New York Real Estate Salesperson ExaminationFinancingEasy
A lender is reviewing a loan application and notices that the borrower has a credit score of 580. The lender is likely to categorize this borrower as having a higher risk profile. What is the primary impact this higher risk profile will have on the loan terms offered to the borrower?
- AThe loan will be automatically denied.
- BThe loan term will be extended.
- CA lower interest rate will be offered.
- DA higher interest rate will be charged.
Show answer & explanationAnswer & explanation
Correct answer: D. A higher interest rate will be charged.
Borrowers with lower credit scores are generally perceived as higher risk by lenders. To compensate for this increased risk, lenders typically charge a higher interest rate to ensure a greater return on their investment.
Why the other options are wrong
- A. While a very low score could lead to denial, a 580 score often results in higher rates, not automatic denial, especially with FHA loans.
- B. Loan term extension is not a direct response to higher risk; higher interest rates or denial are more common.
- C. Lower interest rates are offered to borrowers with excellent credit scores, indicating lower risk.
Risk-Based Pricing
The practice by lenders of adjusting interest rates and loan terms based on a borrower's creditworthiness and perceived risk.
- Higher risk borrowers receive higher interest rates.
- Lower risk borrowers receive lower interest rates.
- Credit scores are a primary factor in determining risk.
Memory trick: Risk and reward balance – higher risk, higher cost.