- On its face, the US credit-scoring system appears race-neutral. But in practice, it has perpetuated the racial wealth gap.
- Credit scores have not considered rent or utility payments in the past, leaving out the majority of Black Americans who don’t own homes.
- Without a good credit score, buying a home or borrowing money is more difficult, holding Black Americans back from building wealth.
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There are a number of stats you’ve probably heard that show the severity of the racial wealth gap in the US. We know, for example, that the median wealth for white families is 6.7 times greater than the median wealth for Black families. And we know that in 2016, the Institute for Policy Studies found that it will take 228 years for the average Black family to attain the same level of wealth as white families.
What isn’t as commonly known is how credit and the credit-scoring system perpetuate the wealth gap.
What is the ‘credit gap’?
To understand the impact that credit scores have on the racial wealth gap, it is important to understand the history of the credit system. Credit scores were created in 1956 by Bill Fair and Earl Isaac — the name FICO is an amalgamation of their names (Fair, Isaac and Company).
Credit scores, much like standardized testing in schools, were meant to simplify the decision-making process for loan approvals. And on its face, credit scoring appears to be a race-neutral formula. However, in practice, the tool embedded an already existing racial bias further into our financial system.
“We have to look at what’s underneath getting a good credit score,” said Shawn Rochester, author of “The Black Tax: The Cost of Being Black in America.”
African Americans typically experience significantly higher rates of unemployment and underemployment compared to their white counterparts — yet 65% of the credit-scoring model is based on payment history and credit utilization. Those factors are directly associated with the ups and downs of a person’s income, Rochester said.
For decades, most credit-scoring models did not consider rental payments. While this consideration is beginning to gain traction now, it’s important to remember that omitting these payments disproportionately affects Black communities, as Black homeownership rates are 30% lower than white homeownership rates.
That homeownership gap contributes to the Urban Institute’s finding that more than 50% of white households have a FICO credit score above 700, compared with only 21% of Black households.
But even when credit scores are equal, discrimination can still tip the scales.
In 2012, one study found that Black borrowers with a 660 FICO credit score were three times more likely to be offered a higher mortgage interest rate than whites with the same 660 FICO credit score. And in 2011, Bank of America paid $335 million in a lawsuit related to Black and Hispanic borrowers paying more in fees and interest than white borrowers with similar credit profiles.
How your credit score impacts your wealth
It is widely known that homeownership is among the biggest contributors to wealth, but what you pay to own that home will vary based on your credit score.
On a 30-year, $200,000 mortgage with a FICO credit score between 700 and 759, one could expect to receive a 2.56% interest rate. But a person with a credit score between 660 and 679 could end up paying an additional $14,914 — 677 is the average credit score for African Americans compared to white Americans at 734.
Researchers have shown time and again that the majority of Black communities have less access to traditional credit, which opens the door for higher-cost alternative solutions like payday loans and check-cashing facilities. This is due in part to the fact that traditional banks tend to require higher minimum balances and initial deposits in predominantly Black neighborhoods, according to Citi.
Those higher interest rates and fees don’t just result in higher overall costs, they also result in less money to save and invest. A low credit score may also result in lost job opportunities.
“I’ve personally had a job offer rescinded in the financial industry due to negative marks on my credit report, which at the time included a defaulted student loan,” said Carmen Perez, founder of Make Real Cents. “The pay that I would have earned from this particular role would have helped me pay back my student loan debt faster, but that benefit was never realized.”
Possible solutions to the credit gap
Credit advocates have asked authorities for a more inclusive credit-scoring model — one that includes payment history for rent, utility bills, and streaming services. Products like Experian Boost, launched in 2019, factor in some of that payment history with a goal of boosting credit scores among users.
And in New York City, the Stop Credit Discrimination in Employment Act prohibits most employers from checking an applicant’s credit history to make hiring decisions.
According to Rochester, though, “At the end of the day, we have to solve the job problem.” Indeed, the credit gap is just another symptom of systemic racism, and finding ways to achieve parity in employment and wages would go a long way to closing the credit gap.
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