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Where credit scores come from and why they don’t quite add up — but can

Credit scores were founded on, and perpetuate, racial inequality.

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 rise of the credit score.H. Hopp-Bruce/The Emancipator/Nadia Snopek/Adobe

It didn’t count, but it should have. Boni, who moved to the United States from Mexico in his late 20s, needed to buy or rent equipment for his growing independent construction business. It was 2016, and he was earning decent money and paying for his housing and other living expenses. But with no credit history, his options for expanding his work opportunities were limited and involved high interest rates that seemed both expensive and risky.

Without a credit score, Boni was stuck. Everything he was doing with his money would have been fine if the credit-reporting companies knew about it. They did not.

Congressman Keith Ellison, a Minnesota Democrat, and Pennsylvania Republican Michael Fitzpatrick joined forces in September 2013 to tell the story of people like Boni and tens of millions of others who were, as Fitzpatrick pointed out, “paying their bills on time. They’re paying their cell phone bills, their utilities, and they’re paying to a private landlord. Those positive credit activities are not getting reported anywhere, but God forbid you miss a payment.”

There was nothing inherently wrong with what Boni was doing, or with what many Black and Latino people do. He simply was not the kind of customer credit-scoring companies had in mind when they developed and promoted consumer credit scores. The result is that millions of 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 rise of the credit score.

One of credit scoring’s inventors, William Fair, testified before Congress in 1979 that there was an inherent fairness in using information agnostically to figure out who is worthy of credit, and who poses high risk of default.

Fair objected to Congress barring the use of race, gender, or other social categories from being used in evaluating credit worthiness. He felt that those factors might be meaningful somehow and therefore should be used. If the public concern was about how credit opportunities were distributed, he said, that wasn’t the data’s fault.

‘More than half of Black adults today have no credit or a credit score under 640, considered to be “poor” or “fair” credit risks.’

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

The credit score system Fair helped invent, branded today as a FICO score, starts at 300 and runs up to 850. More than half of Black adults today have no credit or a credit score under 640, considered to be “poor” or “fair” credit risks, the lowest two categories out of five. Of consumers with a sub-620 score, 41% have late payments at least 30 days past due. And 28% of people in this category are “likely to become seriously delinquent,” according to the Experian credit-rating bureau. A Brookings Institution report found that counties whose residents had average credit scores below 620, but above 560, had high concentrations of Black and Latino people, accounting for 28% and 19% of the county population, respectively.

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

As a result, Black and Latino borrowers pay more to get the same goods and services as their White counterparts, or they are denied the opportunity to buy them at all because of their low scores.

All is not fair in race and credit

As Fair told Congress, full information about a potential customer is better than partial information. Selecting — or banning — just some of that information could effectively favor members of one group over another. But as Sen. Carl Levin, a Michigan Democrat, reminded Fair at that hearing, the government had decided credit decisions should not “disfavor people because of their race, religion, ethnic origin, sex, marital status, age, or handicap.”

Congress had made a decision to place some limits on the market, Levin continued, telling Fair, “Society has decided that we’re not going to stereotype people based on their race or religion or ethnic origin for social purposes, even though it has statistical value, even though a computer can tell us that people who come from Yugoslavia are faster or slower payers than people who come from Austria. We’re not going to let you do it.”

Sen. Paul Tsongas, a Massachusetts Democrat, declared some characteristics of a person were not fair game: “There are certain variables that a person can affect by his behavior – whether you pay your bills, what kind of car, etc. — whereas there’s no way you can get out of being White, Black, Greek, Hungarian, or whatever.” Race, gender and other immutable attributes, Levin said, have “nothing to do with personal motivation or capacity to, if you will, participate in the system successfully.”

Fair took a dim view of government-engineered justice. He believed it should be up to the data analysis to assess whether and when race or gender correlated highly with repayment behaviors. If it just so happens that it does, it does. If that exacerbated racial inequities, at least the cause would be an objective risk, his argument went, rather than a subjective prejudice. Fair’s view, though foul, has shaped America’s credit terrain.

Today credit scores rely on selective histories. Its inventors claim the score is based on a person’s history, but so much of relevant information gets left out. For instance, employment disruptions are higher for Black and Latino people, who are concentrated in occupations that are more vulnerable to financial downturns or are too often the last hired but first fired. Employment disruptions appear to be a race-neutral indicator of a person’s capacity for credit unless you ask what drives the disruptions in the first place.

Likewise, the assumption that the same behaviors will be equally rewarded also ignores evidence to the contrary. Homeownership brings about lower returns on investments for roughly equivalent properties in majority-Black versus majority-White neighborhoods. During periods of financial crisis, such as the coronavirus pandemic, existing financial gaps widened because families with less intergenerational wealth have a harder time weathering hardships.

What’s work got to do with credit?

The effects of bad credit go far beyond a person’s ability to borrow money — and even affect their earning power. At least a quarter of businesses report that they request job applicants’ credit reports — though they’re not allowed to see credit scores — when deciding whom to hire.

There is no evidence that credit reports predict job performance. But some employers say they review credit records for fear a person in financial distress might be more tempted to steal, or a person with lots of missed payments may be disorganized or lack follow-through.

In a randomized experiment with over 1,000 hiring managers, researchers found that women with a bad credit report were less likely to be called in for a job interview than men with the same report. Findings improved for race, at least among men, where Black people were equally likely to be called in for a job interview but were more likely to have the hiring managers recommend a lower starting salary for them than their White counterparts. As explained in the Book of Matthew, from those who have little, even more is taken away.

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

We can fix this

It doesn’t have to be this way. Congress could make credit scoring more equitable just by doing two things.

First, U.S. Congress could restrict the uses to which credit reports are used, outlawing them for hiring, promotion, and other purposes not germane to credit. Work histories and performance evaluations, not credit reports, would then determine who gets hired and promoted.

Second, Congress could provide a public option for consumer credit scores, competing with the private companies’ secret formulas. That way, all Americans could have a transparent set of criteria used to estimate their capacity to repay a loan.

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

With a public option bent on racial justice, the United States could take a step toward acknowledging that the nation’s history shapes the disadvantages visited upon some of its people. William Fair didn’t want to talk about the legacy of current and past racial discrimination, though he wanted to use race to make decisions. It would be unjust to stop talking about this history because in the making of credit scores, America’s racial histories won’t 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 authors of “Credit Where It’s Due: Rethinking Financial Citizenship.”