Risk Management By Lenders
It can be extremely frustrating when you are denied for a loan that you need or when your options are limited to loans and credit cards with high interest rates and exorbitant fees. This can happen when you do not have a good credit score, and it can be very stressful. However, it is better not to villainize the lenders for making it difficult for people with bad credit to borrow money, as it actually makes a great deal of sense from their standpoint. The lenders are simply trying to protect their own interests, which they actually should do in order to be able to stay in business.
In general, a good business practice is to not take a substantial risk unless it will yield a substantial return. When lenders decide to give you a loan, they are taking the risk that you may not repay the balance. As such, people who have lower credit scores and worse credit histories are seen as a bigger risk when it comes to loans. This is why they compensate with higher interest rates and more stringent rules and fees/punishments when you do not make payments on time. Banks identify risk factors associated with each transaction, including loans, and they assign interest rates and other rules associated with the loans accordingly.
This is why people who have lower credit scores generally have to pay higher interest rates when they borrow money; the bank is simply compensating for the increased risk that this person who has shown in a way that they pose a higher risk of not paying the money back will not pay the money back. It is simple risk management on the part of the lender, and this is part of what borrowers should know before they end up thinking that the system is unfair and meant to punish them.
Some lenders, particularly those specializing in personal unsecured loan amounts ranging anywhere from $500 to $1500, will work with borrowers with bad credit. In lieu of credit or collateral, the lender agrees to provide a cash advance against future income. Because the risk on the part of the lender is higher than normal, the interest rates will usually be higher than normal and the repayment window shorter than normal. This reflects the way in which different levels of risk can be incorporated into various forms of financing.
The Five Cs of Credit are what most lenders use to determine the level of risk posed by any particular borrower; these include Character, Capacity, Capital, Collateral, and Conditions. Character is basically the history of the borrower in terms of how they have paid their bills in the past. Capacity is whether or not the borrower has enough income to be able to stick to the terms of the loan. Capital is the equity contribution, and Collateral is an alternative source of repayment if the borrower is not able to make the repayments on his or her own. Conditions refer to the loan structure, meaning the interest rate and the conditions that are placed on the situation to make sure that the balance is paid back to the bank in full.
As you can see, there is a lot to keep in mind in terms of what borrowers should know about risk management that is conducted by lenders before they allow people to borrow their money. It is important to understand that the lenders are not creating these stringent requirements to punish the borrowers but to protect themselves. As a person with a low credit score, you may be confident in your own abilities to pay back lenders after taking out a loan, but they use your credit score as a measure of your abilities to pay them back on their terms. If your credit score is low, they will treat you accordingly; it is nothing personal at all, but it is the only way that they can gauge your ability to pay them back in a timely fashion.