Credit involves risk - Keep in mind that all kinds of credit involve risk, both for the lender as well as the borrower. You take the risk that you will be able to pay later and so does the lender. How high the lender sets the interest rate tells you something about how he or she views this risk. As shown in the chart below, home mortgage interest rates, for example, are often substantially lower than credit card interest rates. Why? Because the lender can foreclose on your home and get some or all of the money back. But with most credit cards, the lender has no collateral and therefore fewer ways to get back the money – so the risk is greater.
Don’t misunderstand risk, however. It doesn’t mean lenders don’t want to lend. They do indeed, as the millions of TV advertisements and direct mail pieces that bombard Americans each year demonstrate. Lenders make their money by lending, that is, by collection the interest and fees they charge you for the convenience of using a line of credit or a loan. But like anyone, lenders try to minimize risk. They want the safest bet they can get for their money.
Credit Risk
Good credit or bad?
So what doe we mean when we say a person has “good credit” or “bad credit?” It really has to do with your financial reputation and your history as a borrower. It also has to do with how good (or poor) a risk you are in the eyes of lenders.
Good credit may not open doors for you all by itself, but it certainly puts you on the doorstep. Bad credit, on the other hand, can and does close doors of opportunity for you. It’s a reputation that precedes you. If lenders see you as a bad risk, as someone that can’t or won’t repay, you may not be able to buy that car or that house or get that credit card to buy that washer/dryer you need. And if one lender sees other lenders turning you down, he or she is like to consider you a poor risk and turn you down or charge you more for the privilege of borrowing.
As we noted, nobody sets out to get bad credit, and it doesn’t happen all at once or overnight. It may start with a late payment here and there, but then it can snowball. Maybe your car breaks down and you need some