Credit Risk
Definition of "Credit risk"
The definition of credit risk is at the core of lending. Banks lend money to businesses and individuals and expect to recover the principal and win interest. Banks offer a variety of loans, each designed for a particular group of borrowers from the market. On the one hand, people with good credit scores and high incomes and businesses with large sales figures will usually get low-interest loans - they are more likely to return the money and interest, so the credit risk is low. On the other hand, borrowers with bad credit scores and companies who are desperate for funding at all costs will receive high-interest loans because they will have difficulties in repaying their debt, which means that the credit risk is more significant. So, the banks can identify the quality of their borrowers from the amount of interest they are willing to pay. The credit risk refers to the probability for a lender to recover all his money and the interest from the borrower. From which the term name as credit risk. What is the risk of loss in case a borrower becomes unable to repay the loan? Obviously, this risk is greater for the borrowers willing to pay high interest rates since they are more likely to default.
An even shorter definition for credit risk would be banker’s biggest fear.
Events that can lead to a default
(1) Due to unforeseen circumstances, the borrower may lose the financial ability to repay the loan placing the collateralized property at risk of foreclosure.
(2) In the case of an adjustable rate mortgage, due to rising interest charges, payments could become unaffordable. The borrower may default on their mortgage and lose the property.
(3) In the event of a depreciating asset, the loan value may exceed the value of the collateralized asset.
(4) In the event of the death of the borrower, payments on a loan will become a liability for the heirs.
A default generally occurs after 270 days in which a borrower hasn't made any payments. However, student loans are considered in default after 120 days of missed payments. Credit defaults are the materialization of the credit risk.
Popular Mortgage Terms
Equations used to derive common measures used in the mortgage market, such as monthly payment, balance, and APR. ...
The largest loan size permitted on a particular loan program. For programs where the loan is targeted for sale to Fannie Mae or Freddie Mac, the maximum will be the largest loan ...
A very large increase in the payment on an ARM that may surprise the borrower. The term is also used to refer to a large difference between the rent being paid by a first-time home buyer ...
The definition of a reverse mortgage is important for homeowners 62 and older who want to supplement their retirement income. What exactly is a reverse mortgage? Some say that it is the ...
The ratio of housing expense to borrower income. This ratio is one factor used in qualifying borrowers. ...
Assuming responsibility for someone else's payment obligation in the event that that party defaults. ...
The process of raising cash periodically through successive cash-out refinancings. This is a scam initiated by mortgage brokers that victimizes wholesale lenders, with the connivance of ...
A condominium project with features that lenders view as favorable in terms of their risk exposure on loans secured by individual condo units. The requirements of warrantability include ...
The interest rate used in calculating the initial mortgage payment in qualifying a borrower. The rate used in qualifying borrowers may or may not be the initial rate on the mortgage. On ...
Have a question or comment?
We're here to help.