Lender
Risk
Risk summary:
Your credit risk is a measure of how likely you are to repay your debts.
Your credit history, income, assets, and existing debt can all factor into the risk equation.
Lower-risk borrowers get better loan terms and have more credit opportunities.
Risk Definition and Meaning
Risk is the possibility of suffering harm or loss. In finance, we use the term "credit risk" to describe the possibility that a lender will lose the money they advance to a borrower.
How Risk Impacts Your Finances
Creditors face the risk of monetary loss every time they fund a new loan or credit line. Creditors can address that risk in a few ways:
Only approve borrowers with low credit risk.
Provide a secured loan, which requires collateral or assets that can be sold to repay the loan if terms aren't met.
Charge higher fees and interest rates to riskier applicants so that, as a group, these loans perform as well as loans to applicants with good credit. It takes more income to balance out the higher losses in this group.
All this means that borrowers with low credit risk have more options, get better terms, and pay less for credit products overall.
Many people use credit every day, whether it's a credit card at the cash-free corner store or the mortgage loan for your six-figure house. It's become hard to avoid credit, so lowering your credit risk is a vital part of good money management.
How Lenders Determine Your Risk
Every lender has its own method of calculating risk, but that equation typically includes:
Your credit history: You present a lower credit risk if lenders can see you've previously paid off debts as agreed and you don't take on a lot of debt at once.
Your income and employment: Lenders want to know you have stable income and the ability to pay the debt back.
Your assets and collateral: Secured loans are less risky for lenders. Secured loans use an asset as security for the loan, meaning the lender can sell it to cover its losses if you don't repay the debt.
Your existing debt: Lenders see a lot of unsecured debt as a high credit risk.
Ways to Reduce Your Credit Risk
The best way to reduce your credit risk is to pay off debt, particularly unsecured debt like credit cards. Reducing your debt can increase your credit score and improve your debt-to-income ratio, making you a more appealing borrower to future lenders.
Another proven way to increase your credit score and lower your credit risk is to build a positive payment history. Make at least the minimum payment for all of your bills and debts every month before the due date.
Lenders typically like to see at least six months of positive payment history free of late payments, but a longer credit history is even better. Many years of on-time payments show you can manage debt and pay back what you borrow.
Risk FAQs
Secured debt is guaranteed by something valuable (collateral) that you agree to give up if you can’t repay the debt. Car loans and mortgages are secured debts. If you default on the loan, the lender could sell the collateral to get the money you owe.
Unsecured debt is a loan that you qualify for based on your creditworthiness. The risk to the lender is that if you don’t repay the debt, the lender is stuck with the loss. That’s why unsecured loans tend to cost more than secured loans.
Most credit cards are unsecured. That means there's no collateral or security deposit pledged. The lender assumes the risk if the borrower doesn't pay the bill.
A secured credit card requires a cash deposit. It acts as a form of insurance that you will repay the debt. Often, the amount of the deposit will be your credit limit. Your purchases aren't, however, deducted from the deposit. That's how prepaid debit cards work, not secured cards. The secured card issuer will hold onto your deposit. You can make purchases, and you'll receive a bill to pay each month. If you don't pay off your charges by the due date, you'll pay interest on your balance. If you don’t pay your bill at all, the creditor can keep your deposit.
If you get a secured card, be sure the issuer reports to the major credit reporting agencies. Otherwise, you won't build credit. Stay up to date on payments, and a secured card could give you the opportunity to build your credit standing.
It depends on the lender and the loan. For an unsecured personal loan, many lenders consider 40% high. But that’s not high at all for an FHA home loan. Here's a list of typical maximum DTIs for different types of loans:
Conforming mortgage: 36% to 45% depending on down payment and credit score
FHA home loan: Up to 57%, but most lenders set their limit lower
Unsecured personal loan: Up to 50%, depending on income and credit
Auto loan: 50% (with good credit, DTI doesn’t matter as much)
Almost all lending guidelines consider a DTI of 36% or lower to be safe.
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