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
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 ...
Limit on the size of payment change on an adjustable rate mortgage. ...
A borrower who must use tax returns to document income rather than information provided by an employer. ...
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 specific property. ...
A mortgage on which half the monthly payment is paid every two weeks. This results in 26 payments per year, which is the equivalent of 13 monthly payments rather than 12. Because of the ...
The lender's risk that, between the time a lock commitment is given to the borrower and the time the loan is closed, interest rates will rise and the lender will take a loss on selling ...
The definition of affordability in real estate is simply a buyer’s capacity to afford a house. Affordability is usually expressed in terms of the maximum amount a buyer will be able ...
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 date on which the closing occurs. On a purchase transaction, there is no financial advantage to the buyer/borrower in closing on any day of the month, as compared to any other day. ...
Have a question or comment?
We're here to help.