Default Probability refers to the possibility of default by a borrower who has borrowed a loan. It can also refer to a borrower missing scheduled repayments.
Evaluating this probability of default allows the lenders to ascertain the the risk of lending and thereby levy a higher rate of interest to compensate for this risk. Lenders consider various factors in determining the default risk like the income or the revenues of the entity, the existing liabilities or financial obligations, monthly expenses, etc.
The default probability has a direct correlation with the rate of interest offered on the loan. If the default probability is low, the rate of interest on the loan will also be low and vice versa.
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