Any lender worth their salt does not care about race, religion, national origin, sexual orientation, or marital status. Lending is a business built around credit risk management, and bias in lending is not just bad business but also illegal and subject to a swath of regulations. Where do credit scores come in?
Credit Card Lending Fairness
The Equal Credit Opportunity Act, which first passed Congress in 1974, when revolving credit card debt was $11 billion in the United States, now oversees over $1 trillion. Special thanks to Gerald Ford for that standard.
Some unfair lending practices date back to segregation when some neighborhoods were “redlined” to help the Federal Housing Administration contain risk. The course was a dark side of American History, and efforts have been at least partially effective to outlaw the practice, though issues continue to exist.
It is rare to see bias in credit card underwriting because of the clinical nature of credit scoring. The dominant credit score, known as the FICO Score, bases its calculation on factual data provided by lenders, such as account opening, amount, line utilization, and age of credit. No information about personal lives is part of the equation.
US News and World Reports published a story today on How Race Affects Your Credit Score, and a finding was not that there is an inherent bias in credit scoring, but they are different social issues that cause a great divide between groups. The story cites data from the Urban Institute, illustrating the disparities in credit scoring found in the Vantage Score. While all Americans average slightly above seven hundred, Caucasians outpace the model, Hispanics trail, African Americans have a deep gap, and Native Americans are at the bottom of the list.
The article quotes a former FICO executive, the dominant credit scoring company:” “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.”
Is the Gap in Credit Scoring or Societal Issues?
US News mentions:
- 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 Hispanics, $74,912 for white, and $94,903 for Asian families, 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 (African-American) 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.
Does a new “inclusion” score make sense? Not if the goal is to assess risk across a wide range of people. Stick to the facts, we say. And the facts are the ability and intent to repay credit. There are broader social issues to correct, but not to replace safe and sound lending responsibilities. The problem here is not in credit scoring but in creating inclusion opportunities and balancing long-known issues about income distribution and opportunity for all.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group