How bad is a default?
The risk of default is the possibility that consumers or borrowers will fail to make their monthly loan payments. This possibility is also known as credit risk and is something that every lender or credit rating agency considers when evaluating an individual or business.
Lenders typically compensate for a high risk of default by charging higher interest rates or, in the case of companies offering bonds, lower credit ratings.
Default risk measures the likelihood that a borrower will not pay its loan obligations as due and required by the company that has provided the facility. A borrower has a higher risk of default when it has a poor credit rating and poor creditworthiness.
For consumers, the risk of default can affect the rates and terms for which you will qualify if a lender views you as a high risk of default. It could even cause you to be denied a loan. Default risk applies not only to borrowers seeking to obtain loans, but also to companies that issue bonds.
To give you a little more insight into how default works and how risky it can be for you, here is a more detailed explanation.
When a person takes out a loan, there will always be a chance that they will default on their obligation to repay and this is the default risk that a lender considers with each borrower. But assessing a person’s (borrower’s) default risk is not a simple thing, much less one that is taken lightly.
Generally for individuals, lenders will look at the credit score to determine the borrower’s level of risk and what kind of interest rates they qualify for. And if you don’t know what a credit score is: It’s nothing more than a three-digit number that assesses how likely you are to repay your loan and make your payments on time.
Your credit score is calculated based on information in your credit report. This includes your payment history, the number of accounts you have open and your overall debt levels.
For every company, credit bureaus analyze your credit scores and creditworthiness to determine the risk of default, a method that is done using logic based on your current credit status.
Credit rating agencies evaluate companies and investments to determine their level of risk. The lower the rating, the higher the level of risk.