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
people with low credit scores are less likely to pay you back to start with regardless of the interest rate. people with less than 600 scores default ~30% of the time, those with north of 700 credit scores borderline never default.
higher interest allows the creditor to recoup their loan faster from higher risk populations. you essentially pay a penalty for your low credit and people like you. i have to collect the full loan amount of 1 in 3 people from the other 2 people in that category basically so that I’m not taking a loss.
Also, if you have a high credit score, you’re likely more fiscally responsible. You aren’t going to borrow money at high interest rates because you probably have other options. You’d explore other options that you probably have first. So. if a creditor wants their money, they have to be competitive with the other means they have of borrowing money. People with low credit scores don’t have those other options usually.
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