September 27, 2022

Is Credit Scoring Really Race-Neutral?

When looking at the numbers, you can’t ignore the racial disparity in credit scores.

Rates of subprime credit scores in majority-Black, Hispanic and Native American communities are at least 1.5 times higher than in majority-white communities, according to a 2022 report from the Urban Institute, a nonprofit think tank. FICO defines subprime as poor or fair credit scores that fall below 670.

A low credit score or no credit history can make borrowing difficult and expensive. If you can’t access good credit products, you may struggle to build wealth. Here’s how discrimination can affect credit scores and what you can do to build and protect your credit.

How Credit Scores Are Developed

Your credit scores are derived from data in your credit reports compiled by the three major credit bureaus: Equifax, Experian and TransUnion.

Scoring systems are based exclusively on the information in those reports, says credit expert John Ulzheimer, formerly of FICO and Equifax. “Race is never on the report and is not considered in a score,” he says. “Neither is your address or a ZIP code where racial diversity is different.”

Lenders supply the credit bureaus a steady stream of consumer credit information, such as the date you opened an account, the balance and whether the account is paid on time.

For revolving credit products, such as credit cards, the amount of the credit line will show up on your credit report. Collection agencies and courts also provide data to the credit bureaus, which means collection accounts and bankruptcies appear.

Credit scoring companies, such as FICO and VantageScore, use proprietary algorithms that emphasize different factors to create scores of between 300 and 850. Higher numbers predict lower credit risk, and scores can change as credit reports are updated.

To have a credit score, you first need to use credit products that are reported to the credit bureaus. But to develop a good credit score, you must use those products responsibly for a long time.

So, in theory, credit scores should not be affected by race. But an individual’s credit is built on his or her history, and for Black Americans, that history may well include a lack of generational wealth partly because of past discriminatory practices like redlining, which denied mortgages in minority neighborhoods. Though redlining was outlawed in the 1960s, Black homeownership still lags; the National Association of Realtors reported that, as of 2020, homeownership rates were about 72% for white households, 62% for Asian, 51% for Hispanic and 43% for Black.

Average Credit Score by Race

Credit scores differ vastly when broken down by race. The credit card processing company Shift found these average FICO scores in 2021:

  • Asian, 745.
  • White, 734.
  • Hispanic, 701.
  • Black, 677.

Then there’s the issue of credit invisibles, or people with no credit history or report at any of the three bureaus. If you don’t do business with companies that report to the credit bureaus, you will be penalized when applying for credit. A thin credit file appears riskier to lenders, resulting in credit denials or higher interest rates for the borrower.

Roughly 15% of Black and Hispanic consumers are considered credit invisible, compared with 9% among white and Asian consumers, according to the most recent Consumer Financial Protection Bureau data. An additional 13% of Black and 12% of Hispanic consumers have unscored records, compared with 7% of white.

How Lending Discrimination Affects Borrowing Opportunities

Lending discrimination prevents qualified borrowers from seeking homes in certain neighborhoods and building wealth through homeownership.

Ulzheimer points to a recent case of lending discrimination affecting borrowing opportunities. The CFPB and the Department of Justice found that Trident Mortgage Co. intentionally discriminated against families living in majority-minority neighborhoods in the Philadelphia area and ordered the company to pay more than $22 million in damages.

Tiffaney Williams, an Atlanta credit educator with a doctorate in business from Trinity International University, has seen lending discrimination firsthand.

“I’ve had clients with the exact same scores and financial situations almost mirrored,” Williams says. “The minority was rejected. My white client’s credit request was accepted on the same exact day.”

She adds: “It also weighs heavy on the client’s confidence to build credit and wealth, making them back away from their goals.”

Other Race-Related Factors That Hurt Credit Scores

Disparities in wealth, student loan debt and financial literacy are factors that can hurt credit scores for different racial groups. Much of the problem with credit scores stems from the income gap, says Ramona Ortega, founder of My Money My Future, a financial services firm helping millennials of color build wealth.

The difference between “the average wealth of a white family and that of a family of color is huge,” Ortega says. “That alone impacts credit scores. If you have a higher income, you are more likely to pay your bills on time and are offered higher credit limits.”

The median income in 2020 for Black households was $45,870, compared with $55,321 for Hispanic, $74,912 for white and $94,903 for Asian households, according to the U.S. Census Bureau.

Regardless of income after graduation, Black households carry more student debt, which can hurt their creditworthiness, reports the Brookings Institution. Student loans can be problematic for credit scores, Ortega says.

Black college graduates owe an average of $25,000 more in student loan debt than their white counterparts, according to a 2022 report by the Education Data Initiative.

Misinformation about credit also can work against communities of color, Ortega says. The sense is that “all credit is bad,” she says, which leads to avoidance of traditional credit products.

Some types of credit favored by Black borrowers, such as payday loans, aren’t factored into credit scores. Black and Latino consumers are more likely than white consumers to depend on high-interest financial services such as payday lenders and check-cashing counters because their neighborhoods have fewer banks, according to a Brookings Institution analysis.

How to Build Credit

Apply for a secured credit card. A secured card can be easier to get than a traditional unsecured credit card because it requires a cash deposit as collateral in case you default on payments. The deposit you will need to make depends on the credit card, and the deposit is typically equal to the credit limit.

Shop around to see which credit cards best fit your needs and because some may charge an annual fee and other fees. Also, check whether you can automatically graduate to an unsecured card and get your deposit back after a certain number of on-time payments.

Become an authorized user. Ask a trusted family member or friend to add you to a credit card as an authorized user. Regardless of whether you use the card, it will appear on your credit report and help you build credit. Just make sure the card reports authorized users to the credit bureaus.

Choose a cardholder with a long history of paying on time and keeping balances low. If either you or the cardholder runs up charges or misses payments, both of your credit scores will suffer. Only the cardholder is liable for the balance, though.

Consider a card from a local bank or credit union. A community bank or credit union is a wise place to start for a quality credit product that reports to the credit bureaus, Ortega says. These financial institutions often understand the needs of the community and have a stated mission to help their customers and members get ahead.

Get a store credit card. These can be easier to qualify for than many unsecured cards. One caveat is that store cards tend to charge higher interest rates than other cards, which means you should always pay off your balance.

Be responsible with your credit. If you have revolving credit accounts, be sure to always pay on time, keep your balance to less than 30% of your credit limit and try to pay your bill in full each month.

Receive credit for rent and utility payments. You or your landlord can sign up for a rent reporting service to put your rent payments on your credit report. You can also add points to your credit score with Experian Boost, a free service that gives you credit for timely utility, telecom and certain streaming service payments.

Use resources for underserved communities. For example, the nationwide Thrive initiative is bringing opportunities for financial education to Black and Latino consumers.

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