Leaders come together to find solutions to credit barriers

Our latest report analyzing credit score patterns in Illinois found some troubling facts:  54 percent of individuals in highly African-American communities had credit scores below 620, while that figure is only 16.5 percent in predominantly white communities. Furthermore, 43.3 percent of individuals in highly African-American communities had a credit score below 580, compared to 11.5 percent in predominantly white communities. The concentration of low credit scores in communities of color raises concerns about the prospects for economic recovery in those neighborhoods, since credit scores are becoming increasingly important in more walks of life. Not only will it be more difficult to access affordable home, small business, and car loans, but having low or no credit scores can impact the availability of rental housing, affordable utilities and insurance, and even employment. Given these challenges, what can be done to improve opportunities in Illinois’ communities of color?

We gathered top leaders from financial institutions and community groups to discuss the scope of the problem and current approaches to improving access to credit. Our Senior Vice President Geoff Smith presented the findings of our credit score report and used the availability of refinance lending as an example of diminished access to credit in communities of color. The below chart demonstrates that in predominantly white communities, refinance lending doubled from 2008 to 2009; however, it dropped precipitously in communities of color.

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Across all communities, insufficient home value and high debt-to-income ratios are the top reasons for denying refinance applications. One factor is significantly higher in communities of color, however: a poor credit history. This suggests that building credit histories in communities of color could considerably open up new opportunities for affordable credit.

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Two different ways of approaching this barrier were presented by Robin Coffey of Neighborhood Housing Services (NHS) of Chicago and Ricki Lowitz of LISC/Chicago’s Centers for Working Families. Coffey described how NHS uses manual underwriting to look beyond credit scores and find other ways of determining creditworthiness. NHS requires potential buyers to attend 8 hours of homeownership counseling and requires that borrowers, who have an average credit score of 628 and are mostly low- to moderate-income, do not pay more than 31 percent of their income to pay for housing costs. Additionally, they have found that regular savings behavior—not just the amount of savings—has been a good indicator of a willingness to pay back a mortgage.

The Centers for Working Families focus primarily on improving credit scores so that their clients can be eligible for affordable credit at a wider variety of financial institutions. Their Twin Accounts program creates an incentive to participate in a credit-builder loan, where a borrower deposits $500 in a temporarily inaccessible savings account and takes out a $500 loan. The loan is fully collateralized by the amount in the savings account and presents no risk to the bank. The borrower then repays the loan and the lender reports positive repayment history to the credit bureaus, likely bringing up their score significantly. At the end of the repayment period, the borrower gets the $500 plus some interest. The Centers for Working Families create an added incentive to participate in a credit-builder loan by providing a matching payment only when the borrower pays on time; if they make all payments on time, they receive $1,000 instead of $500 at the end of the repayment period, as well as an improved credit score that opens up doors to more productive credit.

Participants in the discussion identified several barriers to credit. One banker pointed out that even if they use manual underwriting to look beyond a damaged credit history, the borrower would still likely be prevented from obtaining mortgage insurance since they often have strict credit limits. Fannie Mae and Freddie Mac, who securitize the majority of mortgage loans, will not buy loans with credit scores below a certain threshold. Several bankers reported that their institutions offered non-matching credit builder loans but that there was little to no demand for them; as one put it, people come into their institution looking for a loan, and if they can’t immediately get it, they’re going to go to another institution. Lowitz reiterated her belief that institutions need to do a better job at incentivizing credit-builder loans and that the Twin Accounts program’s matching contributions element was an effective incentive. She suggested that advocates pursue the possibility of using federal Assets for Independence Act funds to provide the matching funds. Woodstock Institute President Dory Rand also suggested that institutions inform borrowers of credit-builder loans when they are denied credit due to low credit scores.

Representatives from community groups also expressed concerns about the tightening of small business credit and invited bankers to join in discussions happening in neighborhoods suffering from barriers to credit. Finally, representatives from financial institutions were concerned that, for Community Reinvestment Act purposes, regulators seem more interested in the number of loans made than the innovation and appropriateness of credit-building and mortgage loan programs designed to reach low- and moderate-income communities.

While credit-building programs and manual underwriting hold great potential for improving access to credit and spurring recovery in communities of color, it is clear that we need to work with financial institutions to improve program effectiveness, communicate the importance of these programs to regulators, and explore possible sources of matching funds to make credit-builder loans more attractive to consumers.

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