How race affects your credit score

Some might consider credit to be a “great equalizer,” since it gives lenders a set of parameters for determining whether a loan applicant can be trusted to pay back a loan.

But for Black Americans, the road to a good credit score – and the rewards good credit can bring – may not always be so smooth. Although the credit scoring system is designed to be objective, studies have shown that people of color are more likely to struggle with credit than their white counterparts.

“There’s an access gap, there’s an information gap and there’s an advisory gap,” says Lynnette Khalfani-Cox, co-founder of The Money Coach and author of the New York Times’ bestseller Zero Debt: The Ultimate Guide to Financial Freedom. “All of these areas need to be plugged.”

According to the Federal Reserve System’s May 2021 Report on the Economic Well-Being of U.S. Households in 2020, Black and Hispanic Americans are less likely to be approved for credit than white and Asian Americans. Black and Hispanic Americans are also more likely to be unbanked or underbanked, placing them outside the mainstream financial system that can help them build a positive credit history and a good credit score.

“Some members of the African American community, maybe because they’ve been burned in the past by bank fees or other issues, have chosen to opt out of the financial mainstream,” explains Khalfani-Cox. “They’ll use a check-cashing service or a payday loan, which means they’re borrowing money at a higher cost without building a credit history.”

But if you want access to today’s best credit cards, it’s important to know how to build good credit – and to understand the systemic and structural biases that might be a speed bump on your path. That’s why we’ve put together a guide to help you understand how race and credit interact, and how you can navigate the current financial system to build the kind of credit history that can set the foundation for a solid financial future.

How lending discrimination affects credit

Even though the credit scoring system is theoretically designed to eliminate bias, a historical legacy of racial and socioeconomic discrimination still makes it difficult for certain groups of people – especially low-income Black Americans – to access credit.

“We have a lot of legacy issues,” explains Khalfani-Cox. “From the 1930s to the 1960s, the federal government flat-out refused to insure home loans for Black people. This meant that 98 percent of the loans approved went to White Americans, which created the White middle class.”

Even though that kind of explicit discrimination is no longer in practice, thanks in part to legislation like the 1968 Fair Housing Act and the 1974 Equal Credit Opportunity Act, other types of implicit and systemic bias still have residual effects in the credit-scoring system.

“The credit system currently in place favors and supports those who historically have had higher education, higher-paying jobs and overall greater access to the resources and tools needed to demonstrate creditworthiness,” says Danielle M. Burns, head of business development at CNote, a women-led community investment platform with a mission to close the racial wealth gap.

This means even if you are not being directly discriminated against, a lender may still deny you credit based on factors such as low income – even though low income does not imply bad credit – or a thin credit file. Even if you’re financially responsible, you might not be building the kind of payment history that gets reported to the three credit bureaus.

“Many People of Color pay rent instead of a mortgage, or make day care payments instead of credit card payments,” Khalfani-Cox explains. “They might have been making every payment on time, but until recently these non-traditional measures of repayment were uncounted.”

The credit scoring system is actively working to eliminate some of these structural biases. Services like Experian Boost allow people to add their bill payment history to their credit file, establishing their ability to manage money responsibly. FICO is also launching new credit scoring models that incorporate alternative data, such as checking and savings account usage. “This will start to close the gap in terms of credit scores,” Khalfani-Cox explains.

Although credit discrimination is illegal, some people may still encounter lenders who exhibit discriminatory practices. “If you think you’re experiencing credit discrimination, carefully document your lending experience,” Burns advises. “Is your lender providing you with timely and accurate data? Do they treat you differently in person versus on the phone? If you believe you have been discriminated against, file a formal compliant with your local, state or federal agency that governs consumer credit.”

How cultural norms affect credit

One way people learn about money and credit is by seeing how others interact with money and credit – and if people in your family, neighborhood or culture had negative experiences with lenders, banks and other aspects of the financial mainstream, you may not have the information or experience you need to build a better financial future.

“There’s a difference between managing your money and just paying bills,” explains Dana S. Branham, financial coach and author of Money Mayday: 7 Steps to Cleaning Up Your Money Mess. “So many of our grandmothers and aunts and uncles just lived to pay bills. They were never able to get ahead enough to be managing money. So, figuratively, we’re starting at a deficit.”

This means a generational elder might not discourage a younger family member from opening a line of credit they don’t need, for example, because they don’t realize opening a new credit card could have a negative impact on their credit.

“Imagine the holiday shopping season,” Khalfani-Cox explains. “You go to your favorite retail store. The person at the counter asks you if you want 10 percent off, and you say yes – not realizing that any time you apply for credit, yes, even that department store card, a hard inquiry gets generated. That inquiry stays on your credit report for two years and counts against you for 12 months.”

That isn’t the only reason applying for store credit cards can be a bad financial decision. “You’ve just spent $100 to save $10,” says Khalfani-Cox.

Branham notes people are often embarrassed to share the current state of their finances. They don’t want people to know about the financial mistakes they’ve made, or they may feel ashamed they don’t know more about managing their money. Not only will they avoid talking about money with their loved ones, but they may feel hesitant to reach out to a financial adviser or credit counselor for help.

“If you won’t talk to a financial professional about it, then who are you talking to about it?” Branham asks. “And then how are your children supposed to learn if you’re not talking to them about it?”

Starting these kinds of conversations takes work – including the work of knowing whom to ask for help. “Many Black people don’t have a trusted destination, a trusted place to go to for guidance or advice,” says Khalfani-Cox. This, in turn, can make it harder for Black Americans to acquire the kind of financial expertise to build not only credit scores but also the kind of generational wealth that can benefit their families and communities for decades to come.

Credit scoring and the racial wealth gap

Having a low credit score can have huge ramifications. A lower credit score means if you qualify for a loan at all, you will pay more in interest on everything from a mortgage to a car, so less of your money stays in your bank account. Over time, it becomes more difficult to build substantial wealth.

Higher interest rates also lead to more debt – which in turn can lead to lower credit scores. “We know that African Americans have substantially more debt, by and large, than their White counterparts,” says Khalfani-Cox. “If you use too much of your available credit, it’s going to translate to a lower credit score. If you miss a payment, you’re not only going to lower your credit score, but you’re also going to pay penalty rates, higher interest charges, finance charges. You’ll be shelling out more money.”

According to recent research by the Urban Institute, more than 50% of white households have FICO credit scores over 700, but only 21% of Black households have achieved the same financial milestone.

Even when Black Americans do have good credit scores, it doesn’t mean they will automatically find themselves experiencing financial security. In fact, Black consumers with credit scores of 700 or above were found to have a level of financial wellness comparable to other groups with credit scores below 700, according to a 2018 study by Elevate’s Center for the New Middle Class, a research firm based in Fort Worth, Texas.

The study, titled African American Financial Experience: Prime and Non-prime, revealed that when compared to all Americans with a credit score below 700, Black adults with a credit score of 700 or higher were:

• 80% more likely to live paycheck to paycheck
• 50% more likely to say they have “too much debt”

Black Americans with a credit score of 700 or above were also less likely to have $1,200 for a financial emergency and less confident they could meet long-term financial goals than their counterparts with lower credit scores.

While the Elevate study suggests factors other than credit scores also contribute to the racial wealth gap, higher credit scores could give Black Americans leverage they can use to build more wealth, experts say.

“If we could get our credit scores up and then get more loans to open businesses that make money or get loans to increase our assets, then our credit habits could help us to close the wealth gap,” Branham explains.

How credit scores can be built

If you’re wondering how to build good credit, how to rebuild bad credit or how to find institutions willing to help you establish a solid financial footing, you’re not alone. “Many Americans, including African Americans, don’t have the credit savvy to understand how their own actions affect their credit scores,” Khalfani-Cox explains.

Here’s what you need to know.

How credit scores work

Before you can build good credit, you have to understand how credit scores work. Here are the five factors that make up your FICO credit score, and how you can use each factor to improve your credit:

• Payment history: 35% of your FICO score is based on your history of on-time payments. Missing a payment can severely damage your credit score, so make sure you make every payment on time.
• Amounts owed: 30% of your FICO credit score is based on the amount of debt you are carrying, often called your credit utilization ratio. The less debt you have, the higher your credit score can go.
• Credit history: 15% of your score is based on the length of time you’ve been using credit. People with longer credit histories have the potential to build higher credit scores.
• Credit mix: 10% of your credit score is based on the different kinds of credit accounts you have. Lenders like to see a mix of revolving loans (like credit cards) and installment loans (like car loans or mortgages).
• New credit: 10% of your FICO score is based on how often you request new credit. Try to keep your credit requests between three and six months apart to avoid damaging your credit score.

How to build your credit

If you haven’t started building a credit history yet, you have options. The best credit cards for people with no credit history include secured credit cards that allow you to access a small line of credit in exchange for a small security deposit, as well as credit-building cards that give you the opportunity to demonstrate responsible credit use.

If a partner or family member has good credit, consider becoming an authorized user on one of their credit accounts. You’ll be able to piggyback off their positive credit history as you build your own credit file.

Can people with bad credit access good credit cards? Yes. The best credit cards for people with bad credit include cash back rewards cards like the Credit One Bank® Platinum Visa® for Rebuilding Credit and the Discover it® Secured Credit Card. Don’t let a low credit score stop you from applying for the kind of credit card that can help you establish a positive credit history.

How to check your credit

If you want to improve your credit score, it’s important to check your credit on a regular basis. Many credit card issuers offer apps or services that allow you not only to check your credit for free, but also to learn how your financial habits might be affecting your credit score. Once you know higher credit card balances have the potential to lower your credit score, for example, you might be motivated to boost your credit while paying off old debt. That’s a win-win.

How to find financial help

Want to know more about building credit? It might be time to seek out financial help.

“Start by educating yourself on current programs and offerings and have a solid understanding of your own credit history,” advises Burns. “If you think you might not match traditional standards, seek out a lender whose mission is to work with people who have historically been left out of the credit spectrum. Look for lenders that assess creditworthiness using expanded factors, such as payment history with rent or utilities.”

You might also want to look for minority-owned credit unions as well as other organizations that have a mission to help people build their financial acumen. “These include Black-owned institutions,” says Khalfani-Cox, “and mainstream institutions that are taking the time to educate people on products and services, not just looking at Black clients as a way to generate revenue.”

Bottom line

“Ultimately, I think it’s in the Black community’s best interests to participate in the financial mainstream,” says Khalfani-Cox. This means taking the time to understand how credit works, including the way credit scoring systems evaluate various financial factors and behaviors.

It also means taking actions that will be viewed favorably under the current credit scoring system – such as maintaining a low credit utilization ratio or building a credit mix that includes both revolving and installment loans – while understanding the ways in which the system can and should be changed. “Actively working toward solutions that challenge outmoded credit assessment methodologies is critical,” Burns explains.

Lastly, it means you should not only advocate for your own credit health, but also use what you learn to help others. Branham advises Black consumers to share their knowledge of how credit works so the entire community can be uplifted.

“If you want better,” Branham says, “you’re going to have to understand that credit is a part of almost everything we do that involves us paying out money or receiving money.”