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?

Question

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

Answer 1

You charge them a higher interest because there is a greater risk they default, and you have the costs associated with repossessing the asset and disposing of it — there are real costs associated with locating a car to repossess and re-sell, or foreclosing on a piece of real estate.

Or you want to collect as much interest up front in case they default and you have to write off their bad debts, say in the case of non-secured debt like credit cards.

Even if they don’t default, having to spend more man hours tracking down late payments and such is an added expense the higher interest charges help cover.