What is a High-Risk Borrower and... Are You One?
, by Rob Kaufman
A high-risk borrower is someone who a lender or creditor would consider more likely to default on his or her loan. High-risk borrowers have certain characteristics in common. But before we get into those, there's something to consider regarding borrowing money in general.
Good Debt vs. Bad Debt
It's important to know the difference between "good" debt and "bad" debt.
Generally, "good" debt provides you with benefits that outlast the payments. For instance, the benefits from a home loan or college loans can definitely outweigh the drawback of temporary payments.
"Bad" debt is the other side of the coin - when debts end up costing more than you can repay on time or whose costs outweigh their benefits. Examples of bad debt include: high-interest credit cards, payday loans, and loans for non-essential items that depreciate over time such as expensive cars and high-tech audio equipment.
You might want to take a look at your current debt and determine if it's "good" debt, "bad" debt or a mixture of both.
The Top 4 Characteristics of a High-Risk Borrower
A FICO® Score below 620. One of the first items a creditor or lender will examine to determine your creditworthiness (degree of risk) is your credit score. Since 90% of top lenders use FICO® Scores, which range from 300 - 850, they'll be looking for a score above 620 - especially for a conventional mortgage loan. Consumers with higher credit scores show a greater ability to make payments on time and have low credit utilization. On the other hand, risky borrowers tend to have lower credit scores, which reflect an ability to pay back loans and have high credit utilization.
Unusual employment status. An unusual employment status is not the same thing as an employment "change". Changing jobs is no longer an impediment to getting a mortgage, it's more your employment status that can make you appear (or not) like a risky borrower. Are you a 40-hour per week employee with a steady paycheck? Creditors prefer that. However, an unusual employment status may exist if you're a part-time worker or are self-employed with less than two years' worth of tax returns to verify your income, most lenders may hesitate to offer you credit.
No down payment. Lenders prefer that borrowers have some "skin in the game", and have an investment in their home from the outset. Typically, if you don't have a down payment (or have less than 20% of the purchase price for the down payment), you'll go through a more rigorous approval process, probably pay a higher interest rate and also pay mortgage insurance. The fact that a borrower doesn't have a down payment is a sign of risk and indicates higher potential that the person borrowing money won't be able to make their payments.
Dodging current financial responsibilities. Any kind of payment delinquency, from credit cards and tax liens to child support or federal student loans, increases the perception of risk. If you're not fulfilling the financial responsibilities you already have, why would the lender think you'd repay the debt your requesting this time around?
Another characteristic of a high-risk borrower (but not in the top 4) includes student loans that use deferments or forbearance (delaying payments). It's not the fact that you have student loans that make you a high-risk borrower, it's the fact that repayment is imminent. Even though you might be getting short-term relief, interest may continue to accrue, adding more of a financial obligation to the original loan you're already having trouble paying off.
So after reading about what makes a borrower appear risky, how do you think you'd appear to a creditor? High risk? Medium risk? Low risk? It's important to know the answer to that question before applying for a loan. That way you won't be surprised at the outcome.
*See how people once considered a "high-risk" borrower have worked to turn that perception around. Check out the myFICO forum anytime, from anywhere. *