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
Insurance provided the lender against loss on a mortgage in the event of borrower default. In the U.S., all FHA and VA mortgages are insured by the federal government. On other mortgages, ...
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 provision of the U.S. tax code that allows homeowners to deduct mortgage interest payments from income before computing taxes. Points and origination fees are also deductible, but not ...
A mortgage loan transaction in which the lender assumes responsibility for an existing mortgage. A wrap-around can be attractive to home sellers because they may be able to sell their ...
Standards imposed by lenders as conditions for granting loans, including maximum ratios of housing expense and total expense to income, maximum loan amounts, maximum loan-to-value ...
USDA loans are a form of government-backed financing for both first-time home buyers and move up buyers looking for a second or third property. These loans have little to do with ...
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 ...
A mortgage Web site designed to provide leads to lenders. A 'lead' is a packet of information about a consumer in the market for a loan. Lenders pay for leads, and these sites are an ...
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 ...
Have a question or comment?
We're here to help.