Risk

Risk summary:

• Lenders consider the risk associated with a loan applicant before making a final approval decision.

• Lenders also take risk into account when determining interest rates. The less risky a loan applicant appears to be, the lower their rate. 

• A strong credit history helps assure lenders you're a low-risk borrower. 

Risk definition and meaning

Risk represents how confident a lender is that you can repay a loan or credit card. The reason an underwriter reviews your application is to evaluate how likely you are to repay what you borrow. 

Risk matters because it determines whether a loan or credit card application will be approved. If your application is approved, the level of risk assigned to you also determines the interest rate you'll pay. Generally speaking, higher-risk borrowers pay more.  

Key concept: Risk refers to how a lender views you as a borrower. The more confident a lender is that you're a low-risk borrower, the more likely it is to approve your application. 

More about risk

Reviewing your credit history is one of the main methods a lender has for determining the risk you present. By checking how you've managed debt in the past, the lender is trying to predict how well you’ll handle a new loan. 

Even if you're just starting out or have a relatively thin credit history, here are a few ways to lower your risk: 

• Pay bills on time

• Keep your credit card balances low

• Don’t apply for new credit unless you really need it 

• Keep older accounts open and active

• Reduce debt, particularly high-interest debt

Risk: a comprehensive breakdown

Just as you weigh the risk of driving in a thunderstorm or rollerblading without knee pads, lenders weigh the risk associated with giving you a loan. In addition to credit history, lenders also check: 

• Your credit score: Your credit score is a three-digit number that reflects your history with credit accounts. 

• Income: Lenders want to ensure you have a way to repay the loan or credit card. 

• Debt-to-income ratio (DTI): Your DTI compares your total monthly debt to your monthly income. The lower your DTI, the more likely it is that you have room in your budget for a new loan.  

• Employment: A stable job history and consistent employment help reassure a lender that you have a steady income. 

• Loan amount: Bigger loans are riskier than smaller loans, because the chance of loss is greater. 

• Assets: Having a savings account or other financial reserves indicates financial stability and reduces perceived risk. 

Finally, when you use collateral to secure a loan, you lower the lender’s risk of loss. Collateral is a financial safety net for the lender. If you fail to make payments as promised, the lender could repossess the collateral, sell it, and recoup its loss. For example, when you get a car loan, the car is the collateral.