An irrevocable letter of credit (or ILOC) is a written agreement between a buyer (often an importer) and a bank. As part of the agreement, the bank agrees to pay the seller (typically an exporter) as soon as certain conditions of the transaction are met. These letters help reduce a seller’s concern that an unknown buyer won’t pay for the goods they receive. It also helps eliminate a buyer’s concern that an unknown seller won’t send the goods the buyer has paid for.
Irrevocable letters of credit are often found in international trade, though they can be used in other types of financial arrangements to ensure that a seller will be paid, even if the buyer fails to uphold their end of the bargain.
Key Points
• An irrevocable letter of credit is a written agreement between a bank and a buyer to guarantee payment, ensuring that the seller will be paid even if the buyer fails to fulfill their obligations.
• Irrevocable letters of credit cannot be canceled or modified in any way without the explicit agreement of all parties involved.
• Irrevocable letters of credit are commonly used in international transactions but can be used in other situations as well.
• Alternatives to irrevocable letters of credit include trade credit insurance and standard letters of credit, which offer different levels of flexibility and protection.
What Is an Irrevocable Letter of Credit?
Simply defined, an irrevocable letter of credit represents an agreement between a bank and a buyer involved in a financial transaction. The bank guarantees payment will be made to the seller according to the terms of the agreement. Since the letter is irrevocable, that means it cannot be changed without the consent and agreement of all parties involved.
Irrevocable letters of credit can also be referred to as standby letters of credit. Once an irrevocable letter of credit is issued, all parties are contractually bound by it. This means that even if the buyer in a transaction doesn’t pay, the bank is obligated to make payment to the seller to satisfy the agreement.
Having an irrevocable letter of credit in place is a form of risk management. The seller is guaranteed payment from the bank, which can help to reduce concerns about the buyer failing to pay. And it ensures that the seller will follow through on their obligations by providing whatever is being purchased through the agreement. In simpler terms, a standby letter of credit or irrevocable letter of credit is a sign of good faith on the part of everyone involved in a transaction. 💡 Quick Tip: Banish bank fees. Open a new bank account with SoFi and you’ll pay no overdraft, minimum balance, or any monthly fees.
How Does an Irrevocable Letter of Credit Work?
An irrevocable letter of credit establishes a contractual agreement between a buyer, a seller, and their respective banks. It effectively creates a safeguard for both the buyer and the seller, in that:
• Buyers are not required to forward payment until the seller provides the goods or services that have been purchased.
• Sellers can collect payment for goods and services, as long as the conditions outlined in the letter of credit are met.
The bank issuing the letter of credit acts as a go-between for both sides, guaranteeing payment to the seller even if the buyer doesn’t pay. Assuming the buyer does fulfill their obligations, they would then make payment back to the bank. In a sense, this allows the buyer to borrow from the bank without formally establishing credit in the form of a loan or credit line. (Check with your financial institution to learn what fees may be involved.)
Before an irrevocable letter of credit is issued, the bank will first verify the buyer’s creditworthiness. Assuming the bank is reassured that the buyer will, in fact, repay what’s owed to complete the purchase, it will then establish the irrevocable letter of credit to facilitate the transaction between the buyer and seller. Irrevocable letters of credit are communicated and sent through the SWIFT banking system.
Recommended: How Do Banks Make Money?
Irrevocable Letter of Credit Specifications
The exact details included in an irrevocable letter of credit can depend on the situation in which it’s being used. The conditions that are set for the completion of the transaction will also matter. But generally, you can expect an irrevocable letter of credit to include:
• Buyer’s name and banking information (that is, their bank account number and other details)
• Seller’s name and banking information
• Name of the intermediary bank issuing the letter of credit
• Amount of credit that’s being issued
• Date that the letter of credit is issued and the date it will expire
An irrevocable letter of credit will also detail the conditions that must be met by both the buyer and seller in order for the contract to be valid. For example, the seller may need to provide written verification that the goods or services referenced in the agreement have been provided before payment can be issued. The letter of credit must be signed by an authorized bank representative. It may need to be printed on bank letterhead to be valid.
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Do I Need an Irrevocable Letter of Credit?
You may need an irrevocable letter of credit if you’re doing business with someone in a foreign country. You may also require one if you are conducting a transaction with a new company or individual (one with which you don’t yet have an established relationship).
Irrevocable letters of credit can help to mitigate some of the risk that goes along with international transactions. These letters ensure that if you’re the seller, you get paid for any products or services you’re providing. They also protect you if you’re the buyer, promising that products or services are delivered to you.
An irrevocable letter of credit could also come in handy if you’re still working on building credit for your business and you’re the buyer in a transaction. The bank will pay the money to the seller; you’ll then repay the bank. Payment may be required in a lump sum from your business bank account or another source. Or the bank may also offer the option of repaying it in installments over time. Repaying your obligation could help to raise your business’s creditworthiness in the bank’s eyes. This may make it easier to take out other loans or lines of credit later. 💡 Quick Tip: Most savings accounts only earn a fraction of a percentage in interest. Not at SoFi. Our high-yield savings account can help you make meaningful progress towards your financial goals.
Alternatives to Irrevocable Letters of Credit
An irrevocable letter of credit is not the only way to do business when engaging in international transactions. You may also consider trade credit insurance or another type of letter of credit instead.
Trade Credit Insurance
Trade credit insurance, also referred to as accounts receivable insurance or AR insurance, is used to insure businesses against financial losses resulting from unpaid debts. You can use trade credit insurance to cover all transactions or limit them to ones where you believe there may be a heightened risk of loss, such as transactions involving foreign businesses.
A trade credit insurance policy protects your business in the event that the other party to a financial agreement defaults. It can insulate your accounts receivable against losses if an unpaid account turns into a bad debt. Purchasing trade credit insurance may be an easier way to manage risk for your business overall, as it’s less involved than an irrevocable letter of credit.
Recommended: Business Loan vs Personal Loan: Which is Right for You?
Letters of Credit
A letter of credit guarantees payment from the buyer’s bank to the seller’s bank in a financial transaction. Like an irrevocable letter of credit, it establishes certain conditions that must be met in order for the transaction to be completed. But unlike an irrevocable letter of credit, a standard letter of credit can be revoked or modified.
You might opt for this kind of letter of credit if you’re doing business with someone you don’t know and you want reassurance that the transaction will be completed smoothly. A regular letter of credit may also be preferable if you’d like the option to modify or cancel the agreement.
The Takeaway
An irrevocable letter of credit is something you may need to use from time to time if you run a business and regularly deal with international transactions. It adds a layer of protection to buying and selling, as a bank is saying it will cover the transaction. An ILOC, as it’s sometimes known, can provide reassurance when working with a new business or establishing your company overseas. The letter cannot be changed, so you’re getting solid peace of mind.
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FAQ
What is the difference between a letter of credit and an irrevocable letter of credit?
A letter of credit and irrevocable letter of credit are largely the same, in terms of what they’re designed to and in what situations they can be used. The main difference is that unless a letter of credit specifies that it is irrevocable, it can be changed or modified by the parties involved.
What is the cost of an irrevocable letter of credit?
You generally need to pay a transaction fee for an irrevocable letter of credit. The fee is typically a small percentage of the transaction amount. The rate will vary from bank to bank.
Does an irrevocable letter of credit expire?
Yes, an irrevocable letter of credit will typically state the date by which the seller must submit the necessary paperwork in order to receive payment.
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Have you been asking yourself, “Should I move to Madison, WI?” Known for its picturesque lakes, exciting cultural scene, and top-notch educational institutions, Madison offers a unique blend of small-town charm and big-city amenities. But is it the right move for you? In this article, we’ll explore the various aspects of life in Madison, helping you weigh the pros and cons to determine if this dynamic Midwestern city is your ideal new home. Let’s get started.
Madison at a Glance
Walk Score: 50 | Bike Score: 66 | Transit Score: 35
Median Sale Price: $425,000 | Average Rent for 1-Bedroom Apartment: $1,625
Madison neighborhoods | Houses for rent in Madison | Apartments for rent in Madison | Homes for sale in Madison
Pro: Access to beautiful lakes
Madison is surrounded by four stunning lakes, Lake Mendota, Lake Monona, Lake Waubesa, and Lake Kegonsa. This close proximity to water offers locals numerous recreational activities. Residents enjoy boating, fishing, and kayaking during the warmer months. The lakes also provide scenic views and serene spots for picnics. In winter, they transform into ice skating and ice fishing venues. This unique feature enhances the city’s charm and outdoor lifestyle.
Con: Harsh winters
One of the significant downsides of living in Madison is the harsh winter weather. The city experiences long, cold winters with heavy snowfall and frigid temperatures that can dip well below freezing. This can make daily commutes challenging and outdoor activities less enjoyable. Residents often have to invest in proper winter gear and prepare their homes and vehicles for the cold season. This can be a significant drawback for those unaccustomed to harsh winter conditions.
Pro: Access to high-quality education
Madison is home to the University of Wisconsin-Madison, a top-tier public research university. This institution offers a wide range of academic programs and has a strong reputation for research and innovation. The presence of the university also means that residents have access to various cultural and educational events, such as lectures, art exhibits, and performances. Additionally, the university’s libraries and resources are available to the public, providing a wealth of knowledge and learning opportunities.
Con: High cost of living
The cost of living in Madison is 4% higher than the national average. Housing prices, in particular, can be steep, especially in neighborhoods close to the university or downtown. Additionally, the cost of goods and services, including groceries and dining out, can be higher than the national average. This means residents may need to budget carefully to manage living expenses in this city.
Pro: Extensive biking trails
With a Bike Score of 66, Madison is known for its extensive network of biking trails. The city promotes cycling as a primary mode of transportation. Trails like the Capital City State Trail and the Southwest Commuter Path offer scenic routes for commuting and leisure. Additionally, the city’s bike-sharing program, BCycle, provides convenient access to bikes for short trips. This emphasis on cycling promotes a healthy and active lifestyle for locals and makes Madison a haven for cycling enthusiasts.
Con: Limited public transportation
While Madison does have a public transportation system, it’s not as extensive or efficient as those found in larger metropolitan areas. The bus routes can be limited, and service frequency may not be convenient for all residents, particularly those living in more suburban or outlying areas. This can make it challenging for individuals without a car to navigate the city and access essential services and amenities.
Pro: Thriving farmers’ markets
Madison hosts one of the largest producers-only farmers’ markets in the nation. The Dane County Farmers’ Market offers fresh, local produce and artisanal goods. It’s a community hub where residents gather weekly. The market supports local farmers and promotes sustainable living. It’s a beloved tradition that enhances the city’s local culture.
Con: Limited nightlife options
While Madison has a variety of bars and entertainment venues, its nightlife options can be somewhat limited compared to larger cities. The city’s smaller size means fewer options for live music, theater, and other late-night entertainment. This can be a significant drawback for those seeking a more vibrant nightlife scene.
Pro: Rich cultural scene
Madison offers a rich cultural scene with a variety of museums, theaters, and art galleries. The Overture Center for the Arts hosts Broadway shows, concerts, and other performances, while the Chazen Museum of Art features an impressive collection of visual art. The city also has a dynamic music scene, with numerous live music venues and annual events like the Madison World Music Festival. These provide locals with ample opportunities to enjoy and participate in the arts.
Con: Seasonal allergies
Madison’s lush environment can be challenging for those with seasonal allergies. Pollen levels can be high during spring and summer. This can cause discomfort and health issues for allergy sufferers. Managing symptoms sometimes requires medication and lifestyle adjustments for some. This can be a significant drawback for some individuals.
Madison is known for its strong sense of community and civic engagement. Residents are often involved in local events, volunteer opportunities, and neighborhood associations. The city hosts numerous festivals and community gatherings throughout the year, such as the Wisconsin Film Festival and the Great Taste of the Midwest beer festival. This sense of camaraderie and active participation helps foster a welcoming and inclusive atmosphere
Jenna is a Midwest native who enjoys writing about home improvement projects and local insights. When she’s not working, you can find her cooking, crocheting, or backpacking with her fiancé.
Relatively Sharp Losses, but Nothing Special in The Bigger Picture
By:
Matthew Graham
Tue, May 28 2024, 3:49 PM
Relatively Sharp Losses, but Nothing Special in The Bigger Picture
Bonds began the day modestly stronger, and that was their first mistake. Starting around 10am, the gains began evaporating following comments from Fed’s Kashkari (who needs to see “many” more months of good inflation before considering a cut) and a big pop in consumer confidence data. In the next 3 hours, both the 2yr and 5yr Treasury auction would add to the pressure. MBS were only down a quarter point on the day, which is an unremarkable move for the first day back after a 3 day weekend, but in contrast to the low volatility gains in the first 2 hours of the day, it feels subjectively abrupt. Mortgage lenders concur, based on the number of reprices (and 2nd reprices).
FHFA Home Prices
0.1 vs 0.5 f’cast, 1.2 prev
Case Shiller Home Prices
1.6 vs 0.9 prev
Consumer Confidence
102.0 vs 95.9 f’cast, 97.0 prev
09:55 AM
Sideways in a narrow range overnight. 10yr unchanged at 4.466. MBS up 3 ticks (.09).
10:23 AM
Slightly weaker after confidence data and Fed comments. 10yr up 2 bps at 4.486. MBS up 1 tick (0.03), but down 3 ticks (0.09) from intraday highs.
11:37 AM
More losses after 2yr auction. MBS down 2 ticks (.06) and 10yr up 3bps at 4.496
01:06 PM
10yr yields are now 5.6bps higher at 4.522 and MBS are down an eighth on the day
03:01 PM
Weakest levels of the day with MBS down 9 ticks (.28) and 10yr yields up 7.4bps at 4.54
Download our mobile app to get alerts for MBS Commentary and streaming MBS and Treasury prices.
The majority of homebuyers stick with the very first mortgage product offered, opting to not shop around with other lenders, a study conducted by an online financial services marketplace found.
Over 54% of borrowers with mortgages on a recent home only received one mortgage offer, a LendingTree survey published Monday said. In cutting their home buying journey short, borrowers may not be getting the best deal for themselves.
The survey, which gathered the opinions of over 2,000 participants in mid-April, concluded that 45% of homebuyers with a mortgage who shopped around got a lower offer than their first.
In breaking down the survey responses, only a mere 22% of borrowers got two offers and 17% got three or more offers.
Millennials in the group were more likely to comparison shop with 62% reporting doing so, while 28% of boomers in the questionnaire say they weighed different options. Meanwhile, a greater share of women (62% of the female respondents) said they are likely to accept the first offer without shopping around, compared to 46% of men.
Figuring out how much borrowers can actually save if they shop around is contingent on mortgage rates and loan size, but it can be a significant chunk of change, said Jacob Channel, senior chief economist at LendingTree, in a written statement Monday.
“That said, it’s not out of the realm of possibility for someone who received multiple offers and then picked the one with the lowest rate to save hundreds of dollars a month, thousands of dollars a year and tens, if not hundreds, of thousands of dollars over the lifetime of their loan,” he added in a press release.
Almost 30% of those surveyed said the top reason for not seeking multiple mortgage offers stemmed from confidence that they were receiving the best rate, followed by 20% saying they had a desire to use the lender recommended to them by their real estate agent.
Refinances, however, are a different story, with the survey finding that out of the 45% of homebuyers who’ve refinanced the mortgage on their current home, 56% shopped around.
A little over 80% of those who shopped around found a lower rate than their current lender offered, the report concluded
To no one’s surprise, a good chunk of the survey’s participants said mortgage rates have had an impact on when they decided to buy a home.
Over a third of buyers (35%) purchased a home earlier than planned to take advantage of low rates. Comparing genders, 43% of men were swayed to purchase a home due to lower rates versus 26% of women respondents.
Meanwhile, about 57% of respondents say they met with a real estate agent before they met with a lender during their home buying process.
The HousingWire award spotlight series highlights the individuals and organizations that have been recognized through our Editors’ Choice Awards. Nominations for HousingWire’s 2024 Women of Influence award are open now through May 31st, 2024. Click here to nominate someone.
For the past 15 years, the HousingWire Women of Influence award has celebrated the exceptional contributions of women leaders in the housing industry. This prestigious recognition honors those leaders who have made a significant impact on their organizations and the industry at large through their leadership, innovation and dedication.
In honor of the 2024 Women of Influence nomination period, we’re taking a look back at previous year’s winners. We reached out 2023 honorees to learn the most valuable lessons they’ve learned throughout their careers. Take a look below to see what they said.
Throughout my career, I’ve really seen that helping others isn’t just nice, it’s crucial. When you’re just zeroed in on your own stuff, it’s easy to lose touch with what’s happening around you. But when you help someone else up, you end up getting new perspectives and ideas that can push your own boundaries. It’s all about making sure we’re not climbing alone. And another lesson, though it might sound cliché, is that the biggest insights often come from making mistakes, particularly when taking chances. Each time I’ve stepped out of my comfort zone, whether things turned out well or not, I’ve gained invaluable skills. These experiences teach resilience, adaptability, and often point you towards your best next move. — Ines Hegedus-Garcia, Executive Vice President at Avanti Way Realty
One of the most transformative lessons I’ve embraced is the art of becoming a ‘collector’ of remarkable people. I don’t just meet individuals; we forge deep connections, cherishing the relationships that form the very fabric of our shared journey. When these remarkable individuals cross my path, I embrace and hold on to the unique value they bring. These aren’t just fleeting interactions but deep, enduring bonds that have stood the test of time—5, 10, even 25 years. They’re fundamental in every aspect, offering more than mere professional collaboration; they are the bedrock of personal growth, support, and the very essence of heartfelt connection. In times of adversity, the power of these connections becomes unmistakably clear. The voices of encouragement and truth from these cherished relationships are priceless, offering not just advice but profound, meaningful engagement that has deeply influenced my path. These are not just relationships; they are the pillars that support and enrich our lives continuously, essential for nurturing resilience and well-being. — Sarah Middleton, Chief Growth Officer at Movement Mortgage
My advice is to dedicate yourself to continuous learning. Whether through formal education, on-the-job-training, industry conferences, or self-study, staying informed is essential in navigating the ever-evolving landscape of the housing market. — Odeta Kushi, VP, Deputy Chief Economist at First American Financial Corporation.
Combining finances with a partner can happen at any stage of your relationship, even if you’ve been married to your partner for a long time. It can be a great opportunity for a couple to get on the same page about what they want their financial future to look like, especially when it comes to big considerations such as child care, homeownership and retirement.
An academic study published in the Journal of Consumer Research in 2023 found that couples with joint bank accounts experience less financial conflict and greater harmony within their relationships. The study results indicated that couples who merged their finances had a strong sense of financial partnership. In contrast, couples with separate bank accounts tended to operate in a more “tit for tat” financial exchange.
If you and your partner feel like it’s time to combine your finances, here’s how you can work toward merging your money.
Taking the plunge on merging finances with your partner
Perhaps you’ve kept your finances separate out of convenience, but now you’re getting tired of making online transfers to your partner for every shared expense. Or maybe you’ve got a considerable expense coming up and you want to streamline your accounts.
Jen Mayer, an accredited financial counselor and founder of the Brooklyn, New York-based firm Fully Funded, often works with couples who are deciding whether to combine their finances after a long time together. The first thing she likes to do is retrace the couple’s steps.
“When helping these couples, we usually want to know why their finances weren’t merged originally,” Mayer says. “There may be some beliefs about money from someone’s childhood — like maybe their parents had a bad marriage with a lot of conflict around money — that led them to want to keep their finances separate. We have to work out those beliefs first.”
Once a couple is aware of potential hang-ups around money, they can communicate more about their money management, goals and expectations as they begin the merging process. They might find that shared bank accounts can make their lives easier, but they also might choose to partially merge their accounts and keep separate accounts as well so each partner can have independent spending money.
Ultimately, if you’re married, Mayer says, all of your money is in the same pot and belongs to both people. A couple just has to decide how they will manage it.
How to merge finances long after marriage
Track spending habits and consider making a budget. For some, the act of tracking income and expenses can bring up uncomfortable feelings.
“If someone hasn’t been tracking their spending, they might not want to know where their money is going,” Mayer says. “But that information is data, and knowledge is power. If you want to change things, you have to be able to make informed decisions with that data.”
Once you have details about your income versus expenses, you and your partner can decide how much you want to spend on groceries, dining out, clothes and more. You also might make bigger decisions, such as moving into a home with lower rent or buying a car with a monthly payment that you can more easily afford.
Discuss how you’ll split shared expenses. Couples rarely have equal incomes, but when you’re married, your household expenses become a shared responsibility. To avoid resentment, couples should discuss an equitable arrangement for how expenses will be paid and who is responsible for which financial tasks in the household. For example, if one partner makes twice as much money as the other, perhaps they’ll contribute double to household expenses.
Open a joint account or add your partner to an existing account. If you don’t have a shared checking or savings account, you can shop around for a new account or see if your bank will allow you to add a co-owner to an existing account. Keep in mind that co-owners each have full ownership of the account and can withdraw as much money as they see fit. You may want to set spending limits with each other so you’ll both be informed about big purchases and avoid potential overdrafts. For a shared savings account, you’ll want to look for a high-yield account that helps you earn as much interest as possible on your money.
As you navigate the world of shared finances, remember that a strong financial partnership starts with a commitment to honest communication, teamwork and shared goals. These values can help you maintain a solid foundation in your marriage, too.
Thanks to reader Lynn, who wrote in this week with some specifics about her household’s situation and an overarching question: When should we start taking Social Security?
I’ll provide background information below, and then we’ll discuss a few common “if –> then” heuristics to help you with your Social Security planning.
Background – The Pros and Cons of Taking Social Security Early
Social Security is a government program that provides financial support to individuals who are retired, disabled, or survivors of deceased workers, funded primarily through payroll taxes. It aims to ensure economic stability and security for eligible participants by offering benefits to mitigate income loss due to retirement, disability, or death.
Today, we’re talking about retirees.
American retirees each have an “eligible benefit” from Social Security, which is based on the following factors.
They must be 62 years old or older
They’ve worked and paid into Social Security for at least 10 years (measured quarterly, for a total of 40 or more quarterly credits)
They could be eligible for additional credits based on their spouse’s work history, too.
Your eligible benefit is determined by your highest 35 years of earnings, with each year’s earnings adjusted for inflation (aka “indexed”). The higher your overall earnings, the greater your Social Security benefit will be.
Quick Example: AIME and PIA
Here’s a quick example:
Bob worked the same job from age 22 to age 62. His salary in 1984 was $25,000, and he’s received a 4% raise every year since; he’s earning $120,000 now in 2024 (his final working year).
We’d use the Social Security indexing factors to adjust each of his prior years’ earnings by rates of inflation. We’d then pick the highest 35 years, find the average, and divide by 12 to get Bob’s average indexed monthly earnings, or AIME.
Bob’s AIME is $8717. Here’s the Google sheet with the math. Feel free to make a copy.
Note 1: because only a certain percentage of income is subject to Social Security taxes, only that portion of earnings is considered for AIME. In 2024, the FICA income limit is $168,800. Even if someone earned millions every year for their entire career, their AIME would only include that smaller portion of income that was taxed by FICA. That logic is why the maximum AIME in 2024 is ~$13,100.
Note 2: if you don’t work a full 35 years, you’ll have some “zeroes” in your AIME math. This isn’t ideal. But depending on the rest of your work history, these zeroes could have a major effect or a minor effect. The PIA section below will shed more light.
Next comes PIA, or the Primary Insurance Amounts, aka what you actually receive from Social Security if you retire at “full retirement age,” or FRA. PIA is the real deal. An individual’s Social Security benefits (or PIA) are based on specific percentages of that individual’s AIME. For 2024, the PIA math is:
Take 90% of AIME below $1174
Plus 32% of AIME between $1174 and $7078
Plus 15% of AIME above $7078
If we run that math for Bob, whose AIME was $8717…
90% of his first $1174 = $1056.60
plus 32% of ($7078 – $1174) = $1889.28
plus 15% of ($8717 – $7078) = $245.85
For a grand total PIA of $3191.73per month.
You see – not all your AIME dollars count the same! The first dollars matter a lot – they’re counted at 90%! The latter dollars are only counted at 15%. And since high-earners’ latter dollars aren’t factored into AIME at all, we can think of those dollars as being counted at 0%. This concept is dubbed the “Social Security bends” or “bend points” because of how it looks when graphed out.
If you have a “zero year” in your 35 years of earnings, your AIME will certainly decrease. But if you’re already in the 0% or 15% section of the PIA graph, it might have only a tiny effect on your PIA. It’ll have a huge effect if you’re in the 90% section.
Bob had his final ~$1700 of AIME in the 15% section of the PIA graph. I ran a quick test and turned his 35th year into a zero. His AIME dropped from $8717 to $8487 – a $230 drop. His PIA dropped from $3192 per month to $3157 – a $35 drop. $35, you might guess, is 15% of $230.
PIA is Bob’s benefit if collects at “full retirement age.” But what if he collects early?
What About the Age You Start Collecting?
Social Security uses a concept called “full retirement age” (FRA) to determine how much of your eligible benefit you get to collect. Your personal FRA depends on the year you were born. The chart below shows the details:
FRA is either 66 or 67 years old for today’s new retirees. You can start collecting Social Security benefits before your FRA, but there’s a price to pay. Your benefits will be permanently reduced. But by postponing your benefits until after your FRA, your benefits will be permanently increased. The two charts below show both sides of that coin for both age 67 FRA retirees and age 66 FRA retirees.
Let’s do a quick decoder to make sure you understand how this all fits together.
If Bob was born in 1962 (and therefore is 62 years old today), he could start collecting Social Security right now. His FRA (based on his birth year) is 67, so we’ll consult the blue section of the table above. By collecting at age 62, Bob will only receive 70% of his full benefit. His PIA was $3192 per month; Bob would only collect 70% of that, or $2234 per month.
If Bob waits to collect, a few things will happen.
First, the AIME math and the PIA bends will likely change to account for inflation and other factors. On net, this will increase Bob’s PIA.
Second, Bob’s postponed filing age will increase his benefit amount, per the blue table above. If Bob waits until age 70, he’ll receive 124% of his PIA.
This begs a question: should Bob collect early to get those extra years of income, though at a discounted benefit? Or collect later, for fewer years, but at a much higher rate? When is the breakeven point?
The Breakeven Point for Collecting Social Security
When is the breakeven point for collecting Social Security? I looked at retirees with FRA = 67 years old. Here’s my Google sheet if you want to play around with it yourself.
With the bare eye, you can see the breakevens occur in the upper 70s. The joke in financial planning is, “Tell me when you’ll die, and I’ll tell you when to start collecting Social Security.” But the rough outline is:
If you die before age 77, collecting as early as possible would have been best.
If you die between ages 78-80, then all scenarios are roughly equal (all within ~6% of one another)
If you die after age 80, then waiting until at least “full retirement age” of 67 has distinct advantages
If you die after age 84, then waiting until the maximum collection age of 70 becomes optimal, and it only gets better the longer you live.
But there’s much more to consider than “how long will you live?”
So let’s get to the real meat of the article: what are some applicable thought processes, strategies, and if –> then scenarios to guide you and your family in Social Security decisions?
This is Hard to Get Right
As Annie Duke says (and I love to repeat), two things determine outcomes in our life:
the quality of our decisions, and
luck.
Or, put another way, there are things in your control and things out of your control.
Whatever decision you make regarding Social Security, you must accept that luck might strike, and your decision won’t have been the optimum one. It’s not because of the quality of your decisions. It’s because of luck. (This is “results-oriented thinking,” a bias worth breaking.)
You Want to Get This Right
This is close to a one-way gate.
Once you start collecting Social Security, you do have up to 12 months to 1) change your mind and 2) repay any benefits you’ve received so far. You get one of these “withdrawals” in your lifetime.
Once you delay collecting, though, you can’t go back in time and reclaim those missed benefits.
Ideally, you want to get this decision right.
Health, Illness, Family History, and Social Security
The most common questions surrounding Social Security revolve around your personal health and family history. We’ve determined that ages in the late 70s to early 80s are the “break even” point. You should ask: does anything in your personal or family history point you toward an early or late death?
If you’re healthy and all your relatives live to 100, it’s reasonable to assume you could have a similar fate. Postponing Social Security as long as possible (age 70) makes sense.
If you’re chronically ill, your relatives have all passed away early, etc., again, you can reasonably assume you could have a similar fate. Collecting Social Security as early as possible would make sense.
Granted, I’m not a doctor. One health phrase worth remembering is, “Genetics loads the gun, environment pulls the trigger.” In other words, you aren’t condemned to your family history. You have dials to control. Don’t forget that.
Do You Need It? It’s Longevity Insurance.
Do you need to take Social Security early? Will that extra income bridge the gap between cat food and a normal human diet? Because if you don’t need Social Security, why take it early?
Delaying your Social Security will act as “longevity insurance,” protecting against the risk that you will live to 90, 95, or beyond. The longer you wait, the higher your benefit will be, and the better your long-term outcomes will be.
Are You Still Planning to Work?
Are you planning to work while also collecting Social Security? Tread carefully! Your work income will actively eat away at your Social Security benefits.
Bob, for example, who is age 62, can only earn $22,320 in ordinary income before he hits trouble. For every $2.00 he earns above that limit, $1.00 will be deducted from his annual Social Security benefit. If Bob earns $125,000 (like he did last year) while also collecting Social Security at age 62, he effectively receives $0.00 in Social Security benefits while being permanently hamstrung by his choice to collect early. Ouch.
That specific income limit increases to $59,520 during the year someone reaches their FRA, and the penalty ratio “lessens” to 3-to-1. The penalty disappears altogether once the FRA has been reached.
There’s always a corner case, so making a concrete rule about working while collecting is hard. That said, it’s like going into credit card debt. You really want to avoid it if you can. You really want to avoid starting Social Security benefits before full retirement age if you plan on working.
Consider Spousal Benefits
Spousal benefits are one of the many rabbit holes in Social Security planning. There are many paths, they go deep, and it’s easy to get lost. Trust me, Alice.
The upshot for basic Social Security planning is that your decision to collect Social Security not only affects you, but could affect your current spouse, your ex-spouse, and/or your future spouse or future widow.
Remember Bob? His PIA is $3192 per month. Bob is married to Sharon. Her PIA is $1200 per month. Let’s say they both opt to start collecting at FRA, and thus collect exactly 100% of their PIA each.
Sharon also gets to collect a spousal benefit. If she applies for a spousal benefit when she hits her FRA, she is eligible for 50% of Bob’s PIA (or $1596 per month). She’ll collect her $1200 benefit and then an additional $396 per month.
But if Sharon had applied for the spousal benefit at age 62, she’d only be eligible for ~35% of Bob’s PIA, or $1117 per month. Since this number is lower than her own benefit of $1200, Sharon will get no extra spousal benefit.
Now, what if Bob dies?
Notably, Sharon would step into Bob’s benefit, receiving the full $3192 per month!
If Bob had started collecting at age 62, though, his benefit would have been $2234 per month. Sharon would step into that $2234 per month benefit when he died.
If Bob had started collecting at age 70, his benefit would be $3958 per month. Sharon would step into that $3958 per month benefit when he died.
Bob’s decision doesn’t only affect his benefits. It also affects Sharon, assuming she outlives him.
Some rules of thumb when it comes to spousal benefits:
The lesser-earning spouse can start collecting Social Security as early as possible, especially if they’ll become eligible for a larger spousal benefit at FRA (e.g. just like Sharon, who jumped from her own benefit up to the spousal benefit of $1596)
The higher-earning spouse should delay Social Security to age 70 because their decision not only has a 100% chance of affecting their own benefit but also has a ~50% chance of affecting their spouse’s eventual benefit (if we assume the “who dies first?” question is a coin flip).
What About the Overall Financial Plan, and Sequence of Returns Risk?
How does Social Security fit into your total financial plan? Especially in the early years of retirement, where you’re most at risk for a sequence of returns disaster?
“Sequence of returns risk” refers to the potential that a poor-performing portfolio early in your retirement will cascade into long-term pain. If your assets are worth less early on, you’ll be forced to sell more of them than you anticipated. This leaves fewer assets in your portfolio to grow for the long run.
One way to mitigate this risk is to find alternate sources of retirement income. Social Security, perhaps?! If early Social Security is a vital part of your overall plan’s success, the failure risk introduced from delaying Social Security could be too great to bear.
Taxability Concerns
Social Security is taxable (for many retirees). It’s worth considering if your decision to collect Social Security will have taxation impacts and what your net-of-tax benefits are.
What Do Your Trusted Advisors Have to Say?
While every retirement is a unique adventure, these adventures often rhyme. Your trusted advisor(s) might have seen dozens or hundreds of successful retirements before, all of which rhyme with your plan.
Their counsel might sway you in an optimal direction.
“I’m Ready Uncle Sam!”
Are you ready for Social Security? It’s not an easy question to answer.
Hopefully, I’ve answered more questions today than created new ones. Still, don’t hesitate to reach out with any questions or concerns.
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
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Most of the company’s loan officers work for the City of Houston, where Firehouse is based, around eight days a month. That means two days a week at the fire department, giving them the time needed to balance loan officer work with their first responder duties. “They’re able to balance out and still give a … [Read more…]
Homeownership is possible with bad credit home loans
The range of home loans for bad credit available today often surprises buyers.
Many lenders will issue government-backed FHA and VA loans to borrowers with credit scores starting at 580. Some lenders even offer FHA loans with a credit score as low as 500, though this is far less common.
With a credit score above 600, your options open up even more. Conventional mortgages require only a 620 score to qualify. And with a credit score of 680 or higher, you could apply for just about any home loan.
Verify your home loan eligibility. Start here
In this article (Skip to…)
Can I buy a house with bad credit?
Yes, you can buy a house with bad credit. While getting approved for a home loan with bad credit is challenging, it’s not impossible.
Check your home loan options. Start here
Across the industry, the lowest possible credit score to get a mortgage loan is 500. However, it’s important to note that mortgage lenders willing to accommodate such low scores are few and far between.
Additionally, these lenders usually charge higher interest rates to offset the risk associated with lending to borrowers with poor credit histories.
What do mortgage lenders consider a bad credit score?
The definition of a bad credit score varies between mortgage lenders. But, as a rule of thumb, the FICO scoring model considers scores below 580 to be “poor” or “bad.” If you’re looking for a mortgage with a credit score below 620, it may be considered a “low credit mortgage.”
Verify your home loan eligibility. Start here
FICO credit score ranges:
Below 580: Bad credit
580 to 669: Fair credit
670 to 739: Good credit
740 or above: Excellent credit
Still, some home buyers can qualify for a home loan with a FICO score as low as 500, depending on the loan program.
Home loans for bad credit
Home buyers seeking bad credit home loans have multiple programs to choose from. Yet, the FHA loan stands out as the most common mortgage option for those with poor credit histories.
When comparing home loans for bad credit, evaluate the loan terms, interest rates, and monthly payments to determine which suits your personal finances best.
Verify your home loan eligibility. Start here
Although each loan program and lender has its own unique credit score requirements and minimum down payments, here’s what you can generally expect to see:
FHA loan: 500 credit score
An FHA mortgage is a government-backed loan guaranteed by the Federal Housing Administration. This is why they’re a good option for borrowers with bad credit. You can qualify for an FHA loan with a low credit score of 500 and a 10% down payment, or 3.5% down if your FICO is 580 or above.
FHA loans accept applicants with credit scores as low as 500.
Applicants with scores between 500 and 579 need a 10% down payment.
Borrowers with low or bad credit may pay higher mortgage interest rates, but FHA loan rate increases are typically lower than conventional loans.
An upfront and annual mortgage insurance premium (MIP) is required, which adds to the loan’s overall cost.
Another appealing quality is that, unlike conventional loans, FHA-backed mortgages don’t carry risk-based pricing. This is also known as “loan-level pricing adjustments” (LLPAs). Risk-based pricing is a fee added to loan applications with lower credit scores or other less-than-ideal traits.
Check your FHA loan eligibility. Start here
FHA loans are a strong option if you’re seeking home loans with bad credit. This type of mortgage offers lenient qualifying credit requirements and no risk-based pricing adjustments.
Non-qualified mortgage (Non-QM): 500 credit score
Non-QM loans offer a more flexible lending criteria for those who do not meet the strict qualifications of conventional mortgages, with some available to borrowers with credit scores as low as 500.
Tailored for applicants unable to qualify for mainstream home loans.
Usually charge higher interest rates compared to other types of loans.
For individuals with bad credit, non-QM loans provide an alternative path to homeownership, albeit with potentially higher costs.
Check your bad credit home loan options. Start here
If you’re interested in a non-QM loan, check out the specialty mortgage programs some banks and credit unions offer that are neither conventional loans nor government-backed. Or, work with a mortgage broker who can recommend products from various lenders that might fit your needs.
VA loan: 580 credit score
The Department of Veterans Affairs offers VA loans to veterans, active-duty service members, and some military-affiliated borrowers. VA loans do not require a down payment or ongoing mortgage insurance payments.
VA loans do not have a minimum credit score, but lenders typically prefer a minimum of 580 to 620.
Borrowers with lower credit scores get rates comparable to those with higher credit scores.
VA loans are renowned for offering the lowest interest rates available.
A one-time funding fee is included, which most borrowers roll into their closing costs.
Verify your VA loan eligibility. Start here
VA loans are among the best options for financing a home for those who qualify, regardless of credit history.
Conventional loan: 620 credit score
Conventional loans are arguably the most common type of mortgage. Borrowers with low credit scores may wish to consider alternative options because a conventional loan would most likely have higher interest rates and fees.
A minimum credit score of 620 is generally required.
Loan-level price adjustments (LLPAs) are based on credit score and loan-to-value ratio (LTV).
Private mortgage insurance (PMI) is required for down payments of less than 20% of the home purchase price.
As your LTV rises and your credit score falls, your fee goes up. For instance, a borrower with a 20% down payment and a 700 credit score will pay 1.25% of the loan amount in LLPAs. But an applicant with a 640 score and 10% down will be charged a fee of 2.75%.
Verify your conventional loan eligibility. Start here
Still, despite the higher costs associated with lower credit scores, conventional loans remain a viable option for many, with FHA loans often presenting a more cost-effective route for bad-credit borrowers.
Fannie Mae HomeReady: 620 credit score
The HomeReady program by Fannie Mae offers an avenue for low- to moderate-income borrowers to secure financing with just a 3% down payment.
A minimum credit score of 620.
Available to both first-time and repeat home buyers.
Offers reduced rates for private mortgage insurance compared to standard conventional loans.
Verify your HomeReady eligibility. Start here
HomeReady is an excellent program for those looking to finance homes in low-income communities.
Freddie Mac Home Possible: 660 credit score
Freddie Mac’s first-time home buyer program, Home Possible, can help buyers get into homes with a 3% down payment.
Minimum credit score of 660
Must be a first-time home buyer
Down payment assistance programs are available for those unable to save the required down payment.
Verify your Home Possible eligibility. Start here
This loan program is particularly well suited for first-time home buyers with moderate credit.
USDA loan: 640 credit score
USDA loans are popular with home buyers in qualifying rural areas because they offer zero-down payment options and competitive mortgage rates.
Applicants need a minimum 640 credit score to qualify.
The property must be situated in a designated rural area.
Household income cannot exceed 115% of the area median income (AMI).
Whether you’re purchasing a home or refinancing your current mortgage with a USDA loan, you’ll pay a 1% upfront guarantee fee and a 0.35% annual fee.
Verify your USDA loan eligibility. Start here
A USDA mortgage is a government-backed loan guaranteed by the U.S. Department of Agriculture. This is why USDA loans are a great option for people looking to buy real estate in a rural area because they have flexible credit requirements and require no down payment.
Bad credit mortgage lenders
A less-than-perfect FICO score doesn’t mean you’re confined to dealing with subpar mortgage lenders. Surprisingly, some top-tier lenders specialize in assisting borrowers whose credit scores hover around or even dip below 600.
While it’s true that qualification may not be possible for everyone and your interest rate might be above what a “prime” mortgage borrower would receive, you have just as much right to seek out the best mortgage rates, fees, and customer service. Don’t let your credit score deter you from exploring all available options.
For comprehensive advice on finding the right lender for your situation, check out our guide to the best bad credit mortgage lenders. This resource lists the top lenders specifically catering to bad credit home loans, helping you make an informed decision that aligns with your needs.
How to get a home loan for bad credit
Improving your chances of getting a bad credit home loan may seem daunting, but there are strategies to boost your loan approval odds. As you begin the loan application process, mortgage underwriters will review your entire financial history. If your credit is low but the rest of your financial picture looks good, you’re more likely to get approved.
Check your home loan options. Start here
By following these proven steps, you can significantly improve your appeal to lenders and streamline your home buying process.
Check your free credit report for accuracy
The three major credit bureaus (Experian, Equifax, and TransUnion) make mistakes sometimes. Your creditors can report inaccurate information to the credit bureaus, too. Monitor your credit history to notice errors before they lower your score. The government has set up a website where you can check your credit accounts free: annualcreditreport.com
Dispute inaccurate information
If you do find inaccurate information in your credit history, be sure to file a dispute, especially if the errors include huge blemishes like foreclosures, repossessions, or collections accounts.
Collections accounts can linger on your credit reports for years. They can negatively impact your financial standing even after they’re paid, as paying off a collection upgrades its status to “Paid” but doesn’t remove it from your report.
Negotiating for its complete removal, known as “Pay for Delete,” by contacting the collection agency and offering payment in exchange for deletion from your credit report is a game-changer. Always ensure this agreement is in writing before making any payments, effectively erasing the financial mishap and potentially boosting your credit score.
Get mortgage loan preapproval
Securing mortgage preapproval is a pivotal step for buyers with bad credit. It not only clarifies your budget but also boosts your appeal to sellers. The preapproval process can also pinpoint where to improve your credit so be honest about your finances when seeking preapproval; lenders may suggest programs for credit issues.
Lower your DTI and credit utilization ratios
Lenders evaluate your debt-to-income ratio, or DTI, to determine if you can afford a new monthly mortgage payment. Reducing existing debts before submitting a mortgage application can make qualifying for a home loan easier.
Similarly, paying down credit card debt and personal loan balances also lowers your credit utilization ratio. Credit utilization measures your debt balance against your credit limit. For instance, a $7,000 balance on a $10,000 credit limit results in a 70% ratio, which is considered high. Aiming for a utilization ratio of 30% or lower can significantly boost your credit score.
Improve your payment history
Missed and late payments will lower your FICO score. Be sure to make on-time payments on all your loans and credit cards. It’s a good idea to set your accounts on autopay.
Consider a co-signer
If you’re unable to qualify for a mortgage due to a low credit score, you might want to consider bringing a co-signer into the equation. A co-signer essentially vouches for you, making lenders more comfortable with extending credit your way. In essence, you’re leveraging another person’s higher credit score and financial stability to boost your chances of securing that loan.
That said, it’s crucial to understand the responsibilities and implications for both parties involved. The co-signer’s credit score will be affected, for better or worse, by the loan’s performance. Lenders might also average your credit scores, depending on their specific policies, which can make the loan more attainable. Nevertheless, your interest rates will often be based on the lower of the two scores, meaning you may pay a bit more over the life of the loan.
Avoid unnecessary hard pulls
First things first: not all credit checks are detrimental to your credit score. Soft inquiries, such as those conducted for background checks, don’t affect your score.
However, hard inquiries, like the ones made when you apply for a new credit card or a loan, can lower your score a bit. Each hard pull can reduce your credit score by a few points. So always check whether the creditor will be performing a hard or soft pull on your credit report.
Leverage home equity
For homeowners who are unable to cash-out refinance due to bad credit, a home equity line of credit (HELOC) may be a solution. A HELOC allows access to funds based on the equity built in the home. By tapping into home equity through a HELOC, individuals bypass the strict credit requirements of conventional cash-out refinancing.
This approach can unlock cash for renovations, debt consolidation, or other financial needs, even when a poor credit score would typically close doors to such opportunities.
FAQ: Home loans for bad credit
Check your home loans for bad credit options. Start here
What is the lowest credit score to buy a house?
The lowest credit score typically required to buy a house is 500 with an FHA loan, which requires the borrower to make a 10% down payment. For credit scores of 580 or higher, a 3.5% down payment is sufficient. Conventional loans typically require a minimum credit score of around 620.
Can you get a mortgage with very bad credit?
Yes, it’s possible to secure a mortgage with bad credit, especially through government-backed loans designed to assist borrowers in this situation. Some lenders also offer home loans for bad credit, which are designed to assist potential homeowners with lower credit scores. These loan programs may offer other benefits, such as lower minimum down payments or no down payment requirements at all.
Which mortgage lender is best for bad credit?
Different mortgage lenders will view your application differently, so it’s important to shop around when you have bad credit. Online mortgage lenders have opened up more choices for many low-credit-score borrowers. Make sure to work with someone who has a Nationwide Mortgage Licensing System (NMLS) license.
How are mortgage lenders able to offer home loans for bad credit?
Unlike personal loans and student loans, mortgages are secured loans. The security comes from the value of your home, which your lender could repossess if you default. FHA, VA, and USDA loans have an additional level of protection: backing from the federal government. That’s why you could still get an FHA loan, for example, even with a credit score below 580, which most lenders consider subprime lending.
Can I get a home loan with a 500 credit score?
It is possible to find an FHA lender willing to approve a credit score as low as 500. You may also be able to find a non-QM (non-conforming) conventional lender with a 500 credit score minimum. But you won’t have many choices and must be prepared to make a larger down payment. It will also help if you have fewer other debts compared to your monthly income.
Check your eligibility for a bad credit home loan
It’s possible to buy a house with bad credit.
You’ll likely pay a higher mortgage rate, but you could get on the homeownership ladder now and start building equity. And you can always refinance to a lower rate later once your credit improves.
Want to find out whether you qualify for one of the many home loans for bad credit? Consulting with a mortgage loan officer about your options is free and will help you determine which bad credit mortgage program is best for you.
Time to make a move? Let us find the right mortgage for you
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Named after their grandmother, Mitzi is a family-owned business located in the Hudson Valley in New York. After three generations working in lighting, Mitzi was created to offer high end, statement lighting at approachable prices. The owners talk about how their grandmother inspired this work, saying, “Grandma Mitzi’s well-designed, eclectic style inspired the whole thing. As a painter and antique collector, Mitzi had an eye for finding the perfect piece at the right price.” Now the company’s mission is to help consumers do the same thing.