What are high-risk loans?

0-9 A B C D E F G H I J K L M N O P Q R S T U V W X Y Z

A high-risk loan is a financing or credit product that is considered more likely to default, compared to other, more conventional loans. The higher risk of default can be attributed to one or more factors when evaluating a loan request. A high-risk loan issued by a lender to a borrower may result in higher interest rates and changes to the loan term, so as to compensate for the additional risk taken.

The “risk” factor in the high-risk loan usually refers to the lender’s risk exposure – and not the borrower’s.

To minimize loan risks, lenders must consider important borrower and loan factors that determine the likelihood that the loan will be repaid as scheduled. These risk factors include the following:

  • Ability to repay. Does the borrower have the income or revenue (after paying all other necessary personal or company expenses) to repay the loan? For example, lower-risk loans, such as home mortgage financing, typically limit the loan payment amounts so that the monthly payments are less than 30% of the borrower’s documented monthly income. Higher risk loans may allow for a higher percentage — or not consider the borrower’s income qualification at all.
  • Security for the loan. If a borrower puts up valuable collateral as security for the loan, that borrower is basically taking some of the risk for the loan. For example, with standard automobile loans, the borrower gives the car title to the lender as security for the loan, often resulting in lower interest rates than unsecured loans.
  • Past history of repayment. The borrower’s credit history indicates their past history of paying debts on time (or not). Borrowers with strong credit records are considered less risk for lenders than those with poor credit ratings.
  • Guarantees. Third-party guarantees can also help minimize the risk to the lender and affect the terms of the loan. For example, a co-signer can offset some of the credit weaknesses of the primary borrower. Perhaps the biggest loan guarantees enjoyed by Americans are those given by Fannie Mae, Freddie Mac and the U.S. federal government on many residential mortgage loans – resulting in relatively lower interest rates.

One common example of a high-risk loan is one issued to a borrower with poor credit. If a borrower fails to show the lender a responsible credit history, the likelihood of making late payments on the loan or defaulting on the loan agreement in its entirety is heightened. This is in contrast to a borrower with an excellent credit history showing a history of an ability and willingness to repay incurred debt.

A high-risk loan can also be one made to someone with no credit history at all, as the consumer has yet to prove the ability to handle credit responsibly. Finally, with regard to credit, a high-risk loan may also include loan programs where no credit report review is conducted at all.

Income-based high-risk loans

Another example of a high-risk loan is one issued without reviewing the income of the applicant, such as with No Income Verification (NIV) or No Documentation loans. When a lender reviews a loan application the ability to service the debt is typically documented with current paycheck stubs and income tax returns. Loans that do not require income verification can be considered high risk. Higher risk can also be associated with unsecured loans or for secured loans with no money down from the borrower.

Lenders that specialize in high-risk loans understand the potential problems in the high-risk lending category. To offset the higher risks and potential for losses, these lenders may charge higher fees and offer different terms, in exchange for issuing a high-risk loan.

For borrowers with high-risk characteristics, these lenders provide a borrowing opportunity. As borrowers take out a high-risk loan and repay the loan terms as agreed, they can find their credit may improve – and more favorable loan terms may be made available to them in the future.

Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.

back to glossary

Check Your Eligibility

This won’t affect your credit score!