Discriminatory Effects of Credit Scoring on Communities of Color

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Table of Contents    I. Introduction  II. The Nation's Dual Credit Market Rooted in Discrimination         A. Overt Historical Discrimination         B. Subprime Lending and Its Long-Term Discriminatory            Effects         C. The Proliferation of Fringe Lenders in Communities            of Color III. Credit Scoring Has a Discriminatory Impact and Is Not the         Best Measure of Risk         A. Limited Scope, Quality, and Transparency of Credit            Information         B. Disparate Impact of Credit-Scoring Factors            1. Payment History: 35% of FICO Score            2. Amounts Owed: 30% of FICO Score            3. Length of Credit History: 15% of FICO Score            4. New Credit: 10% of FICO Score            5. Types of Credit Used: 10% of FICO Score         C. Existing Credit-Scoring Systems Do Not Adequately            Predict Risk         D. Risky Loan Products and Unsafe Lending            Environments--Not Borrowers--Were Clearly the Culprit  IV. Why the Federal Government and Lenders Have an         Obligation to Change the System   V. Policy and Enforcement Solutions to Improve Credit-Scoring         Systems         A. Broaden the Scope of Financial Data Utilized by            Underwriting and Credit Scoring Models         B. Improve the Quality of Data         C. Make the System More Transparent         D. Adequately Assess the Impact of Credit-Scoring            Mechanisms on Underserved Groups         E. Reduce the Overreliance on Credit-Scoring Mechanisms         F. Evaluate Product Risk         G. Fix Credit Scores for Victims of Discrimination  VI. Conclusion 

I. INTRODUCTION

Our current credit-scoring systems have a disparate impact on people and communities of color. These systems are rooted in our long history of housing discrimination and the dual credit market that resulted from it. Moreover, many credit-scoring mechanisms include factors that do not just assess the risk characteristics of the borrower; they also reflect the riskiness of the environment in which a consumer is utilizing credit, as well as the riskiness of the types of products a consumer uses.

Until only a few decades ago, communities and people of color were explicitly excluded from access to low-cost government and other mainstream loans. In the 1930s, the Home Owners Loan Corporation (HOLC) used blatant discriminatory rating systems and "residential security maps" to deem communities of color to be high risk. (1) The Federal Housing Authority (FHA) and Veterans Administration (VA) continued this discrimination into the 1950s. (2) Banks, real estate agents, appraisers, and others also perpetuated redlining and segregation in the housing markets. The passage of the federal Fair Housing Act of 1968 improved conditions, but federal regulatory agencies refused to acknowledge their enforcement responsibilities under the Act until the mid 1970s. It was not until civil-rights groups sued the agencies that the federal government began to collect information on the mortgage-lending practices of the institutions it regulated, and to establish and implement fair-lending examination procedures.

Because of this history of racial discrimination, segregated neighborhoods formed and people of color had limited access to affordable, sustainable credit. Instead of accessing mainstream credit available to white borrowers and white neighborhoods, people of color were relegated to using fringe lenders and paying much more than they would have had to otherwise. While segregation and housing discrimination have abated somewhat, we still live in an extraordinarily segregated society. (3) Access to credit is even now often based on where we live rather than our individual ability to repay that credit. As this Article will explore, people of color were steered to subprime loans even when they qualified for prime loans, contributing to the fact that the foreclosure crisis has hit communities of color worse than the rest of the country. …