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
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 ...
Same as term Interest Rate: The rate charged the borrower each period for the loan of money, by custom quoted on an annual basis. A mortgage interest rate is a rate on a loan secured by a ...
The period until the last payment is due. The maturity is usually but not always the same as the period used to calculate the mortgage payment. ...
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 comprehensive and time-adjusted measure of loan cost to the borrower. IC on a Mortgage: IC is what economists call an 'internal rate or return.' It takes account of all payments made by ...
A term that small lenders sometimes use to distinguish themselves from mortgage brokers. ...
Requirements stipulated by the lender that the ratio of housing expense to borrower income and the ratio of housing expense plus other debt service to borrower income cannot exceed ...
Refinancing for an amount in excess of the balance on the old loan plus settlement costs. When the main objective of a refinancing is to raise cash, the relevant question is whether the ...
A computer-driven process for informing the loan applicant very quickly, sometimes within a few minutes, whether the application will be approved, denied, or forwarded to an underwriter. ...
Have a question or comment?
We're here to help.