What Does Credit Risk Mean?
Credit risk is the risk of financial losses due to a borrower not being able to pay back a loan. Lenders use credit risk to assess whether or not a particular borrower appears to be a reliable investment. The higher the credit risk, the higher the interest rate that lenders charge on their loans. Higher interest rates help to decrease a risk of losing money on the loan. In the context of insurance, a lender can purchase various types of insurance to decrease their risk in the market.
Insuranceopedia Explains Credit Risk
If lenders did not calculate credit risk, then they would not be able to determine which borrower may be a safe investment, and which borrower may be a poor investment. This could result in banks and other lenders losing a lot of money from taking bad risks. To prevent this, lenders check credit risk to screen potential loan candidates. The better a person’s credit score and the steadier their income is, the higher the chance that they would be a low credit risk. This can dramatically improve the person’s odds of qualifying for a loan.