To most of us, credit scores are an obscure subject, something to think about only when we're applying for a loan. But they're deeply tied to the foreclosure crisis and the cloud of gloom surrounding the housing market and the economy generally. They have contributed to the disproportionate effect of the foreclosure crisis on minorities, and have the potential to create a vicious cycle that will pound communities of color even further.
Case in point: Last week, the National Community Reinvestment Coalition filed a discrimination complaint against twenty-two lenders, charging that they were discriminating against minority borrowers by denying FHA-backed mortgages to applicants who met the FHA requirement of a FICO score of 580 or better. The lenders, NCRC charged, were insisting on FICO scores far higher than the FHA demands.
And there's plenty of evidence that credit scoring as it's now done puts borrowers of color at a disadvantage.
FICO scores (from the Fair Isaacs Co.), for example, are based on the following: payment history, including bankruptcy or foreclosure status (35 percent), level of outstanding debt and debt utilization (30 percent), length of credit history (15 percent), new credit and credit inquiries (10 percent) and types of credit used (10 percent).
While some details vary at other companies providing credit ratings, the essential components are similar -- and what's missing is important. Credit history -- mortgages, car loans, credit cards, etc. -- is included in these models, but other types of bill-paying are not. Much information, such as payments for rent and utilities, is not reported to credit agencies.
This puts those who have little experience with credit but a long, stable history of on-time payments of rent, utility bills, etc. at a huge disadvantage. Because credit scoring models consider mortgage payments but not rent, there is a built-in advantage for whites: 74.7 percent of whites now own their own homes, compared to rates of 47 percent for Latinos, 45 percent for African Americans and 57.3 percent for other races. Clearly this contributes to the fact that people of color on average have lower credit scores than non-Hispanic whites.
Another thing credit scores don't do is account for changes in individual or neighborhood circumstances that may temporarily cause an otherwise responsible borrower to miss payments. And several indicators suggest that the current recession has had a disproportionate impact on minority communities.
As of November 2010, the unemployment rate for whites was 8.9 percent, according to the Bureau of Labor Statistics, compared to 13.2 percent for Latinos and 16.0 percent for African Americans. And an impact index released last year by the Center for Social Inclusion found that states with higher percentages of people of color were hit harder by the recession overall -- with Florida, which has a large Latino population, hit hardest of all.
As I've noted before, there is evidence that blacks and Latinos with high credit scores were more likely to receive high-cost subprime mortgages than whites with comparable scores. Add this to the likelihood that these borrowers have artificially low credit scores due to factors that have nothing to do with their willingness to pay their debts, and you have a sort of double jeopardy.
And it could get worse. Millions more homes are in danger of foreclosure. Many of these are due to circumstances that have little or nothing to do with the borrower's long-term creditworthiness, such as misleadingly marketed and predatory loans or recession-related job losses.
If those foreclosures go ahead as scheduled, millions of Americans -- disproportionately people of color -- will not only lose their homes, they'll take a devastating hit to their credit ratings. Millions of responsible, hard-working Americans will be locked out of any reasonable shot at home ownership for many years to come, causing a continuing drain on the housing market and impacting employment in fields related to construction and real estate.
This is a continuing downward spiral that will prolong the recession and ultimately hurt all of us. That's one more reason why we need a serious effort to provide relief based on reducing the principal of troubled mortgages, and we need it now.