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
Interest that is earned but not paid, adding to the amount owed. For example, if the monthly interest due on a loan is $600 and the borrower pays only $500, $100 is added to the amount owed ...
Using a brokers time and expertise to become informed and creditworthy, then jumping to the Internet to get the loan. ...
The sum of all interest payments to date or over the life of the loan. This is not a good measure of the cost of credit to the borrower because it does not include upfront cash payments and ...
A Web site of an individual lender offering loans to consumers. Most Internet shoppers want a list of lenders in whom they can have confidence, who will provide them with the information ...
The definition of an assumable mortgage is what happens when a buyer assumes or takes over a mortgage that the seller contracted. This is a type of financial arrangement that passes an ...
The standards imposed by lenders in determining whether a borrower can be approved for a loan. These standards are more comprehensive than qualification requirements in that they include ...
A non-citizen with a green card employed in the U.S. Non-permanent resident aliens are subject to somewhat more restrictive qualification requirements than U.S. citizens. Permanent ...
A mortgage that does not meet the purchase requirements of the two federal agencies, Fannie Mae and Freddie Mac, because it is too large or for other reasons, such as poor credit or ...
The option to convert an ARM to an FRM at some point during its life. ...
Have a question or comment?
We're here to help.