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 highest rate possible under an ARM contract; same as 'lifetime cap.' It is often expressed as a specified number of percentage points above the initial interest rate. ...
Adjustable rate mortgages on which the interest rate is mechanically determined based on the value of an interest rate index. Indexed ARMs are distinguished from Discretionary ARMs, in that ...
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 ...
Employees of lenders or mortgage brokers who find borrowers, sell and counsel them, and take applications. Loan officers employed by mortgage brokers may also be involved in loan ...
The period between payment changes on an ARM, which may or may not be the same as the interest rate adjustment period. ...
A mortgage on which interest is calculated daily based on the balance on the day of payment, rather than monthly, as on the standard mortgage. ...
Equations used to derive common measures used in the mortgage market, such as monthly payment, balance, and APR. ...
A mortgage on which the borrower gives up a share in future price appreciation in exchange for a lower interest rate and/or interest deferral. SAM's in the private market had a brief ...
Every ARM is tied to an interest rate index. An index has three relevant features:availibility, level, volatility. All the common ARM indexes are readily available from a published source, ...
Have a question or comment?
We're here to help.