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

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

Estimated reading time: 2 minutes

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.

Follow Brian on Linkedin: Brian Pillmore


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