What are the different types of CDFIs?

•   What CDFIs offer?

•   Pros and cons of CDFIs.

What is a Community Development Financial Institution?

Community Development Financial Institutions, or CDFIs, are financial institutions — mainly banks and credit unions — that help those in underserved communities in rural and urban areas. CDFIs were established by the Riegle Community Development and Regulatory Improvement Act of 1994. At the same time, a CDFI Fund was formed to assist these institutions in providing loans (business and personal) and other types of financial assistance to those in need.

To promote accessible products and services, CDFIs typically rely less on common factors such as credit scores and monthly fees when providing loans and bank accounts. (For instance, economically disadvantaged people may have trouble opening a standard checking account if they have a low credit rating and typically be given access to a second chance checking account. A CDFI may offer more options.)

CDFIs may also help invest in the local community by providing tools to build credit, encourage savings, and share other financial literacy tools. Currently, there are around 1,000 CDFIs across the U.S.

How Do CDFIs Work?

CDFIs work by providing products that, among other things, offer individuals and businesses the opportunity to borrow funds at a lower cost and to build their credit. The CDFI Fund, part of the U.S. Treasury, allows financial institutions to offer low-cost loans and mortgages for small businesses and first-time home buyers. CDFIs also can offer credit builder loans to help borrowers build a positive credit history.

Here’s an example of how a CDFI might help underserved communities build financial literacy and save money. If a person needs $400 to pay for a car repair, they might not have the cash available and would instead need a loan. Instead of seeking banking alternatives and, say, heading to a payday loan lender that offers a 350% interest rate, a CDFI might offer a loan with a rate of 20%. Doing so can save the borrower a significant amount in interest and contribute to their financial wellbeing.

What Are the Types of CDFIs?

There are several types of CDFIs; they tend to have similar, but not identical, missions. If you want to understand the specifics of what a CDFI is, you’ll find a few options:

Community Development Banks

Community development banks tend to be for-profit organizations that provide loans to those who are in distressed or underserved communities. Most commonly, borrowers are small businesses, non-profit organizations, local entrepreneurs, and housing developers.

Insured through the FDIC, these loans include business and non-profit loans, mortgages or home improvement loans, and some banking services.

Community Development Credit Unions (CDCUs)

CDCUs are financial institutions that are non-profit and member-owned, offering products and services to both business and consumers. Some of these may include credit counseling, consumer banking products like checking and savings accounts, and business planning for lower-income folks who are members of the CDCU. Given that these services are designed for the economically disadvantaged, customers may not have to deal as often with such issues as figuring out why a bank account is frozen and instead get support and financial literacy training.

They might also gain more services, such as being able to wire money to others.

Community Development Loan Funds (CDLFs)

CDLFs are typically funds that work with small businesses, non-profit organizations, and social-service provider facilities in lower-income communities. These mostly non-profit funds tend to provide pre-development, start-up, and business expansion loans at a lower interest rate. Typically, they also offer extra guidance such as help with business planning.

Community Development Venture Capital Funds (CDVC)

CDVCs provide funds, both equity and debt, for medium-sized businesses to encourage them to create jobs and other resources that help benefit lower-income and other types of underserved communities. Borrowers also tend to be businesses with a high potential for growth to which the CDVC will also provide extensive guidance.

Microenterprise Development Loan Fund

This type of loan fund offers loans and assistance, such as technical support, to lower-income entrepreneurs and self-employed individuals who can’t access conventional loans. These funds are usually non-profit and offer a peer lending model.

Community Development Corporations

Community development corporations are non-profit organizations usually formed by the local community and run by a volunteer board. They aim to use funding and investments to revitalize lower-income communities by offering affordable housing, providing social services, and creating jobs.

Requirements for CDFI Certification

To be eligible for CDFI certification, a financial organization must have a main mission of offering services to lower-income and underserved communities.

Other eligibility requirements include:

•   Providing financial and educational support services

•   Serving in a minimum of one eligible target market

•   Need to direct a minimum of 60% of their services to at least one eligible target market

•   Maintaining accountability to their defined eligible target market

•   Being a non-governmental and legal entity (except Tribal government entities) when applying for CDFI certification

How Do CDFIs Help People of Lower Income?

These mission-driven financial organizations work specifically to help underserved communities, particularly those who are lower-income. By offering financial services, such as bank accounts and loans, they can elevate the community. Even if funding goes towards businesses, the loan proceeds need to be able to help lower-income communities, whether that’s through job creation or other forms of assistance.

What Do CDFIs Offer to Communities?

CDFIs offers the following products and services to communities:

•   Low-interest loans

•   Affordable housing opportunities

•   Bank accounts for those who may not have access to traditional financial products and services

•   Training such as financial literacy and business development assistance

Benefits of CDFIs

Advantages of Community Development Financial Institutions include:

•   Access to banking services for those who have been denied by conventional means

•   Access to low-interest loans to grow a business or find a more affordable path to homeownership

•   Increased access to financial and business training

•   Potential growth opportunities in lower-income and other underserved communities

Drawbacks of CDFIs

Disadvantages of Community Development Financial Institutions include:

•   Not all areas will have easy access to a CDFI

•   May not always be easy to get loans or funding, depending on the borrower

•   Interest rates may be higher than conventional loans for creditworthy borrowers

•   CDFIs’ ability to provide funds may be limited by investors and the federal government

The Takeaway

Community Development Financial Institutions, or CDFIs, are stepping up to help lower-income and underserved communities access affordable loans and financial products they otherwise may not have. While there are a limited number of CDFIs and funding is not infinite, they are working to improve both funding and financial literacy in some of America’s more vulnerable communities.

For those who are looking to avoid the usual charges that come with personal banking, SoFi has a great fee-free option. When you sign up for Checking and Savings with direct deposit, you don’t pay any fees like monthly, minimum-balance, or overdraft. Need more good reasons to open a new bank account? You’ll also have access to a network of 55,000+ fee-free ATMs and earn a competitive APY.

FAQ

What is the difference between a bank and a CDFI?

Banks and CDFIs are both types of financial institutions, though the main difference lies in their mission. Banks tend to be for-profit organizations that focus on satisfying their shareholders by generating profits. CDFIs, on the other hand, aim to provide accessible and affordable financial products and services (such as bank accounts and loans) to lower-income and other underserved communities across the U.S.

How does a bank become a CDFI?

A bank can become a CDFI by getting certified by the U.S. Treasury. It needs to meet certain criteria, such as directing at least 60% of its funds towards financial products and services for lower-income communities, as well as navigating other stringent certification processes.

What are the benefits of being a CDFI?

The benefits of being a CDFI include getting additional training resources, networking opportunities with other financial institutions, and some exemptions to lending caps and mortgage rules. Of course, there’s also the benefit of knowing your organization is helping underserved communities grow and thrive.

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What Is Max Pain?

Max pain, or the maximum pain price, is the strike price with the most open options contracts combining puts and calls. It is the strike price that causes the highest dollar value of losses among option buyers on a given stock at a specific expiration.

According to the Chicago Board Options Exchange (CBOE), about 30% of options expire worthless, 10% are exercised, and 60% close out before expiration. The concept of max pain focuses on the 30% of options that expire with no intrinsic value.

Some large institutional options sellers see an investment opportunity in writing options that eventually expire worthless, according to max pain theory. If options expire worthless, the seller of those options keeps the entire premium as profit.

Max pain options trading stems from the Maximum Pain Theory. The theory contends that option sellers seek to hedge portfolios with options expiration. The Maximum Pain Theory also suggests an option’s price will arrive at a max pain price where the most options contracts held through expiration will experience losses. Bear in mind that an options contract that is not “in the money” at expiration is worthless.

Recommended: Popular Options Trading Terminology to Know

How Max Pain Works

The Maximum Pain Theory asserts that the price of the underlying asset is likely to converge at the maximum pain strike price. The max pain price is the strike with the greatest dollar value of calls and puts. As the expiration date approaches, the underlying stock price might “pin” to that option strike price.

Some day traders closely monitor the max pain price on the afternoon of expiration – usually the third Friday of the month for monthly options or each Friday for weekly options contracts.

Max Pain trading can be controversial, as some believe it borders on “market manipulation” when traders seek to pin a stock price to a certain price at a certain time. Market participants disagree about whether or not Max Pain Theory works in practice. If a trader can predict which strike price will feature the greatest combination of dollar value between calls and puts, the theory states that they could profit from using that information.

Some market makers may consider Max Pain Price Theory when hedging their portfolios. Delta hedging is a strategy used by options traders – often market makers — to reduce the directional risk of price movements in the security underlying the options contracts. A market maker is often the seller of options contracts, and they seek to hedge the risk of options price movements by buying or selling underlying shares of stock.

This activity can cause the stock price to converge at the max pain price. Delta hedging plays a significant role in max pain trading.

How to Calculate the Max Point

Calculating the max pain options price is relatively straightforward if you have the data. Follow these steps to determine the max pain strike:

•   Step 1: Calculate the difference between each strike price and the underlying stock price.

•   Step 2: Multiply the results from Step One by the open interest at each strike.

•   Step 3: Add the dollar value for both the put and the call at each strike.

•   Step 4: Repeat Steps One through Three for each strike price on the option chain.

•   Step 5: The strike price with the highest dollar value of puts and calls is the max pain price.

Since the stock price constantly changes and open interest in the options market rises and falls, the max pain price can change daily. An options trader might be interested to see if there is a high amount of open interest at a specific price as that price could be where the underlying share price gravitates toward at expiration, at least according to Max Pain Theory.

Max Pain Point Example

Let’s assume that XYZ stock trades at $96 a week before options expiration. A trader researches the option chain on XYZ stock and notices a high amount of open interest at the $100 strike. The trader performs the steps mentioned earlier to calculate the max pain price.

Indeed, $100 is the max pain price. Since the trader believes in Max Pain Theory, they go long shares of XYZ on the assumption that it will rise to $100 by the next week’s options expiration. Another options trading strategy could be to put on a bullish options position instead of buying shares of the underlying stock.

This hypothetical example looks simple on paper but many factors influence the price of a stock. There could be company-specific news issued during the final days before expiration that sends a stock price significantly higher or lower.

Macro factors and overall market momentum might overwhelm market makers’ attempt to pin a stock to a max pain strike. Finally, stock price volatility could cause the max pain price to shift in the hours and even minutes leading up to expiration.

Pros and Cons of Using Max Pain Theory When Trading

Max Pain Options Theory can be an effective strategy for options traders looking for a systematic approach for their options strategy. That said, not everyone agrees that Max Pain Theory works in practice. Here are some of the pros and cons of Max Pain Theory.

Max pain trading in the options market is easier today amid a brokerage world with low or even no commissions. Previously, it was simply not economical for many retail traders with small account sizes to buy and sell options using max pain theory.

Critics contend that there should be more regulatory oversight on max pain price trading — particularly on large institutions that could be manipulating prices. It’s unclear whether there will be more oversight of such practices in the future.

The Takeaway

Max Pain Theory is one approach to options trading based on the strike price that would cause the most losses. Options traders who calculate the max pain price, can use that information to inform their investing strategy. But it’s not necessary to invest in options at all to build your nest egg.

But if you’re ready to tackle options trading, check out the SoFi options trading platform. Investors can trade options either from the mobile app or web platform, with an intuitive and approachable design. Whether you’re a seasoned trader or an options trading beginner, you might also perusing the educational content about options offered, too.

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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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