If you have applied for or researched loans, you may have already heard this term. Risk-based pricing is a practice commonly-used by many lenders, including your local credit unions to describe the total cost of a loan. When a borrower applies and is approved for a loan, it is then “priced” with an interest rate. The amount of interest that accrues based on the loan’s interest rate over the entire lifespan of the loan—from when you first receive it until your last payment is made— is the loan’s cost. In other words, how much did this loan cost you in interest. The higher an interest rate, the higher the cost, and vice versa.
So if price deals with the cost of a loan, how is risk involved? When risk-based pricing is used, interest rates are determined by the borrower’s credit score.
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