What is a Consumer Credit Risk?

A consumer credit risk is a term that describes how likely a person would be to repay a loan. This type of financial assessment is completed by banks and lending institutions during the initial stages of the lending process, and several factors are taken into consideration. Things like examining past loan transactions, levels of income, and the amount of current debt all help create a picture of a consumer's overall creditworthiness. The consumer credit risk assessment is then used to determine whether or not a lender should grant the loan and what the repayment terms would be.

Financial institutions base almost all of their lending decisions on a consumer credit risk analysis. This process normally starts with the lender reviewing an applicant's credit profile to determine how well he repaid debt in the past. A credit scorecard of this type would also show how many loans the consumer currently has in his name, how long he has been at his current residence, and any recent credit applications he has completed. Each of these factors helps a lender to create a credit profile that would suggest whether or not the loan was likely to be repaid in a timely fashion.

Once an initial credit check is completed, a lender would then focus on equity. If a borrower was purchasing a home that was priced well below market value, for instance, then the consumer credit risk formula would consider this factor favorably. Even if the bank felt that the consumer may not be able to repay the loan in full, there is a chance that the loan would be granted because the bank could profit on the equity. When the borrower's assets are not valued in excess of the loan amount, the consumer credit risk increases.

After each of the consumer credit risk factors is considered, a loan officer can calculate an interest rate and a repayment process that would be favorable to the lending institution. Consumer credit risk profiles that are considered low would receive the most favorable terms, with options like reduced down payments and extended repayment times. High-risk consumers would likely face very high interest rates and other penalties if the loan is approved.

Consumer credit risk assessments are also used by other businesses as well. Many insurance carriers perform this type of check to determine how responsible an applicant is. Likewise, some businesses also analyze consumer credit risk to prepare targeted promotions for certain groups of people. For example, many retail establishments specialize in financing for high-credit risk borrowers that could not obtain lines of credit elsewhere. Some employers also perform a similar search to determine how focused an employee is on finance and responsibility.