Policy Spotlight: Reducing debt disparities to close the racial wealth gap

A new brief from Aspen Institute’s Financial Security Program says debt is “underappreciated as a driver of racial wealth gaps.”

Black History Month is a time for reflection, celebration, and action at TrustPlus. Today, we shine a spotlight on policies to reduce debt, which “remains underappreciated as a driver of racial wealth gaps,” according to Disparities In Debt: Why Debt Is A Driver In The Racial Wealth Gap.

Broadly speaking, the new research brief from the Aspen Institute’s Financial Security Program (FSP) finds that Black or African American and Latino/Latina/Latinx identifying households tend to hold fewer or less valuable assets and more bad debt than white households. These disparities are pervasive, systemic, and destructive both financially and in terms of “diminished health and well-being and reduced trust in institutions.”

While strict definition can be elusive, bad or harmful debts are “non-loan debts such as medical bills and public fines and fees, and alternatives to mainstream credit such as payday, vehicle title, and private student loans…They can be barriers to employment and medical care, and they can be entry points for entanglement in court systems.” In other words, bad debt leads to higher debt and lower credit scores rather than to financial security, with ramifications that extend far beyond personal finance.

The report is a valuable contribution to the growing body of research showing the critical role that debt plays in advancing or inhibiting one’s path to financial empowerment, and to closing or expanding the racial wealth gap. Here’s an overview of the findings and calls to action.

KEY FINDINGS:

1) Racial Disparities in Debt Are Pervasive

The data show that millions of households were in a position of net debt rather than net worth, including 10.8% of households with zero or negative wealth. Disproportionate numbers of Black (18.9%) and Hispanic/Latino (11.3%) households were in net debt.

2) Racial Disparities in Debt Are Systematic and Destructive

Households of Color are Disproportionately Likely to Hold Harmful Debt

• Medical debt diminishes “households’ ability to amass investible sums and can limit access to credit for years (due to the impact on credit scores)…These debts are most common in states that have not expanded Medicaid.”
• Public fines and fees like unpaid parking tickets and court costs “can quickly derail a household’s financial stability,” “turn a one-time cost into a long-term drain on household financial health,” and “result in jail time (which can itself impose additional fees).”
• High-cost alternative loans–the two most common of which are payday loans and vehicle title loans–“tend to lock borrowers into a cycle of predatory debt” with interest rates “generally in the triple digits.” Too often they are the only options for Low-income Black or African American and Latino/Latina/Latinx households who “have reduced access to affordable financial products and services.”

People of Color Are More Likely to Become Involved with Court Systems Due to Debt

• Debt collection lawsuits: About 70 million Americans have a debt in collection but “Black and Latino consumers face a higher incidence of debt collection lawsuits” while “Black consumers tend to be sued over smaller amounts compared to their white peers.” And if you’re sued for debt, chances are you’re going to lose in court: “more than 70% of debt collection lawsuits end in a judgment against the alleged debtor, even though debt collectors often do not need to show any proof or records.” Incredible.
• Bankruptcy is the most common solution for people who cannot pay their debts. Here, too, the disparities are alarming, and sadly unsurprising, “with significantly higher rates of bankruptcy filings in majority Black ZIP codes than in majority white ones.” It gets worse. “Bankruptcy cases filed in primarily Black neighborhoods were twice as likely to be dismissed as those in white areas.”
• “Imprisonment for unpaid debt” aka debtors’ prison: What may be surprising to some readers, in 44 states, “debtors face the possibility of jail time for not cooperating or abiding by post-judgment proceedings” including “Black residents in New Orleans” who “faced jail time for lack of payment of fines at 1.5 times the rate of their white peers” in 2019.

People of Color Disproportionately Experience Non-financial Damage from Debt

“Consumer debt is associated with both physical and mental health challenges” and with reduced trust in institutions which is bad for individuals, institutions, and society. A major study of studies “found in nearly 80% of the studies a link between being in debt and poorer physical health.” Student loan debt appeared to weigh especially on mental health.

Also unhealthy for people and for the economy is a lack of trust in institutions based on negative experiences with debt which people of color experience at disproportionate rates. In turn, this “can lead people away from these financial institutions, affecting not only borrowing for future asset purchases but also utilization of formal savings mechanisms.” A vicious cycle.

3) Racial Disparities in Debt Disrupt Every Phase of the Wealth-Building Process

Building wealth requires financial stability. Once that’s achieved, according to FSP, “there are three phases to sustainable wealth-building: 1) amassing investible sums through personal savings and transfers 2) acquiring assets, which requires access, financing, and information and confidence; and 3) protecting the accumulated holdings.”

Systemic disadvantages are present in each of these phases of the wealth-building process. So what to do?

EVIDENCE-BASED CALLS TO ACTION:

1) Cancel federal student loan debt, at least $30,000 of federal student loan debt for all borrowers.

2) Massively increase access to homeownership and high-quality mortgages for people of color, particularly Black and Native homebuyers.

3) Increase access to insured, affordable health care, expanding Medicaid in every state.

4) Eliminate most public fines and fees and stop issuing bench warrants for unpaid fines and fees.

In developing its report, FSP pulled from a variety of sources, including FSP’s Consumer Insights Collaborative of which we’re a member.