Closing the Racial Wealth Gap — Series | Credit Score
People often have a love-hate relationship with their credit score.
The reason people love it is because it can give them the ability to engage in important wealth building activities like purchasing a home, financing a business, obtaining insurance, and sometimes even securing a job.
The reason they hate it is because it is so elusive...and low-key discriminatory.
The problem is that many of the factors that go into determining a person’s credit score penalize individuals with lower wealth much harsher than those with wealth. And as we discussed in the first installment of this series, black and brown people have disproportionately less wealth than white people.
According to the United States Federal Trade Commission your credit score is determined by the following:
- How much money you owe
- Whether you’ve paid on time or late
- How long you’ve had credit
- How much new credit you have
- Whether you asked for new credit recently
Let’s take this one factor at a time:
“How much money you owe” — if a person lacks wealth and/or a living wage they are more likely to over extend their use of credit to just make ends meet.
“Whether you’ve paid on time or late” — again, if a person lacks wealth and/or a living wage and is living paycheck to paycheck they’ll need to prioritize their monthly expenses. Basic needs such as food and shelter often take priority over paying back creditors, which we’ve seen in this current economic crisis.
“How long you’ve had credit” — a person can’t just access credit building tools such as credit cards and loans; they have to be approved for them. So it’s up to financial institutions to determine when a person is qualified to borrow and therefore when their credit history can begin.
“How much new credit you have” — once again if you do not have the wealth or income to sustain yourself or your family you will need to continue to depend on credit to finance your life.
“Whether you asked for new credit recently” — I’m going to sound like a broken record, but this bears repeating. If you are low-wealth and/or low-income you will likely depend on various sources of credit to finance your life. Which may lead to regular attempts to access new credit.
Considering their wealth position, it’s no surprise that people of color also have poorer credit.
In 2017 the Urban Institute developed a dashboard based on research on the financial health of 60 major U.S. cities. They found that:
Thirty-eight of the 60 cities have differences in median credit scores of 100 points or more between predominantly white and nonwhite areas. Nationally, the difference in median credit scores is nearly 80 points (697 versus 621, respectively), which, for a conventional mortgage, can cost families an additional $100 or more a month and thousands of dollars over the life of the loan.
The irony is that credit scores were so widely adopted, in part, in response to the subjective ways lenders used to determine a person’s credit worthiness that would consistently lead to discriminatory lending practices. However, the new system runs into the same issues.
In Dr. Ashlyn Aiko Nelson’s 2010 paper, “Credit Scores, Race, and Residential Sorting,” she writes:
Before credit scores became industry standard, loan officers exercised substantial discretion over loan decisions, and there is ample evidence that these practices often resulted in racially discriminatory lending practices (Ross & Yinger, 2002). Yet while standardized credit scoring practices expand access to credit, they may also perpetuate racial disparities in loan approvals and denials, as well as the cost of credit as measured by the loan interest rate and other terms. Concerns have been raised about racial bias in credit scoring by policymakers, researchers, and consumer advocacy groups alike.
The business of credit scores is much bigger than one might imagine. Even though you can access your credit report once a year for free, you still have to pay for your own credit (FICO) score. Also people are now paying credit repair companies to “fix” their credit as well as paying alternative financial institutions such as payday and title loan lenders, that don’t require a high credit score, to access quick financing.These are often much more expensive ways to access capital.
In contrast, those who are high net-worth or wealthy individuals don’t have to worry as much about their credit score.
Think about it.
If you are wealthy, you don’t need to finance the purchase of a new home. You just buy it. You don’t need to finance a business, you pay for it yourself or get help from friends and family. You don’t have to experience a potential employer refusing to hire you because you can just employ yourself or tap into your network of business owners to take you onboard. And if you don’t qualify for insurance, no problem, you or someone in your network can cover the cost in the event of an accident.
Using credit to determine whether a person has access to wealth building tools is not about wealth building for the individual.
It’s about lenders maximizing profit through consumer debt, which also tends to disproportionately penalize low-wealth and low-income communities.
Now, there is nothing inherently wrong with debt. It’s used as a tool to accomplish a myriad of financial goals.
What can be unhelpful about debt and its relation to credit scores is how much it can prevent low-wealth and low-income people from engaging in wealth building activities.
What do we do?
There needs to be a more equitable way of accessing wealth building tools such as home ownership, business creation, and employment. There needs to be transparency around industries that profit off of our need to know and raise our credit scores, and there need to be alternative methods for determining how people can access financing.
Now, you may be thinking, “You’re just mad because you have bad credit.”
The truth is I have great credit. I’m not trying to brag…well, maybe a little.
It’s over 800.
And I was feeling really good about myself until I realized that it doesn’t matter. Not in terms of measuring actual wealth or my ability to transfer wealth to my family or community.
You can’t pass your credit score on to your children.
You can’t donate your credit score to charity.
Too often there is a push to make black and brown communities fixate on their credit scores.
Although credit scores currently play a role in personal finance, equating specific credit scores with financial health is misleading. Throughout this series we will explore more accurate ways to assess financial wellbeing and address the racial wealth gap.
