Underwriting & credit
Risk-Based Pricing: Definition & Example
What Is Risk-Based Pricing?
Risk-based pricing is setting a loan’s interest rate, fees, or terms based on the borrower’s estimated risk, so applicants with weaker credit pay more than those with stronger credit.
What does risk-based pricing mean?
Lenders price for risk using factors such as credit score, down payment, debt-to-income ratio, loan type, and property type. A borrower with a 780 score may receive a lower rate than one with a 640 score on the same loan.
Under the Fair Credit Reporting Act’s risk-based pricing rule, a lender that offers less favorable terms based on a consumer report must give the consumer a risk-based pricing notice, or in many cases a free credit score disclosure instead.
Landlords can do something similar, such as requiring a larger deposit or higher rent for applicants with lower credit scores. When that decision is based on a consumer report, adverse action or notice rules may apply.
Risk-based pricing example
Two borrowers apply for identical auto loans. The one with a 760 credit score is offered 6.1% APR. The one with a 620 score is offered 11.4%. The second borrower receives a credit score disclosure explaining how his score affected the terms.
Related terms
- Credit ScoreA credit score is a three-digit number, usually from 300 to 850, that estimates how likely a person is to repay debt based on the information in their credit report.
- CreditworthinessCreditworthiness is a lender’s judgment of how likely a person or business is to repay borrowed money on time, based on credit history, income, debts, and assets.
- Adverse Action NoticeAn adverse action notice is a disclosure required by the Fair Credit Reporting Act when a landlord, lender, or employer takes a negative action based in whole or in part on a consumer report.
- Fair Credit Reporting ActThe Fair Credit Reporting Act (FCRA) is a federal law that regulates how consumer reporting agencies collect and share consumer information and how others use consumer reports.
- UnderwritingUnderwriting is the process a lender, insurer, or landlord uses to evaluate the risk of an applicant and decide whether to approve them, and on what terms.
