Before a lender issues a loan to a borrower, the lender will often attempt to determine the likelihood that the borrower will default on the loan. This is done by identifying several factors that will affect the borrower's ability to pay back the loan. The risk factors can be applied for both personal loans and for larger loans, such as corporate bonds.
Income
One of the main credit risk factors is income. Borrowers with higher income, as well as those with more assets, are generally considered to be at a lower risk of default. When attempting to secure a loan, an individual will usually be required to provide proof of income, while a business seeking to issue debt will usually need to show proof of revenues.
Interest Rate
Many loans are set at a fixed rate of interest, meaning that the borrower will pay the same amount of interest on each payment. However, some loans have floating rates of interest, typically pegged to current market rates. For these adjustable rate loans, the current and predicted rate of interest can be a risk factor, since if it spikes too high, the borrower may be unable to make payments and will default.
Economy
The state of the economy is considered a risk factor for all kinds of debts, including personal, corporate and state. If the economy declines, a company may see sales fall, while a government may see a drop in tax revenues. This can lead both entities to default. Similarly, the economy can affect personal loans, as a bad economy can lead to drops in pay or layoffs, which will affect the individual's ability to pay off loans.
Credit History
One of the main risk factors that creditors look at is a borrower's credit history. Most creditors operate on the belief that an individual or organization's past credit history provides a strong indication of whether they will make payments in the future. If the individual, state or company has defaulted in the past, a creditor may believe that they are likely to default again in the future.
Outstanding Debt
Many creditors will also use the borrower's outstanding debt as a factor in his perceived ability to pay. Because the amount of debt that a person has is relative -- for example, a $1,000,000 debt may be enormous for an individual, but a pittance for a state -- outstanding debt is usually calculated in the form of a ratio, such as debt to income or debt to assets.
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