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 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 ...
Acceleration Clause is a contractual provision inserted in a mortgage, a bond, a deed of trust or other credit vehicles, that gives the lender the right to demand repayment of the ...
Allowing the interest rate and points to vary with changes in market conditions, as opposed to 'locking' them. Floating may be mandatory until the lender's lock requirements have been met. ...
A second mortgage on a property that is not paid off when the first mortgage is refinanced. The second mortgage lender must allow subordination of the second to the new first mortgage. ...
Acceptance of the borrower's loan application. Approval means that the borrower meets the lender's Qualification Requirements and also its Underwriting Requirements. In some cases, ...
The monthly index is a ratio of monthly interest costs to total funds, expressed as a percentage. Annualized interest, the numerator, is calculated by multiplying the deposit balances at ...
After reaching a certain annual income, you might be interested in finding the definition of a jumbo mortgage. What is a jumbo loan? It is something like a mortgage with ...
Proliferation in the number of loan, borrower, property, and transaction characteristics used by lenders to set mortgage prices and underwriting requirements. Nichification is unique to ...
Often referred to as a “second mortgage”, a home equity loan is a type of loan where the borrower disposes to the lender its equity to the home as collateral. To ...
Have a question or comment?
We're here to help.