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Credit scores put Black Americans at a disadvantage — here's how

Twenty/20​

Credit scores, which are intended to gauge financial responsibility, also reflect the economic disadvantages many Black Americans face. 

"Credit scoring is one of the ways the racial wealth gap manifests itself," according to Lisa D. Cook, a Michigan State University economist and a former senior economist at the White House Council of Economic Advisers under the Obama administration. Black families in the U.S. have 90% less wealth than White families.

Credit scores, Cook argues, also end up making the wealth gap worse. That's because credit scores are closely tied to someone's ability to grow wealth and succeed financially in the U.S. since scores often determine eligibility for loans, apartment rentals, and even jobs.

More than 50% of White households had a FICO credit score above 700, compared with only 21% of Black households, according to a 2017 study by the Urban Institute. A "good" credit score (700 or higher) is often necessary to be eligible for the best interest rates for most types of loans.

"Discrimination has harmed Black Americans' creditworthiness," Cook says. Statistically, Black Americans are at a financial disadvantage: They earn less, they are saddled with higher-interest debt, and they are less likely to own a home than White Americans. "We need to reverse the damage."

How credit scores put Black Americans at a disadvantage

"Your credit score is probably the most important number in your financial life," says Ted Rossman, industry analyst at Bankrate. A high credit score can lower your interest payments on student loans and mortgages, which means it can end up helping you save thousands of dollars. Landlords often check your credit score when you apply for an apartment, and employers can even use your score when considering you as a job candidate, he explains.

"Credit scores are supposed to be blind to race, age, income, and geography," Rossman says. While he is confident that credit bureaus mainly rely on information like payment history, debts, and the length of one's account history to calculate creditworthiness, there is a "semisecret sauce, or algorithm," that goes into credit scoring, he explains.

No one knows all of the information that is collected and used in credit score calculations, he adds: "Credit scoring isn't perfect."

Several factors contribute to a credit scoring model that puts Black Americans at a disadvantage, Cook says. 

One of those factors is a long history of discriminatory lending and banking practices. From 1933 to 1968, U.S. banks denied Black Americans access to financial services in a practice known as redlining. While this practice is illegal today, it had catastrophic, lasting results, Cook says: "It has forced many to turn to high-fee financial products like payday loans." 

Many low-income Americans must rely on higher-cost financial services, including payday loans, paycheck advances, pawn shop or auto title loans, and tax refund advances, because they are "unbanked" or "underbanked," meaning they lack of access to traditional bank accounts. The majority of "underbanked" Americans are either lower-income, less-educated, or part of a minority community, according to a 2017 study by the Federal Deposit Insurance Corp.

We need to reverse the damage.
Lisa D. Cook
Michigan State University economist and former senior economist at the White House Council of Economic Advisers

Payday loans and the like are harder to pay off, so customers accumulate more debt and often end up with lower credit scores. Those lower credit scores makes access to capital, like loans, even more expensive, due to higher interest rates, Cook says.

"It's a domino effect," Cook says. "These high-fee products baffle me and they should be avoided."

A push for more comprehensive credit scoring

To combat this cycle, "one proposal is for [credit bureaus] to take into account the payment of utility bills, like water and electric bills, because they really show how creditworthy you are," Cook says.

Currently, FICO scores do not factor in your income, savings, utility bills, job status, or debit transactions, but some members of Congress are hoping to change that by introducing legislation to improve credit bureaus.

In January, the House passed The Comprehensive Credit Act of 2020, which could tackle many of the issues Cook highlights. This bill proposes requiring credit bureaus to remove adverse information from a credit report related to predatory lending practices, ban the use of credit scores for employment purposes, and it would take into account bills for cellphones and utilities when determining creditworthiness. In order for the bill to be enacted, the Senate and the President must sign off on the legislation. Neither branch has taken action yet. 

On a corporate level, Experian and FICO have both unveiled products this year that will incorporate additional information in your credit report. The programs, called Experian Boost and UltraFICO, allow consumers to opt in to supplementing their credit report with information about their history of paying utility, cable and cellphone bills. 

Experian Boost has helped more than 840,000 users increase their scores by 13 points on an average, according to the company's data.

VIDEO2:5302:53
This is how your credit score is actually measured

Video by David Fang

Having a low credit score, or no credit score at all, isn't only an issue for minorities. Fully 45 million American consumers are so-called credit invisible, according to the Consumer Financial Protection Bureau. Black and Hispanic consumers were almost twice as likely to have no credit score, the study found, with a 15% rate of credit invisibility, compared to 9% for White Americans.

There are strategies you can take to boost your credit score, or create a credit history, without the help of these products. To boost your score, experts recommend checking your credit history for mistakes, paying your bills on time, and lowering your credit utilization rate. 

There are also financial start-ups like Tomo and Petal, that give customers credit cards without taking their credit history into account, Rossman says. "They're geared towards young adults, immigrants, or any customers who are credit invisible or have a low credit scores to help them establish credit."

VIDEO1:5001:50
3 steps to build your credit score with Matt Schulz

Video by Ian Wolsten

Consider a credit union

Where you keep your cash can help to promote equality, Cook says. She recommends considering credit unions: Unlike traditional banks, credit unions have the ability to cater to the specific needs of their communities by offering access to loans and other financial products to low-income earners and minority groups.

"Minority-owned and managed credit unions play a critical role in providing financial services to communities that have been traditionally underserved or unbanked," according to the National Credit Union Association

"Some credit unions have a specific mission to help close the racial wealth gap," she says.

Still, at all financial institutions, change needs to come from the top down, Cook says. In order for there to be a fairer financial system, one that works better for everyone, "there has to be more diversity [in leadership] at these institutions, people from different backgrounds with different life experiences."

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