Financial Education

Risk-based pricing

The myth that "non-prime" and "sub-prime" loans are harmful to service members' financial readiness is just that-a myth. Responsible, risk-based pricing of loans allows those who have other than pristine credit, or no credit history at all, access to needed funds.

In order to better understand risk-based pricing, one only needs to look at the way car insurance is priced, as it is very similar to sub-prime lending. The higher the risk attributed to lack of experience or the probability of a claim/default, the higher the insurance premium or loan cost.

  1. At age 16, auto insurance is very expensive due to the extreme risk. This theory also applies to lending, since a borrower in his late teens or early twenties is also more risky due to his inexperience paying bills.
  2. If a young driver avoids problems (tickets, accidents or DUI) he can expect to be rewarded with lower insurance costs after age 25. Likewise, if the young military family pays their bills as agreed, does not require collection services, or does not require court-assisted bankruptcy, they can expect to be rewarded with lower-cost loan products.

According to one CRL study, active-duty military personnel are three times more likely than civilians to use a payday lender, and one in five used the service last year. The study also notes that this costs military families more than $80 million a year in fees.

While the rates may be higher for non-prime and sub-prime risk customers, they can find responsible alternatives for insurance and loans. Access to insurance or loan products provides military families an opportunity to build a robust track record typically reflected in credit scores, credit history, or driving records. In a service member's case, this ability to improve credit scores and build a better credit profile can help improve financial readiness, not detract from it.

Furthermore, service members should note that higher rates or costs are not necessarily indicative of "predatory lending." The term "predatory" refers more to poor practices than to specific industries, companies or products.

For more information about credit scores and credit risk, visit www.myfico.com, and www.icfe.info. For information about predatory lending, visit www.predatorylending.org.

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