It is fact that people having bad credit reports pay higher interest rates. The credit report, therefore, is very important in relation to your credit profile. The question is how a bad credit report is responsible for your paying higher rate of interest. The answer is very simple. The credit report shows your credibility in the credit market. It proves your sincerity.
If you are loosing two things, no body will either lend you money or will demand higher rate of interests. That is why people with credit problems pay higher interest rates. With bad credit report, you may have to pay higher insurance premium. The insurance companies will not trust you for having bad credit report and will demand higher rates in case you fail to pay the premium in time or make yourself a defaulter.
It is known to all that a traffic ticket, in which you get points on your driving record, may increase the insurance premium you pay. The reason is that the traffic ticket has created an emerging pattern of risk you create while driving. It is also true that there are more chances of getting traffic tickets if you have already got one traffic ticket. You are under strict supervision. However, you can easily file a claim in the future.
Why has it been made so? The answer is that your driving can lead to accidents. It can cause damage to property or even life. Such carelessness poses real risks, and therefore the insurance company has to pay claims more frequently. If it takes place repeatedly, the companies will meet loss. The companies have to pay for the claims getting increased day by day. If so, they will meet less instead of profit, or they will have little money left. Profit making companies will turn to be loss making ones.
This calculation is same in the credit world. If you pay your bills late, your credit score will go down, and the interest rate on your next financing increases. Your late payment will create risks. The companies will think that the factors responsible for your late payment will continue, and every time you will be late with increasing risk. If your expenditure becomes more than your income owing to this or that, you will have deficit time and again. Your living beyond your means will put you into trouble. Your repayment capacity also will get affected. Companies will think that the factors responsible for late payment will not easily get obliterated, and the chain of late payment will continue or may increase to any extent including delinquency in the future.
However, the credit market differs from the insurance companies. Lenders are not required to loan you money. While buying annuity which would pay you on monthly bases for 30 years, you could choose an annuity that pays you the full amount every month with a rating of A. The other annuities sometimes pay you late and sometimes misses a payment completely with a rating of B. if so, an investor who may not get paid entirely by choosing such annuities. Even meeting the risk of losing your money, you require a higher return on investment.
When the investors are not satisfied with the added risk, they will choose annuities without risks. Though pays a lower yield, it is to some extent guaranteed. They will receive their investment with profit in time. Now consider this calculation in case of lending. Replace the words investor with lender, and yield with interest rate ***** annuity with a mortgage loan. A borrower who pays regularly every month is a low risk borrower, and therefore he pays the lower interest rate. The reason is that the lender is relatively assured of getting the money back.
Another borrower who is at higher risk is paying higher interest rate. The reason is that the lender is taking the risk. He is not sure of getting his money back since his clients are irregular in repayment and is in higher risk. Now you should decide who you should lend money to. one is paying regularly and the other is not regularly. You will definitely charge the higher interest rates to such borrowers who are not irregular in paying.
The game is always between the risk and the opportunity. People with credit problems pay higher rates because they are the risk factors. They create risks. It has nothing to do with race, religion, ethnicity or national origin.