How credit analysis can result in consumer paying a lower interest on purchases.?
Credit analysis (otherwise known as Credit risk analysis) deals with understanding the Risk of the borrower defaulting on payments. Credit analysis is done for every account at the time of opening or taking a new loan. And the outcome of the credit risk analysis helps the lender in pricing the risk, i.e, setting the interest rate for the loan. Typically, an Interest rate works on the following model: Interest Rate = Risk free Return in the market + Expected losses + Risk premium Risk free return in the market can be return on a treasury bond. Lets assume that the interest rate for risk free return is 3% Suppose, the lender wants to give out 100 loans of $1000 each. The total loan amount is $100000. Hstorically, it might have been notice that 5% of the loans given out are never recovered. HEnce, expected losses are 5% Finally, a person would like to get some premium for the extra risk taken. The person can decide this risk premium based on what competition takes for same risk. Say, comp