Feb 14, 2023

What is a “Risk Continuum” and why on earth should you even care??

Feb 14, 2023 | Brian's Blog

Because for the first time in 15 years — you HAVE to.

A risk continuum has to do with the interest rates that a bank charges, but before we dive deeper, you need to understand some called the “index” rate, or the “risk-free” rate.
To put it simply, this is the rate you would give someone with a 100% chance of paying you back in full.
A.K.A. risk-free.

The “risk continuum” is what your bank uses to determine how far away you are from being “risk-free”.
Just like your teachers did in school, they give you a grade A – F.
Depending on the grade they give you, you get a different rate on your loans.

Obvious enough right?
Here’s the problem.

For the majority of the last 15 years, the risk-free rate has hovered around 0.5% (50 basis points) or lower.
Might as well be 0.

So even ‘F’ borrowers have been getting favorable rates.
And that is not what any bank wants to give to a risky borrower.

I’m sure you saw recently the FED raised the index rate by another 25 basis points, bringing us to an interest rate of 4.5%.
This finally allows for some differentiated pricing along the risk continuum, and allows banks to account for risk when pricing their loans.
‘A’ borrowers now get rates of 5-6%, and ‘F’ borrowers get ~12%+.

If you’re wondering why your interest rates have gone up by far more than what the FED has announced, now you know….
Your bank doesn’t consider you an ‘A’ borrower.

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