Definition of "Credit risk"

Nora  Haddow real estate agent

Written by

Nora Haddowelite badge icon

All Towne Realty

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.

image of a real estate dictionary page

Have a question or comment?

We're here to help.

*** Your email address will remain confidential.
 

 

Popular Mortgage Terms

The upfront and/or periodic charges that the borrower pays for mortgage insurance. There are different mortgage insurance plans with differing combinations of monthly, annual, and upfront ...

The option to convert an ARM to an FRM at some point during its life. ...

When a borrower has difficulty making the scheduled payment. Position of the Lender: A good place to start is by understanding the position of the lender. A game plan for survival ...

The federal law that specifies the information that must be provided to borrowers on different types of loans. Also, the form used to disclose this information. Truth in Lending (TIL) is ...

The amount the borrower owes at maturity. ...

The number of months for which the initial interest rate holds on an ARM. ...

The ratio of total housing expense to borrower income. This ratio is used (along with other factors) in qualifying borrowers. ...

An upfront cash payment required by the lender as part of the charge for the loan, expressed as a percent of the loan amount; e.g., '3 points' means a charge equal to 3% of the loan ...

The interest rate adjusted for intra-year compounding. Because interest on a mortgage is calculated monthly, a 6% mortgage actually has a rate of .5% per month. If there were no principal ...

Popular Mortgage Questions