How Credit Scores Rule — & Ruin — Our Lives

The idea of credit is simple — and old. You want something that you can’t offer anything for at the moment, so you work something out with the vendor. You'll take the item now, but reimburse them, plus a little extra for their trouble, at a later date. 

In centuries past, these interactions might have been done in various ways, including bartering; more recently, credit was often contingent on knowing who it was that a person was effectively borrowing from, adding a layer of the personal to a professional interaction. Today, consumer credit is a titanic industry, complete with products and services marketed and sold for impressive profit — it’s a far cry from the relationship you have with your neighbor who owns the local supermarket. And whether or not you’re considered a viable credit risk has nothing to do with your long-standing relationship with that supermarket-owning neighbour, but is rather based on an inscrutable mix of credit-reporting algorithms. No wonder the most common reaction we have about our credit score is: “Why?”

Perhaps the first thing to know about credit scores is that they’re about much more than just assessing lending risk. Credit determines our ability to move around in the world. Most major purchases we make — and therefore, life decisions — demand that we have “good credit.” As soon as we turn 18, common financial advice says that we should not only get a credit card, but also start swiping it everywhere — not too much that we can’t pay our balances, but enough to build what every adult is told that we must have: a credit history.

It’s hard to overstate credit’s impact on the course of your life. You need good credit to get a loan, to buy a home, to buy a car. All of that is pretty obvious. But even — perhaps especially — if you’re renting, you’re going to want good credit, as your landlord is going to want to do a credit check. And, if you’re buying car insurance, good or bad credit can affect the rate you’re offered. According to HR.com’s 2020 study on the use of background checks, a shocking 90% of employers reported doing at least one kind of background check on all their full-time employees, which increasingly includes credit reports. On such a credit report, your employer could potentially see your employment history, what credit lines you have, what loans you’ve taken out, payment history, debt collections records, bankruptcy or foreclosure records, among other private information. 

Having excellent credit opens doors. Having bad credit leads to a snowball effect that can lock low-income Brits and Americans into poverty forever. The problem isn’t just that having bad credit means, for example, that it’s hard to qualify for a mortgage — bad credit also makes life more expensive. “It’s a huge deal in part because it forces you often to turn towards other types of credit products, like predatory loans,” says Ariel Nelson, an attorney with the National Consumer Law Center (NCLC). “In housing, the places that will accept you might have really poor conditions that might cost more than they should for what they are.” You have less money and therefore are more likely to need credit, but can only access high-interest loans where you end up paying more over the course of the loan than someone with good credit would. It’s a system that punishes people who don’t have much money by making them pay more money. 

But of course, class isn’t the only discriminatory axis when it comes to credit and lending. An Urban Institute analysis of credit data shows that, nationally, the average credit score in predominantly white neighbourhoods is 697, while in predominantly non-white areas it’s 621. This disparity can be even wider in certain cities. In New York City, US, people living in predominantly white areas have an average score of 740, while those in non-white areas score around 648.

Nelson emphasises that the consumer credit system doesn’t just reflect symptoms of existing inequalities. “It’s also a system that perpetuates it,” she says. One example is the fact that non-white consumers often end up paying more for cars than white consumers with similar creditworthiness. A 2018 National Fair Housing Alliance report tested the degree to which your race can affect car prices, and it found that 62.5% of the time, their non-white testers were offered higher-interest loans compared to white testers who had worse credit. Non-white testers who were discriminated against were offered terms that, on average, would have resulted in them paying $2,662 (£1,925) more for the car. This “mark-up” for Black and Latinx car buyers has been well-documented over the years.

They're given more expensive terms for mortgages, too. Housing costs in neighbourhoods with mostly Black residents are about 25% higher than those in comparable neighbourhoods that are majority white. Racism in mortgage-lending goes beyond the now well-known practice of redlining, which has been used mainly to deny home loans to Black Americans. It was made illegal in the Fair Housing Act of 1968, but modern redlining still exists. “Most likely, these days, it could be that they have a policy or a practice that appears neutral on its face,” says NCLC attorney Odette Williamson. “But the outcome is that people in a certain community are not getting those loans.”

In fact, she explains, decades of redlining helped set up the disaster of the 2008 subprime mortgage bust. The credit industry is a business concerned with profit, after all, and spurred by a desire to expand into new markets to sell even more products, combined with some financial market deregulation in the ’80s, lenders began offering predatory subprime mortgages in the very communities that had traditionally been excluded from homeownership. “It was called reverse redlining,” says Williamson. “Black and Latinx communities were given these loans that were just awful, terrible, not sustainable, and just blew up in your face after a while.”

An NCLC paper that Williamson co-authored states that these communities were “easy prey” exactly due to the fact that they “had been starved for credit for generations.” The paper notes that “even adjusting for income, subprime was sold disproportionately to borrowers of colour.” And actually, the likelihood of subprime loans being given to non-white borrowers compared to white borrowers increased the higher the income bracket.

A “subprime” loan is, at its core, an expensive loan. That on its own doesn’t necessarily make it predatory, but the loans that were given to people of color in the lead-up to the mortgage crisis didn’t just have high interest rates. According to Williamson, they were often marketed in deceptive ways and the terms were both “opaque” and “abusive.” For example, they were much more likely to contain something called a “prepayment penalty” — a fee for paying your mortgage off too early. While only 2% of all mortgages contained such a penalty at the time, 80% of these subprime mortgages had one. The penalty often had a devastating financial impact on homebuyers who tried, understandably, to refinance the mortgage into a lower rate.

The frenzy of reverse redlining had a staggering impact. As of 2012, when the NCLC paper was published, the median wealth of white households was 20 times greater than that of Black households, and 18 times that of Latinx households. It compares this gap to 1984, when the wealth of white households was 12 times that of Black households and eight times that of Latinx households. The homeownership disparity between white and Black Americans widened in the aftermath of the Great Recession, and overall economic recovery for non-white Americans lagged far behind that of white Americans.

It’s a tragedy that’s continuing to unravel before our eyes right now. “[These] communities really didn't recover fully before COVID, and now they don't really have the resources to withstand some of the financial challenges brought on by COVID,” says Williamson.

There’s growing acknowledgement that the current credit scoring system isn’t working, especially for people who aren’t rich and white. One hope is that the system could use what’s called “alternative data” — like Netflix bills — to boost people’s credit, and that more intelligent use of big data and machine learning could provide a more accurate picture of someone’s creditworthiness. “In one sense, by using these algorithms and machine learning, there's a potential to eliminate some of the discrimination in credit,” says Williamson.

But there are also plenty of warning signs that those types of data-driven solutions may not help much. We already know, from self-driving cars that fail to recognise people with dark skin, that algorithms can be racist. There’s nothing that necessarily prevents these newer credit scoring models from making assumptions about race, especially if they’re not created with extreme care.

“If you give the algorithm too much data, especially if it's a machine-learning algorithm, you can correlate anything to race — the fact that you listened to hip-hop or the fact that you read Ebony magazine,” Williamson points out. With something like rent payments, it might be helpful to some, but especially during a pandemic that has prevented so many from being able to pay rent, it could also hurt people’s credit histories even more.

Being simply raceblind isn't a panacea either — there’s a great need for the credit system to course-correct and actively redress the entrenched economic injustice that people of colour face. Williamson would recommend, for one, more robust enforcement of existing laws and government agencies tasked with protecting against financial discrimination. For example, practices that have a “disparate impact” on people of color are already illegal under the Fair Housing Act. “But the [Department of Housing and Urban Development] under the prior administration tried to water down the disparate impact standards,” Williamson says. “So the first thing we're asking is for the administration to overturn those rules.”

A broader question is how much we want to continue using “creditworthiness” — which has always been a murky, subjective concept — as a barometer of who deserves opportunity, access, and respect. The fact that credit reports can appear as part of employment background checks is a sign that the credit system isn’t purely about money. It’s about reputation and character.

“Credit scores were designed to predict the likelihood of default,” says Nelson. “They're not designed for this other context of whether someone is going to be, you know, a good or responsible employee.” Last January, the House passed a bill that would ban almost all uses of credit reports when hiring for a job, but it wasn’t introduced in the Senate.

“It should not be shorthand for so many things,” Nelson says. “Our current COVID-19 financial crisis is such a good explanation of why it shouldn't be shorthand for everything. So much of what's happening right now is out of people's hands. They didn't do anything. And now they're really behind on rent, for example. And if you're behind on rent, your landlord might refer that debt to a debt collector and then a debt collector will report that to the credit bureaus.”

At the heart of the problem is the degree to which we’ve tacitly agreed that your history should be a ball and chain — an ethos that inevitably harms the most marginalised groups. You have to always be paying a debt to your past, even after your actual debts have been paid.

Teresa Hodge has firsthand experience of this reality. She spent almost five years in federal prison for a non-violent crime — and one of the many ways that incarceration impaired her future was that it significantly lowered her credit score. She was unable to keep paying her bills while incarcerated, nor was there any way for her to monitor her financial standing from prison. “Just being away from your credit, and not having access to your credit, makes all the difference in the world for many people who are incarcerated,” she says. This is in part why people in prison are so vulnerable to identity theft.

“The thing that was difficult for me was just making sure that, when I came home and talked to creditors, I didn't say things like, ‘Oh, I didn't pay this because I was actually in prison,’” recalls Hodge. It was important to prevent creditors from finding out that her address had once been a federal prison, because previous addresses can remain on your credit report permanently, even as actual conviction records can be wiped from criminal background checks after seven to 10 years in some states.

“It was a real hard dance just to make sure that I was able to remove things that shouldn't have been there, try to get back in good standing on accounts and pay things off,” she says. It took her over six years to get to a place where she felt financially stable — not to where she had been before prison, but enough to survive.

How long it takes to get to this point greatly varies, of course. “Your ability to improve your credit often hinges on your ability to have access to money to start with,” Hodge says. “When you're coming home from prison, what that really means is that you’ve got to keep going backwards. And it's your ability to get a job, or it's your ability to have a family network or support system that's strong enough to handle those things for you.”

Access to money is one of the hardest aspects of recovery after someone has been released from prison. Many job applications are automatically rejected if an applicant checks the box asking if they have a criminal record. “I was fortunate in that I went to prison at 44. I went to prison later in life, so I went to prison with good relationships, and I managed and maintained some of those relationships,” Hodge says. “I got a job from a friend who said, ‘When you come home, no worries. I'll hire you.’” It speaks to the difference that could be made if we systematically tried to create a country more like a community than a prison, with people taking care of one another.

“A lot of my friends who came home couldn't find a job, or they were exploited and people would try to pay them under the table because they knew that they were desperate,” she says. Other friends got a job only to be fired when their employer later ran a background check.

A recent paper by the Washington Center for Equitable Growth detailed the impact of race and incarceration on economic well-being. One indicator of that was that the average FICO score for Black people who had been incarcerated was 200-plus points lower than that of white people who had never been incarcerated. “The credit scoring system is old and needs to be reformed for everybody,” Hodge says. “It is extremely damaging to certain populations.”

Hodge’s own experience became the impetus for founding R3 Score, which offers an alternative to traditional background checks that adds more context and nuance to people’s histories. She’s also the president of Mission: Launch, an organization helping formerly incarcerated people reach financial stability. Hodge believes that we overuse background checks and credit reports. “The information is static. People are dynamic, and it does not give people a pathway to opportunity,” she says.

Though she felt that entrepreneurship was a better path to attempt than applying to jobs that would dismiss her out of hand, it’s difficult to get a business off the ground when you don’t have access to credit lines and growth capital. “I started it with my own money,” Hodge says. “I probably worked, for the last four years, 15 hours a day. I was never able to secure a line of credit for the business, and that's because I’ve never been able to get to that level of stability just yet. Probably 2020 was the first time that I felt like I was going to be able to exhale, and then COVID happened.”

“I used to own a home, you know? I still have not gotten back to where I was. It depends on your starting point — your point of contact with the legal system determines [whether] you get back to that place,” she says. “I was more middle-class, very stable, [and] could live on my own. [But] I don't have that same level of stability even today, 10 years later. And if I really had to guess, it'll probably be 12 years from the time of leaving prison that I will have my life back on track, and maybe be able to do a comparison of what was and what is.”

“Our credit system is a game, in a sense, that we all have to play — to participate in.” But she says that it’s a broken game. “If you don’t have the means, the resources, the money, you can't gamify the system. You can’t play it.”