Fed Examines Credit Scores, Finds No Bias

By Kenneth R. Harney
Saturday, September 1, 2007

In a report to Congress that is certain to generate controversy, the Federal Reserve Board says that credit scores vary "substantially" among racial and ethnic groups but that their use has made credit more available for major purchases such as buying homes.

The Fed's study, encompassing credit bureau records and demographic data from a national statistical sample of 301,536 people, was mandated by Congress in 2003. Credit scores are heavily used not only in home mortgage underwriting and pricing, but also for credit card, auto loan, employment, insurance and rental application screening.

Critics have questioned the accuracy and fairness of credit-score models, charging that in some cases they are inherently biased against minority groups such as blacks and Hispanics.

After a research effort over several years that focused on three credit-scoring models -- including one created by Federal Reserve staff economists -- the central bank concluded that:

? Credit-score statistical models are not biased against any demographic group and are highly predictive of future payment performance. Lower scores correlate strongly with future delinquencies; higher scores are associated with good payment performance.

? Blacks and Hispanics, on average, "have lower credit scores than non-Hispanic whites and Asians."

? Younger individuals of all demographic groups have lower credit scores on average than older people, in part because credit-scoring models focus on payment histories and length of credit accounts. Younger consumers generally have fewer accounts and shorter payment histories.

? The payment performances of some demographic groups differ from what their numerical scores might suggest. For example, according to the Fed, "blacks, single individuals, individuals residing in lower-income or predominantly minority census tracts show consistently higher incidences of bad performance than would be predicted" by their credit scores. On the other hand, "Asians, married individuals, foreign-born (particularly, recent immigrants), and those residing in higher-income census tracts consistently perform better than predicted" by their credit scores.

? Recent immigrants' scores might be improved by expanding the range of creditlike accounts reported to the national credit bureaus to include rent payments and other recurring accounts. Once in the bureaus' files, these accounts could then be used to help compute immigrants' scores, enhancing the bureaus' ability to predict future payment behavior.

? The types of credit used by various demographic groups "do not appear to be the source of differences in performance once credit score is taken into account." That finding runs counter to criticism by some consumer advocates that mortgage lenders and brokers tend to steer black and Hispanic borrowers into higher-risk, higher-cost loans -- subprime adjustable-rate home loans with hefty payment jumps, for example -- that increase the likelihood of default and foreclosure.

Researchers confirmed that black and Hispanic borrowers make heavier use of finance-company installment loans and that interest rates paid by blacks appear to be higher in general than those paid by whites.

Although most fair-lending groups have not yet fully reviewed the Fed's study, at least one consumer advocate lambasted the report. Calvin Bradford, formerly of the University of Minnesota's Hubert H. Humphrey Institute of Public Affairs and now a fair-housing consultant, challenged the study's statistical sampling methodology, selection of data and failure to probe more deeply into the marketing of credit products to minorities. Bradford said the Fed used "an old database" provided by the credit bureau TransUnion that dated to 2003 and underrepresented minorities with mortgages while over-representing whites, based on their proportions in the general population.

Bradford said he doubted that anyone in the statistical-modeling business would accept such small samples. He also rejected any conclusion that types of credit products marketed to minorities have no impact on payment performance.

"If blacks are paying more for access to the mortgage market than they really need to, then that is going to increase their household debt burdens" and contribute to higher delinquency rates, Bradford said.

Paul Hancock, former director of the Justice Department's fair-lending unit, now in private practice with the law firm of K&L Gates, called the study's results "startling."

"It is very troubling for me as someone who has been an advocate for fair lending for many years" to find such credit-score divergences among racial and ethnic groups. "It shows some very serious social inequities attributable to our history" -- the lingering impacts of segregation, unequal educational opportunities and severe economic differences.

Mortgage lenders are often accused of charging minorities more, Hancock said, but the Fed study suggests that credit scores accurately predict payment performances, "so the burden here can't fall entirely on the shoulders of lenders."

Kenneth R. Harney's e-mail address isKenHarney@earthlink.net.