Where do credit scores come from and why they don’t quite match up – but can

There was nothing inherently wrong with what Boni was doing, or what many blacks and Latinos are doing. They just weren’t the kind of customer credit reporting companies companies thought of when they developed and promoted consumer credit reports. The result is that million americans who should have access to credit do not.

What is a credit score?

A 1970 federal law required that cold, hard facts guide credit decisions, rather than the prejudicial inclinations that were normal at the time. This resulted in the increase in credit score.

One of the inventors of credit scoring, William Fair, testified before Congress in 1979 that there was an inherent fairness in the agnostic use of information to determine who is creditworthy and who is at high risk of default.

Fair objected to Congress banning the use of race, gender, or other social categories in assessing creditworthiness. He felt that these factors could be significant in one way or another and should therefore be used. If the public concern was about the distribution of credit opportunities, he said, it was not the fault of the data.

“More than half of black adults today have no credit or a credit score below 640, considered ‘poor’ or ‘fair’ credit risk.”

Rather, he said, determining fairness was the responsibility of legislators. He told senators at the hearing that determining fairness is “your prerogative, your duty and your responsibility, not mine. I will comply with the law and advise our clientele to do just that.

The credit scoring system that Fair helped invent, now referred to as FICO score, starts at 300 and goes up to 850. More than half of black adults today have no credit or a credit score below 640, considered “low” or “fair” credit risk, two lowest categories out of five. Among consumers with a score lower than 620, 41% have late payments of at least 30 days late. And 28% of people in this category are “likely to become serious offenders”, according to the Experian rating agency. A Brookings Institution report found that counties whose residents had average credit scores below 620, but above 560, had high concentrations of blacks and Latinos, accounting for 28% and 19% of the county’s population, respectively.

People with lower credit scores are more likely to be denied mortgages, loans and credit cards – or be charged higher interest rates than people with higher scores. Consumers with more credit scores over 760 would save just under $33,000 in interest payments on a 30-year mortgage, enough to buy a car or pay for two years of public university attendance, according to a 2016 report.

As a result, black and Latino borrowers pay more for the same goods and services as their white counterparts, or they are denied the opportunity to purchase them because of their low scores.

It’s not all fair in race and credit

As Fair told Congress, complete information about a potential customer is better than partial information. Selecting – or forbidding – only some of this information could actually favor members of one group over another. But as Senator Carl Levin, a Democrat from Michigan, reminded Fair during that hearing, the government had decided that credit decisions should not “disadvantage people because of their race, religion, ethnicity, gender, marital status, age or disability”.

Congress had made the decision to place limits on the market, Levin continued, telling Fair, “Society has decided that we’re not going to stereotype people based on their race, religion, or ethnicity. for social purposes, even if it has statistics. value, even if a computer can tell us that people who come from Yugoslavia pay more or less quickly than people who come from Austria. We’re not going to let you.

Senator Paul Tsongas, a Democrat from Massachusetts, said certain characteristics of a person were unfair: “There are certain variables that a person can affect by their behavior – whether you pay your bills, what kind of car, etc. – while there’s no way you can get away from being white, black, Greek, Hungarian or whatever Race, gender and other immutable attributes, Levin said, n have “nothing to do with personal motivation or the ability, if you will, to successfully participate in the system”.

Fair had a low opinion of government-designed justice. He believed it was up to data analysis to assess if and when race or gender were strongly correlated with repayment behaviors. If it happens to be, it is. If it exacerbated racial inequality, at least the cause would be objective risk, according to his argument, rather than subjective bias. Fair’s view, while crude, shaped the terrain of American credit.

Today, credit ratings are based on selective background. Its inventors claim that the score is based on a person’s history, but much of the relevant information is left out. For example, job disruptions are higher for Blacks and Latinos, who are concentrated in occupations more vulnerable to financial downturns or who are too often the last hired but the first fired. Job interruptions seem to be a neutral indicator of a person’s credit capacity, unless you ask what is driving the interruptions in the first place.

Similarly, the assumption that the same behaviors will be equally rewarded also ignores evidence to the contrary. Home ownership lowers the return on investment for roughly equivalent properties in predominantly black neighborhoods compared to predominantly white neighborhoods. During times of financial crisis, such as the coronavirus pandemic, existing financial gaps have widened because families with less intergenerational wealth find it more difficult to overcome difficulties.

What does work have to do with credit?

The effects of bad credit go far beyond a person’s ability to borrow money and even affect their earning capacity. At least one quarter of companies report that they ask for job applicants’ credit reports — although they are not allowed to see credit scores — when deciding who to hire.

There are no proof that credit reports predict job performance. But some employers say they review credit records lest someone in financial difficulty might be tempted to steal again, or someone with many missed payments might be disorganized or lack follow-up.

In a randomized experiment with more than 1,000 hiring managers, researchers found that women with poor credit reports were less likely to be called in for a job interview than men with the same report. The results improved for race, at least among men, where black people were just as likely to be called in for a job interview, but were more likely to have hiring managers recommend a starting salary below that of their white counterparts. As explained in the book of Matthew, of those who have little, even more is removed.

H. Hopp-Bruce/The Emancipator/Nadia Snopek/Adobe

We can solve this problem

It doesn’t have to be that way. Congress could make the credit score fairer simply by doing two things.

First, the US Congress could restrict the uses for which credit reports are used, prohibiting them for hiring, promotion, and other non-credit related purposes. Work history and performance reviews, not credit reports, would then determine who gets hired and promoted.

Second, Congress could provide a public option for consumer credit scores, replacing the secret formulas of private companies. This way, all Americans could have a transparent set of criteria used to assess their ability to repay a loan.

This public option could use cell phone bills, rent payments, bank transactions and cash data, and other financial information relevant to the loan. It could highlight the resulting differences in its scores compared to those of private companies, thereby introducing more accountability and competition into the system.

With a public option focused on racial justice, the United States could take a step toward recognizing that the nation’s history shapes the disadvantages experienced by some of its people. William Fair did not want to talk about the legacy of present and past racial discrimination, although he wanted to use race to make decisions. It would be unfair to stop talking about this story, because in the making of credit scores, America’s racial histories will never stop talking about us.

Frederick F. Wherry is a professor of sociology at Princeton University and director of the Dignity + Debt Network, a partnership between the Social Science Research Council and Princeton. He, Kristin Seefeldt and Anthony Alvarez are the authors of “Credit Where It’s Due: Rethinking Financial Citizenship”.

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