How do lenders evaluate their credit risk?

A lender evaluates their credit risk based off of two main factors: your ability to repay the loan and your willingness to repay the loan. The outcome of this analysis will determine whether they will make the loan and under what terms they will offer it.

The criteria used to judge a borrower's ability to pay back a loan is their debt-to-income ratio . This ratio considers the portion of your gross monthly income that is spent on debt, including on-going property-related fees and monthly consumer debt. A debt load that does not leave enough money to pay the mortgage would signify a high credit risk. An income that is high enough to cover the current debt load plus the intended mortgage would indicate an ability to repay the loan and thus a lower credit risk.

To evaluate willingness to repay the loan, a lender uses the borrower's credit score. The credit score is created by weighted points assigned to different aspects of your credit profile, such as payment performance, age, type and balances of your credit. The most common scoring system is the FICO model. A low-end FICO score (300) indicates a low willingness to pay back the loan, and thus a higher credit risk. A high-end FICO score (850) demonstrates a high willingness to repay, thus a lower credit risk.