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8 Ways How Bad Credit Risk Is Assessed

by | Dec 1, 2023 | News

When it comes to evaluating the credit risk of individuals with a bad credit history, there are certain factors and methods that are commonly used. Here’s a rundown:

1. Credit Score:
People with bad credit usually have low credit scores. These scores are numerical representations of a person’s trustworthiness based on their past credit performance. Lenders often refer to FICO scores and VantageScore as popular models for assessing creditworthiness. A lower score implies a higher risk.

2. Credit History:
An analysis of an individual’s credit history helps identify any recurring patterns of late payments, defaults, bankruptcies or other negative financial incidents. It is important to understand the reasons behind their bad credit, such as medical emergencies, job loss or other exceptional circumstances.

3. Debt-to-Income Ratio (DTI):
Assessing an individual’s ability to handle additional debt involves calculating their debt-to-income ratio. This ratio compares the amount of debt they have to their income. A higher DTI may indicate an increased likelihood of default.

4. Income Stability:
Evaluating the stability and consistency of an individual’s income is crucial. Having a stable job and a dependable source of income can indicate positive aspects.

5. Collateral:
When it comes to secured loans, it’s crucial to evaluate the value and quality of the collateral. This serves as a safety net for the lender in case the borrower defaults on the loan.

6. Character References:
Occasionally, personal or professional references can shed light on an individual’s character and reliability. However, this is not very common and can be subjective.

7. Loan Purpose:
Take into consideration the intended purpose of the loan. If the funds are intended for financially responsible reasons like consolidating debt or education, it may impact how risky it is perceived to be.

8. Alternative Data:
Some lenders utilize alternative sources of data, such as payment records for utilities, rental history or employment records, in addition to traditional credit information.

It’s important to keep in mind that while these factors are generally taken into account, each lender may have their own set of criteria and methods for evaluating credit risk. Moreover, certain lenders specialize in providing loans to individuals with bad credit scores. However, these often come with higher interest rates as a way to compensate for the increased level of risk involved.