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Credit Union Resources

Risk-Based Loan Pricing

Risk-based loan pricing in lending is a method utilized by lenders to develop loan interest rates that reflects the risk being taken.  It is a common industry practice in consumer and commercial lending.  The method enables the lender to receive a level of reward that is in-line with the risk taken and is consistent with the financial theory of risk and reward.

Fair lending practices require that any risk based program be unbiased.  Lenders can take on regulatory risk and potential financial liability if their pricing methods utilize potentially biased criterion.  Therefore, many lenders use a breakdown of FICO scores from the credit bureau report to determine the risk of the credit borrower and therefore the pricing of the loan.  The FICO score is used because it is issued by the credit bureau through a license with Fair, Isaac Co. and the credit union has no way to influence the score.  The score is completely independent and therefore unbiased.

Generally, three or more tiers are set up with escalating interest rates as the credit risk increases.

Other items can be used to refine the interest rate charged to the borrower also as long as the credit union can not influence the loan’s pricing.  This could include things like: the length of employment in a similar or same field, the percentage of unsecured borrowing to their unsecured credit limit, and the length or term of the loan.

An example of a risked based lending breakdown is as follows (these are only examples and not suggestions):

A rating	FICO score exceeding 780	New car loan rate 5% with no down payment
B rating	FICO score 720-779	New car loan rate 6% with no down payment
C rating	FICO score 660-719	New car loan rate 8% with minimum 10% down
D rating	FICO score 600-659	New car loan rate 10% with minimum 10% down
F rating	FICO score under 600	New car loan rate 18% with minimum 20% down

A good resource for risk-based loan pricing is to network with other credit unions and lenders that have a history of risk-based loan pricing.  Your trade association may also resources available.