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:
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.
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.
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