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Giving Credit Where It's Due
Finding New Ways to Build Credit Can Help Low-Income Consumers Buy Homes
By Anne Kim
Good credit, like beauty, is in the eye of the beholder.
Fundamentally, "creditworthiness" is an educated guess about a
particular borrower's likelihood of default. Though lenders rely
upon a variety of objective factors in making their lending
decisions, these criteria nonetheless shape the prism through which
lenders view applicants. Occasionally, distortions in this prism put
low-income and minority borrowers at a great disadvantage.
Because many of the factors on which creditworthiness is judged depend
on a borrower's income and assets, lower-income and minority borrowers
tend to have a tougher time obtaining credit, especially for home mortgage
loans. Lower-income and minority loan applicants generally have smaller
stocks of savings than more affluent borrowers, for example, and
are less likely to be able to afford a substantial down payment.
Lower-income and minority applicants are also less likely to own bank
accounts. All of these factors can affect whether a borrower qualifies
for a loan, and if so, at what interest rate.
Although lenders logically should consider a borrower's income and
assets, an overemphasis on these factors may unfairly hinder low-income
and minority borrowers. A low-income person who under current measures
of creditworthiness is labeled a poor credit risk may, under different and
less restrictive standards, prove to be a worthy borrower. Developing
alternative measures of creditworthiness can correct lenders' perspectives
on some low-income borrowers and open up access to credit for those worthy
borrowers now being bypassed for loans.
One such overlooked measure, for example, is rental history. Renters may be
surprised to know that credit bureaus don't currently keep track of whether
tenants pay their rent on time. Thus, tenants who make timely payments won't
see their diligence rewarded in their credit rating. Because low-income and
minority households are more likely to rent, this gap in data collection is
disproportionately damaging to them. The lack of available information on rental
history is even somewhat puzzling, given that whether a person pays his rent on
time would seem to be an excellent indicator of whether he will pay a mortgage on time.
One group of private interests, led by PCI/EquiCap & Partners, has asked
the Department of Housing and Urban Development (HUD) for help with a pilot
project, dubbed the National Housing Credit Repository (NHCR), to begin keeping
track of rental payment performance by both tenants in Section 8 public housing
and renters generally. As conceived by its inventors, the NHCR would function
much like a credit bureau, gathering consumers' rental payment histories and
making it available to creditors and home mortgage loan originators. This
information would be provided to the NHCR by banks and other financial
institutions that would collect rent payments on behalf of landlords and property managers.
Ideally, the NHCR would become an important alternative means by which
low-income and minority consumers without conventional credit can establish
their creditworthiness. Eventually, proposals such as these could help overcome
the persistent "credit gap" between white and minority borrowers. According to
data collected under the Home Mortgage Disclosure Act (HMDA), minority borrowers
are much more likely than whites to be rejected for home loans. Last year's HMDA
data, for example, found that the rejection rate for conventional home mortgage
loans was 45 percent for African-American applicants and 31 percent for Hispanics.
In contrast, the denial rate for whites was 22 percent.
Consequently, while homeownership among blacks and Hispanics has risen to
a record level over the past decade, minority homeownership rates still lag
significantly behind those of whites and of the nation as a whole. While nearly
three out of four white households own homes, the proportion of black and Hispanic
homeowners is less than 50 percent.
One limited study by Fannie Mae attributed half the gap in mortgage
approval rates between whites and minorities to differences in credit
history. If wealth and income are also factored in, according to Fannie
Mae, loan approval rates for whites and minorities become nearly identical.
Expanding credit to previously underserved groups doesn't necessarily mean
greater risk for lenders. In recent years, analyses of borrowers' creditworthiness
have become increasingly sophisticated, in large part due to the advent of
computerization in home mortgage lending. Home mortgage lenders are increasingly
relying upon computers, rather than humans, to make their lending decisions,
which provides borrowers with two advantages: (1) computers replace the biases
of human officers with objective analysis and (2) computers can make finer-tuned
judgments about a borrower's creditworthiness than a human loan officer.
Indeed, among the advances credited to the growing trend toward automated
underwriting is the greater availability of credit to low-income and minority
borrowers. In perhaps a rare example of machines being more forgiving than people,
one result of automation has been that some minorities and low-income borrowers who
otherwise would have been rejected for credit can now get loans.
One demonstration conducted by Freddie Mac found that computers were far more
likely than humans to extend credit to low- and moderate-income buyers. In this
study, Freddie asked both human loan officers and their computerized counterparts
to review 1,000 loan applications from low- and moderate-income borrowers. The humans
approved 51.7 percent of the applications, and Freddie's computers accepted 85.2 precent.
Further refinements in the data analyzed by automated loan programs, such as the
addition of information collected under efforts such as the NHCR, should be
relatively
easy to integrate into existing systems. Moreover, the effect of such additional
information would not only level the playing field for low-income and minority borrowers,
but broaden it.
Refining standards to improve access to credit is obviously only part of the solution to
boosting homeownership, especially by minority households. Public policy should strive to
narrow the wealth and income gap between minorities and whites, and government should
support all efforts to bring low-income and minority households into the economic
mainstream. This means promoting initiatives to "bank" the millions of American
households that are "unbanked" and supporting the wide availability of financial education.
Nevertheless, proposals such as the NHCR can lead the way in helping lenders give
deserving borrowers the credit that is their due.
Notes and References
Freddie Mac, "Automated Underwriting: Making Mortgage Lending
Simpler and Fairer for America's Families," Sept.
1996.
Wessel, David, "From Blind Justice, An Eye-Opener," Wall
Street Journal, May 31, 2001.
Remarks made by Franklin Raines, Chairman and CEO, Fannie Mae, at the Fannie
Mae Conference: "The Role of Automated Underwriting in Expanding Minority Homeownership," June 8, 2000.
Data collected under the Home Mortgage Disclosure Act is available at the
Federal Financial Institutions Examination Council's website, http://ww.ffiec.gov.
Anne Kim is the director of the Progressive Policy Institute’s Work, Family & Community Project.
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