Credit Discrimination: 6.4.2.2 Discrimination’s Legacy
If certain groups have been denied access to credit in the past as a result of discrimination, the use of credit scoring systems will perpetuate that lack of access.
If certain groups have been denied access to credit in the past as a result of discrimination, the use of credit scoring systems will perpetuate that lack of access.
A potential issue is whether credit scoring systems give more points to homeowners. According to FICO, one of the categories of factors used to derive FICO scores is the types of credit in use. A good mix may be one that includes a mortgage loan.121 The question is whether FICO’s scoring models explicitly give more points to mortgage holders, which would mean homeowners are favored over renters. Black people have lower rates of homeownership than White people.122
In response to these concerns, the credit scoring industry and its proponents have consistently maintained that their systems are not discriminatory.140 Moreover, they point out that credit scoring actually reduces discrimination against protected groups. They note that the human—and potentially discriminatory—element in credit evaluation has been replaced by a system that is blind to race and other prohibited bases.
If a credit scoring model or one of its factors has a disparate impact on borrowers of color or another protected group, it does not necessarily mean the model violates the Equal Credit Opportunity Act (ECOA) or Fair Housing Act (FHA).
In the mid-2000s, there were a handful of credit discrimination cases challenging credit scoring.156 A class action challenged that Fannie Mae’s use of credit scores in its Desktop Underwriter automated underwriting system has a disparate impact on Black consumers in violation of ECOA and the FHA.157 The plaintiff’s discrimination claims under the FHA and the ECOA survived a motion to dismiss.158 However, the court did express skepticism about the
The prior discussion of credit scoring and potential discrimination focused on the disparate impact created by the scoring systems themselves. However, the potential for discrimination does not stop there. Even assuming a credit scoring system that does not disproportionately affect people of color, credit scoring does not immunize a lender from discrimination. Lenders have found numerous ways to disfavor applicants of color when they are using a scoring model.
One use of credit scores that clearly puts applicants of color at a disadvantage is the use of different credit score thresholds or “cut-offs” for White applicants than for applicants of color.
The Office of Comptroller of the Currency (OCC) raised a concern that because the credit scores of a large percentage of applicants fall in a gray area, lenders will continue to use subjective or “human” underwriting to review these applications. The OCC expressed concern that decisions to override the credit scores in these situations may undermine the objectivity and/or integrity of credit scoring and lead to discriminatory results.169
As a fundamental principle, the Equal Credit Opportunity Act (ECOA), the Fair Housing Act (FHA), and other credit discrimination statutes set forth a general rule against discrimination in every aspect of a credit transaction. In addition, the ECOA has specific prohibitions and procedural requirements that creditors must follow in the various stages of a credit transaction. The FHA and federal Civil Rights Acts do not contain equivalent specific prohibitions and requirements but nevertheless apply broadly to all stages of a credit transaction.
The next few chapters of this treatise will follow the five major stages in a credit transaction. Each chapter will discuss both general discriminatory practices and the special ECOA requirements specific to that stage of the credit process.
Before discussing discrimination specific to each stage of the credit transaction, it is helpful to understand some principles about the general rule against discrimination embodied in the Equal Credit Opportunity Act (ECOA), the Fair Housing Act (FHA), the Civil Rights Acts, and other credit discrimination statutes.
The term “discriminate” is defined by Regulation B as treating an applicant less favorably than other applicants.2 Consequently, the ECOA prohibits treating an applicant less favorably than other applicants on a prohibited basis at any stage of the credit transaction, ranging from application procedures to terms of the transaction to the subsequent handling of defaults.
The general rule against discrimination applies during every stage of the credit transaction. This is true for the ECOA, the FHA, and the federal Civil Rights Acts.
The first stage of a credit transaction in which discrimination may take place occurs prior to the actual application—i.e., when the creditor takes various actions to encourage or discourage persons from seeking credit from that creditor.13 While most of the Equal Credit Opportunity Act (ECOA) applies only to “applicants,”14 Regulation B does include a pre-application prohibition forbidding creditors from discouraging prospective applicants on a prohibited basis.
Regulation B specifically prohibits any oral or written statement to prospective applicants in advertising or otherwise that would discourage, on a prohibited basis, a reasonable person from pursuing an application.20 Similarly, the ECOA’s general rule against discrimination prohibits advertising and other marketing that discriminates on a prohibited basis as to who is encouraged to apply.21
An examination procedures guide from the Federal Financial Institutions Examination Council (FFIEC) describes the following scenarios as potential indicators of disparate treatment in marketing:44
Many studies have shown that, from 2000 to 2009, subprime lenders provided the greater share of lending in neighborhoods of color.47 This pattern appeared to hold true even in middle-class and higher-income areas, indicating that the segmentation of the market into prime and subprime was correlated more strongly with race than with income.48
A good example of how the dual market for credit develops can be found by contrasting the cases of two lenders in the Washington, D.C. area—Chevy Chase Federal Savings Bank and Capital City Mortgage Corp. Chevy Chase, a metropolitan D.C. bank, and its subsidiary, B.F.
Another form of potential marketing discrimination occurs when lenders use direct marketing to send solicitations, including pre-approved credit offers, to potential applicants.
Even if an applicant from a protected group can get past the marketing discrimination and through the creditor’s door, pre-application discrimination may still take place in the creditor’s office. One means of discouraging applicants on a prohibited basis is a practice called “steering.” Steering occurs when a loan officer refers prospective applicants away from one type of product or market (for example, a prime product) to another (for example, a subprime product).86
Sometimes, differential encouragement at the pre-application stage can be very subtle and may be discovered only through the use of paired testers.
The next stage of the credit transaction involves the procedures for application for credit.107 In general, under the Equal Credit Opportunity Act (ECOA), there can be no differences in the application procedures if those differences are on a prohibited basis.108 The Fair Housing Act’s (FHA) general rule against discrimination also prohibits such discrimination in housing financing.
A caveat exists regarding the application process in that Regulation B permits creditors to take either oral or written applications for credit.