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 clause in the note that allows the lender to demand repayment of the balance in full. A demand clause is even better (for the lender) than an acceleration clause. An acceleration clause ...
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 ...
Prices that assume a more or less standardized set of transaction characteristics that generally command the lowest prices. Generic prices are distinguished from transaction specific ...
Someone authorized by the original credit card holder to use the holder's card. While authorized users are not responsible for paying any charges, including their own, they are sometimes ...
In connection with a home, the value of the home less the balance of outstanding mortgage loans on the home. ...
Interest from the day of closing to the first day of the following month. To simplify the task of loan administration, the accounting for all home loans begins as if the loan was closed ...
A borrower, usually refinancing rather than purchasing a home, who allows a lock to expire when interest rates go down in order to lock again at the lower rate. ...
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 government-owned or -affiliated lender that makes home loans directly to consumers. With minor exceptions, government in the U.S. has never loaned directly to consumers, but housing banks ...
Have a question or comment?
We're here to help.