Author: Dave Czach

Article:
Why Bad Credit People Pay Higher Rates by Dave Czach

Let's face it. People with credit problems pay higher rates for
the same reason people pay higher auto insurance premiums -
risk. Virtually everyone knows if you receive a traffic ticket,
you get points on your driving record and an increase in your
insurance premium. Why? Because the traffic ticket has created
an emerging pattern of risk. If you got one traffic ticket, the
chances of receiving another one are now greater than when you
had no tickets. Therefore, there is a greater likelihood of you
filing a claim in the future. A speeding ticket can lead to
accidents, property damage or even vehicular manslaughter. All
of which pose a real risk of the insurance company paying a
claim. The more claims the company pays, the less money they
have to pay other claims and make sound investments to pay
future claims. The credit world is similar. If you pay your
bills late, your credit score decreases and the interest rate on
your next financing increases. Why? Because the late payment has
created an emerging pattern of risk. Whatever the reason for
your late payment is the basis for future late payments. For
example, if you have been living beyond your means buying items
on credit because you can't afford to pay cash, this causes
larger monthly payments. When it gets to the point of causing a
late payment, it's most likely to continue because you have
demonstrated you don't have enough money to pay your bills.
Hence, there is a greater chance of frequent or severe
delinquency in the future. But the real world credit market
differs from the insurance comparison due to one more factor -
opportunity. Lenders are not required to loan you money.
Afterall, from their perspective, they are comparable to annuity
investors. That's right - investors. Suppose you were buying an
annuity that would pay you monthly for 30 years. You could
choose Annuity X that pays in full and on time every month with
a rating of "A." Or you could select Annuity Z that sometimes
pays late and sometimes misses a payment completely with a
rating of "B." As an investor who may not get paid entirely by
choosing Annuity Z, it's only fair that you require a higher
yield - or return on investment - in exchange for accepting the
extra risk of losing your money. If the investor is not
comfortable with the added risk, they could exercise their right
of opportunity and choose Annuity X. It pays a lower yield. But
they are relatively assured they will receive all their money in
full and on time. Now let's flip the perspective back to
lending. In the above investor example, replace the words
investor with lender, yield with interest rate and annuity with
mortgage loan. Now we see a more clear picture. Borrower A who
pays in full and on time every month is a low risk and receives
the lower interest rate because the lender is relatively assured
of receiving their money. Borrower B is a much higher risk and
pays the higher interest rate because the lender is accepting
the chance they may not be repaid all their money. Now let's
take it a step further. Imagine you had $100,000 to invest and
had to choose between Borrower A and Borrower B. Which one would
get your money? Moreover, why not loan $100,000 to Borrower B at
the same rate as Borrower A? Afterall, "B" borrowers often claim
they no longer have the same problems that caused their
delinquency. "They turned a new leaf." Yet, they haven't proven
it. They still pay their bills late. Would you take them at
their word and give them the same rate as Borrower A? A true
investor would not. In conclusion, it's as simple as risk and
opportunity. Contrary to the divisive manipulation of data from
the media and organizations with an agenda, people with credit
problems pay higher rates because they are a higher investment
risk - period. It has nothing to do with race, religion,
ethnicity or national origin. From my experience in the mortgage
business, loan officers only care about one color - green! ©
2003 SonicPoint.com

About the author:
Dave Czach has 12 years experience in the mortgage business plus
a Bachelor's Degree in Real Estate.

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