- At first glance, America’s credit rating system appears race neutral. But in practice, it perpetuated the racial wealth gap.
- Credit scores haven’t taken rent or utility payments into account in the past, leaving out the majority of black Americans who don’t own homes.
- Without a good credit rating, it is more difficult to buy a house or borrow money, which prevents black Americans from building wealth.
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You’ve probably heard a number of statistics that show the severity of the racial wealth gap in the United States. We know, for example, that the median wealth of white families is 6.7 times greater than the median wealth of 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 reach the same level of wealth as white families.
What is not as well known is how credit and the credit scoring system perpetuate the wealth gap.
What is the “credit gap”?
To understand the impact of credit scores 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, like standardized tests in schools, were intended to simplify the decision-making process for loan approvals. And at first glance, credit scoring appears to be a race-neutral formula. However, in practice, the tool has incorporated a racial prejudice that already exists further into our financial system.
“We have to look at what’s behind it to get 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 than their white counterparts – yet 65% of the credit scoring model is based on payment history and credit usage. These factors are directly associated with the ups and downs of a person’s income, Rochester said.
For decades, most credit scoring models ignored rent payments. While this consideration is starting to gain ground now, it is important to remember that the omission of these payments disproportionately affects black communities, as black homeownership rates are 30% lower than black homeownership rates. home ownership by whites.
This homeownership gap contributes to the Urban Institute’s finding that more than 50% of white households have a FICO credit score above 700, compared to just 21% of black households.
But even when credit scores are equal, discrimination can still tip the scales.
In 2012, a study found that black borrowers with a FICO credit score of 660 were three times more likely to be offered a higher mortgage interest rate than whites with the same FICO credit score of 660. And in 2011, Bank of America paid $ 335 million in a lawsuit related to black and Hispanic borrowers paying more fees and interest than white borrowers with similar credit profiles.
How Your Credit Score Affects Your Wealth
It is well known that homeownership is one of the biggest contributors to wealth, but what you pay to own that home will vary depending on your credit score.
On a $ 200,000, 30-year mortgage with a FICO credit score between 700 and 759, one would expect to receive an interest rate of 2.56%. 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 of African Americans compared to White Americans at 734.
Researchers have repeatedly shown that the majority of black communities have less access to traditional credit, which opens the door to more expensive alternatives like payday loans and check cashing facilities. This is in part because traditional banks tend to require higher minimum balances and initial deposits in predominantly black neighborhoods, according to Citi.
These higher interest rates and fees not only result in higher overall costs, they also result in less money to save and invest. A low credit score can also lead to the loss of job opportunities.
“I have personally seen a job offer canceled in the financial industry due to negative scores on my credit report, which at the time included a delinquent student loan,” said Carmen Perez, founder of Make Real Cents . “The salary I would have earned for this particular role would have helped me pay off my student loan debt faster, but that benefit was never realized.”
Possible solutions to the credit deficit
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, take some of this payment history into account in an effort to improve users’ credit scores.
And in New York City, the Stop Credit Discrimination in Employment law prohibits most employers from checking a candidate’s credit history in making hiring decisions.
According to Rochester, however, “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 employment and wage parity would go a long way in closing the credit gap.