ElI5: What is the financial logic behind charging higher interest on loans for people with low credit scores? Doesn’t increasing the price like that make low credit individuals even less likely to repay the loan?

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ElI5: What is the financial logic behind charging higher interest on loans for people with low credit scores? Doesn’t increasing the price like that make low credit individuals even less likely to repay the loan?

In: Economics

17 Answers

Anonymous 0 Comments

Although the increased rate does cause more defaults, it only increases the default rate a little bit. The fact the customer has a low credit score indicates there is already a high likelihood of default. The credit score is the main factor in predicting the default rate. This factor much outweighs the increase caused by a higher interest rate.

If the lender already knows that 10 times as many loans are going to default when the customers have a low credit score, they need to increase the interest rate to make up for it. Otherwise, it is not worth it to even give out loans to these customers.

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