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Risk based pricing

Risk based pricing Definition

Risk based pricing is the practice in the financial services industry to charge different interest rates on the same loan to different people, depending on their credit score and other factors which make it seem like they are more likely to not pay back the loan. Those with worse scores have a higher interest rate, those with better scores have a lower one.

In most financial services companies and products, the credit score is by far the major element used to make this rate decision, income and assests are almost tottaly ignored (income however is used to decide if the loan is too high for the person to afford). The idea of the process is to avoid the tragedy of the commons, which happen if everyone had the same interest rate, since those who were less likely to default are paying subsidizing in a way those who do default. In risk based pricing, those who are more likely to default help pay for their own costs to the company, while those who have flawless records get supposedly cheaper interest rates then they could before.

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