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One of the things lenders do in evaluating the risk of a potential borrower defaulting on a loan is to consider the p...
on September 1, 2019
Why is A correct? Why is B incorrect?
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on September 8, 2019
The stimulus tells us that lenders consider the borrower's credit score to evaluate the risk of default. The higher the score, the less the risk. Yet for mortgage loans, the proportion of defaults is much higher for borrowers with the highest credit scores. How do we resolve this discrepancy?
(A) tells us that mortgage lenders are less likely to consider other risk factors when evaluating borrowers with highest credit scores, meaning there is another risk factor that lenders missed that ended up contributing to the high rate of defaults for the borrowers with high credit scores, e.g.perhaps they tend to have more debt than other lenders because it is easier to get a loan with high credit score.
(B) tells us that credit scores are not always accurate but in this case, would not all credit scores be affected not only the credit scores of the borrowers with the highest credit scores? And skew the risk across the board for all types of borrowers?
Since this fact fails to explain the particularly high default rate for only a certain group of borrowers, we can rule (B) out as the correct answer choice.
Let me know if this makes sense and if you have any further questions.