Credit Risk Management Strategies for Consumer Lending

Consumer credit companies utilize a variety of risk management strategies. They fund the credit bureaus that track consumer credit behavior, allowing companies to evaluate potential borrowers based on their past credit behavior. Collection agencies can harass delinquent borrowers until they pay their debts. In many cases, as with mortgages guaranteed by the Federal Housing Administration (FHA), consumer credit companies turn to the government to manage their risks.

Credit Behavior Monitoring

Credit scores and credit reports are the primary means by which consumer lenders insulate themselves from risk. By observing the ability of a consumer to manage his debts responsibly, they can determine how risky it is to lend him money. There is always risk in any business venture, but past behavior is a reasonably good indicator of future performance. The credit score system is largely automated, however, and consumers can take advantage of ways to take on more risk than the companies price into interest rates.

Lawsuits

Creditors have a right to sue for collection for delinquent debts until the statute of limitations runs out in the state in which they made the loan. These lawsuits are usually only profitable for debts well into the four figures, but it is an effective method for encouraging debtors to continue to meet their obligations. If creditors were not able to sue for collection, it would be much easier for debtors to walk away from their contracts.

Seizure of Secured Assets

Consumer lenders manage their risk by offering secured loans such as mortgages and auto loans. A mortgage holder is less likely to default on someone's debts if it knows she will lose her house if it does so. Credit bureaus award higher scores to individuals with a mixture of secured and unsecured debts because it is more difficult for them to enter bankruptcy or default on their loans without suffering major consequences. The mere threat of asset seizure keeps many debtors making their minimum payments.

Debt Settlement and Collection

Consumer lending companies protect against the possibility of a total write-off by selling delinquent debts to collection companies. This enables the lender to recoup at least some of its losses and saves on the overhead of running a larger collections department. Lenders also make offers to settle debts for less than the original amount to work on reducing their losses. These settlements end up working out even more in the favor of the lender because any loss on the original debt can be written off for tax purposes.