Opinions surrounding credit scoring vary but one thing is certain...there's a significant contingent that believes that credit scoring discriminates against both minorities and the poor.
Before I start digging into this hornet's nest let me first give you the following facts.
- Credit bureau risk scores are designed to identify the level of someone's credit risk and that's it. If they are used for something other than that then, as any decent lawyer will tell you…"the factory warranty no longer applies."
-
Credit bureau risk scores are calculated from information on a consumer's credit report and nothing more.
- Credit reports do not contain data that specifically identifies your race, gender, income, education or lifestyle preferences. Therefore credit scores can't be rewarded or penalized for any of those reasons. Having said that, you could make a reasonable argument that other information on your credit report could be used as a proxy for these things. For example, if a fictitious David Smith's credit report shows that he lives in Beverly Hills, has student loans, has a mortgage loan for $5,000,000 and a car loan with Rolls Royce credit you could make a pretty good assumption that David is a college educated "he" with an expensive car and an even more expensive house. Given that information you could assume that he makes an impressive and substantial salary. I am able to make a pretty solid assumption of all of these things even though his credit reports didn't overtly state any of this.
The question is do credit reports and credit scores take sufficient steps to assure that the non-David Smiths of the world aren't unfairly penalized by their systems. Should they? Is it the job of the credit bureaus or the credit scoring companies to ensure fair lending?
As with any charged topic like this there will be those who have an opinion based solely on emotion, politics, hypersensitivity, racism or previous negative experience. Let's address those folks first.
- Those who believe that credit reports and credit scores overtly discriminate are incorrect and we won't address their opinions further.
- Those who believe that credit reports and credit scores have absolutely no unfair impact to minorities or poor people are also incorrect and we won't address their opinions further.
The answer is clearly somewhere in between and any rational industry insider who has any sense of intellectual integrity is going to admit as such.
Now that we've set the ground rules, we can continue.
I've seen multiple studies on this very topic and amazingly they all "validate" the opinion that the conducting organization would commonly champion as part of their stated charter or mission. You can take that however you want to take it. What it tells me is that they are all right and wrong to some extent and we really haven't seen a completely unbiased and scientifically sound study on the matter and we probably never will.
Don't be fooled by studies that say that "at the aggregate" or "nationally" credit scoring is fair or unfair. Any study that simply looks at millions and millions of consumer's as part of their sample is so watered down that it's irrelevant. Think of a children's choir made up of 100 kids singing Happy Birthday in unison. Together they sound pretty good. But, when you pull out one or two kids and ask them to sing the song by themselves…they don't sound that good, do they? The sample sizes cover up the deficiencies of these studies.
The point is that you can always find horrible examples of unfair treatment if you are willing to look past the masses, roll up your sleeves and get down into the geographic minutia.
Here's the real deal on the matter:
Credit reports and scores do not intentionally discriminate against anyone. But, it's a fact that they do treat some homogenous group unfairly. Here is the primary example as I see it…
Those who live in rural areas of the country and those who live in areas that are considered high minority areas are treated less favorably by the credit reporting and credit scoring systems. I believe that most negative impact is because of their limited access to mainstream lending institutions.
Take, for example, the metro Atlanta area. Significant minority population just south of downtown, a significant "majority" population north of downtown and rural areas within a 2-hour drive in almost any direction from downtown.
Anyone who has spent any significant time in the Atlanta area knows that anywhere north of the city there is no shortage of bank branches, ATM machines and advertisements for mainstream lender services. However, in the minority areas of the city you're much more likely to find an abundance of payday lenders, car title lenders and finance companies. And in the rural areas, you are likely to find a fairly unappealing ratio of finance companies to banks.
I imagine that this is how it is in any city that has poorly integrated racial or socio-economic populations. Poorly, in this case, is defined as a significantly uneven ratio of all races and incomes across all areas.
People who live in these areas are going to gravitate to the services offered locally. As such, poor people, minorities and rural folks are going to have more exposure and access to credit offered by non-banks. It may or may not be their intentional choice, but it may be who is marketing their services more aggressively to the local population.
Anyone who has ever dealt with finance companies, payday lenders or their ilk knows that their offerings are designed specifically for higher risk borrowers. Their rates approach the legally allowed limit, their marketing tactics have been accused of being predatory and the terms of their loans almost always contain strict penalties for even the most minor payment transgressions.
Less experienced borrowers are more likely to fall into difficult situations when their lenders have the ability to change their terms or accelerate payments to impossible standards. As such, their credit reports and credit scores are going to suffer more than consumers who had similar credit management practices but with banks and credit unions.
And, it's commonly known that having a finance company account on your credit report will cost you credit score points. The reason is that consumer's who have finance company accounts tend to be higher risk borrowers than those who don't. What we don’t know is why are they higher risk?
The credit score developers have tried for years to fully eliminate this from their models in lieu of something else but the fact that it has some degree of value in the score has kept it around. As you can imagine, this is a public relations problem.
Is the problem that higher risk consumer's gravitate to less prestigious lenders or is the problem that those who have accounts with these companies are more likely to have their credit reports and scores trashed because of unreasonable and hard to understand loan terms?
It's safe to say that the answer is a little from column A and a little from column B.
So, do credit reports and scores treat minorities and poor people unfairly? I would say that they do, but it's not their fault. And, I would say that criticism of these systems would be more productive if it were aimed at some of the less ethical lending institutions. Screaming at the credit bureaus and credit scoring models is kind of like yelling at the librarian because you don’t like the books.
