Introduction
Credit card is a system of payment used by the holder to purchase goods and services on credit, with holders promising to pay for that service later. The company that issues credit cards grants credit services to a group of consumers while purchasing and the holder can also borrow some cash from any finance lending institution or individual. The card holder pays the money back with some interests to the card issuer (Clark, 2009). The interest rates charged on the credit differ from one card to the other.
Risk compensation
Those with bad credit cards lenders tend to charge more points and higher interest rates than those with good credit cards. Loans offered to borrowers with poor credit are said to carry more risks to the lenders. In return, the lenders charge a higher interest rate as a way of creating a compensation for this risk. Those borrowers with good credit cards control themselves from entering into a contract over a loan with rates based on a bad credit loan (DeFranco, et al., 2008). This is because the points they pay and their rates are determined on the basis of the risk carried by their cards. In most cases, charging good borrowers a bad interests rate and points in the same manner as the bad credit borrowers is one of the most common fraudulent loan practices recorded. The law guarantees those people who have worked hard for good credit to enjoy their benefits which they deserve.
Bad credit leads to higher rates of interest as well as origination fees for the holder’s of these cards. Moreover, even though they are charged a higher interest rate there are limits above which the mortgage industry should not go beyond (DeFranco, et al., 2008). The points charged on loans equals one percent of the total amount of the loan. Most of the time, holders of the good credit cards end up paying no points while holders of the bad credit cards end up paying four to six points. Loan brokers take advantage of the customers who have little knowledge about the mortgage industry and they are charged as much as ten points. However, charging many points as much as ten is considered justice (Maurice & Thomas, 2008). For instance when one is borrowing a loan of about 15000 dollar a charge of ten points is considered as a small fee in relation to the total dollars charged.
FICO scores
In addition, another determining factor for charging a higher interest for bad credit and less interest rate for good credit is the credit scores (Hirt & Ferrell, 2006). Credit scores help lenders to measure the likelihood of settling the debt on time. These scores are based on the borrower’s credit report information. The scoring system used currently to determine the scores of a borrower is the FICO scores which was developed by fair Isaac Corporation. The FICO scores fall between 300-850. The FiCO scores are counted on the basis of the borrower’s payment history, the amount of money that one owes, how long is the credit history of the borrower, availability of new credit accounts, and other minor factors like having different types of credit.
According to many lenders the borrower’s credit scores above 700 are considered as a good sign of financial health (Hirt & Ferrell, 2006). FICO scores of below 600 shows an increased risk to lenders and as a result they charge a higher interest rate or else they turn down the borrower’s application for a loan. For instance when a borrower is in need of a loan for a thirty- year mortgage with FICO scores of about 730, the probability is the borrower will qualify for the loan with a low interest rate of 5.5%. In case his credit scores are below 570, the borrower may fail to qualify or be considered with a higher interest rate of about 8.6% or even more.
Conclusion
In conclusion, the laws of the mortgage industry are favoring the wealthy people with good financial reputation to continue acquiring more wealth while weakening those who are trying to strengthen their financial bases (Maurice & Thomas, 2008). On the other hand, it’s wise for the lenders to charge higher interest rates to bad credit cards as a way of trying to cover up the risks involved and vice versa.
Reference list
Clark, K. (2009). The Complete Idiot’s Guide to Getting Out of Debt, ISBN1592578470, 9781592578474. Alpha Books.
DeFranco, et al. (2008). Hospitality Financial Accounting, (2nd ed), ISBN0470083603, 9780470083604. John Wiley and Sons.
Hirt, A.G. & Ferrell, L. (2006). Business: a changing world, (5th ed), ISBN0072973587, 9780072973587. McGraw-Hill/Irwin.
Maurice, S., & Thomas, C. (2008) Managerial economics w/ CD (9th ed.) New York, NY: McGraw-Hill. ISBN: 007334656X