Credit Risk

Definition - What does Credit Risk mean?

Credit risk is the associated risk and uncertainty that a debtor will meet their financial obligations to repay a debt. Risk for non-payment exists for any entity that has borrowed funds, including businesses, individuals and sovereign governments.

For consumer risk assessment—such as when an individual is seeking to qualify for a home loan, an unsecured personal loan or any other credit product—assessing the credit risk is very important for the lender.

Justipedia explains Credit Risk

To assess a debtor’s risk, the lender will not only review the debtor’s credit report, but they will also review the debtor’s credit score. Although there are several numbers that can be used, the most popular is called the FICO credit score. FICO scores range from 300 to 850, with the lowest credit scores representing debtors with the highest credit risk.

The FICO score is currently used by 90% of financial institutions when assessing the credit risk of their potential customers.

The FICO score is comprised of five major categories: payment history, amount of debt owed, length of credit history, new credit and type of credit used. Some factors are weighed more heavily than other factors in the FICO calculation. For example, a debtor’s payment history comprises 35% of the score.

Debtors who are considered a high credit risk, which means they have a greater chance of defaulting on a loan, may find it difficult to get loan financing. Debtors who do receive credit may also have to pay substantially higher interest rates to borrow money, thus compensating the creditor for the increased risk of loaning money.

To find out more information about your credit score and whether or not you are considered a high-risk lender, you can contact each of the three largest credit agencies—Experian, Equifax and TransUnion—for a free annual credit report.

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