If you’ve ever tried to borrow money, you might’ve heard the bank officer throw around some choice words like “credit score” and “credit risk.” Ever wondered what they all mean?
Well, credit risk is the potential loss a lender will incur should you fail to repay a loan. Borrowers deemed high risk are often denied loans or made to pay high interest rates. Low-risk borrowers, however, are approved faster and get favorable rates.
But how is risk measured? Why does it matter? Is there any way to lessen your risk?
Keep reading to find out.
How Credit Risk Is Measured
Risk is measured based on your ability to repay debt. To determine this ability, lenders use the 5 C’s:
- Credit History
- Capacity to Repay
- Conditions of the Loan
- Collateral Associated with the Loan
These five C’s form the basis of your credit profile. Credit bureaus condense this profile into a single number–your credit score. Your credit score will then give lenders an idea of your risk.
Of course, that brings up another question:
How Are Credit Scores Calculated?
Credit scores range from 0-999. The higher the number, the better your credit, and the lower risk you pose to a lender. The scale looks something like this:
- 767-999 (Excellent)
- 681-766 (Good)
- 614-680 (Favorable)
- 583-613 (Average)
- 527-582 (Below Average)
- 487-526 (Bad)
- 0-488 (Poor)
As we mentioned earlier, the 5 C’s form the basis of your credit score. The other way it’s calculated is based on your handling of debt.
Do you pay your bills on time? How long is your credit history? How much debt do you have? How do you compare to other credit-active consumers?
Your credit score is the quick answer to all these questions. The detailed answers come in the form of your credit report. You can, and should, check both.
The law entitles South African citizens to one free credit check per year. You can use consumer reporting agencies like Equifax or Transunion. You can also receive text updates via MyCreditCheck.
Why Does It Matter?
We’ve touched on credit risk’s importance somewhat. It helps determine both your qualification for a loan and its interest rate.
Low-risk means better mortgage rates, favorable car loans, and less stress when starting a business. You also have an easier time renting a house or a car.
Low-credit risk makes life easier in general. But let’s say you’ve checked your credit, and it’s not the best. Can you fix it?
How to Lessen Your Risk
Fortunately, you can reduce your credit risk. The trouble is, it can take a while. But with a smart financial strategy, you can improve your standing.
The first step is to pay your debt. Missed or late payments are the biggest bad credit culprits. It’ll stay on your report for a couple of years, but it will go away as long as you continue to pay your bills on time.
If you have little or no credit, establish a history by getting a credit card. Lack of variance in your accounts will heighten your risk since banks are unsure of your capacity to repay a loan.
Above all, stick to a budget. Know where your money goes and cut off unnecessary spending.
Credit risk determines your interest rate for loans and your approval. It also gives lenders a snapshot of your ability to handle debt.
Knowledge is your friend when it comes to credit. Check your score, check your report, and know where you stand.
And if you need more financial help or you want to see about a loan, we can help. We’re Little Loans, and we dedicate ourselves to matching you with the right lender.
Check us out today!