Why young adults in minority communities tend to start out with lower credit scores

Young adults in majority Black and Hispanic communities tend to have lower average credit scores compared with those who reside in majority white communities, according to new research from the Urban Institute.

The research found 25- to 29-year-olds in majority Black communities have a median credit score of 582 — below the subprime threshold of 600. In comparison, 25- to 29-year-olds in majority Hispanic communities had a median credit score of 644, while those in majority white communities had a median score of 687.

What's more, young adults in majority Black and Hispanic communities are also more likely to have their credit scores decline as they age, according to the nonprofit research organization.

Between 2010 and 2021, 32.9% of 18- to 29-year-olds in majority Black communities saw their credit scores decline, while 26.2% of those in majority Hispanic and 21% of those in majority white communities saw their scores go down.

The research is based on the Urban Institute's analysis of consumer records from one of the three major credit bureaus. The specific source for the data was not disclosed.

Those low scores have significant and long-lasting financial consequences.

"People with credit scores below that [600] threshold are less likely to secure credit at affordable rates," said Thea Garon, senior policy program manager at the Urban Institute.

"They're more likely to borrow high-cost credit, and that can lead to cycles of debt and further erode their credit scores," she said.

Subprime lending options tend to be more visible in underserved diverse communities, noted Bruce McClary, senior vice president of membership and communications at the National Foundation for Credit Counseling.

Residents of those areas who are income challenged and don't have a lot of job stability may turn to subprime financing with higher interest rates and high fees, which in turn can hurt their credit scores. "It's kind of a recipe for disaster," McClary said.

One such high-interest product, the payday loan, has recently come under scrutiny for the cycles of high fees and debt associated with it.

Credit scores measure how likely a borrower is to pay back debt on time. Most credit scores range from 300 to 850. The higher the score, the better the interest rate a borrower may get on credit cards, as well as mortgage, auto and other loans.

Credit scores are determined by factors including a borrower's current unpaid debts, the number and type of loans they have, how long the loans have been open and available, bill payment history and how much credit is being used.

The reason Black and Hispanic borrowers start out behind on their credit scores has less to do with individual behavior and more to do with the limited financial resources of their family households, Garon said.

Those households have less wealth to draw on from previous generations due to lending policies that favored white borrowers, such as property covenants that prevented Black people from living in majority white areas, and redlining, whereby mortgage lenders would restrict the customers they served.

"The disparities are rooted in decades of discriminatory policies that have systematically denied communities of color equal access to affordable financial services as well as opportunities to pass wealth to future generations," Garon said.

For individuals who are trapped in a high-cost credit borrowing cycle, counselors or nonprofits can help, Garon said. Credit unions may also be a resource for consolidating loans at lower interest rates, making it easier to pay debt balances down.

Importantly, because credit scores are based on how well someone honors their financial obligations, they do not necessarily need to have more means for their score to go up.

"You can start small and still build a pretty decent credit score if you need to rebuild your credit or improve your credit to get to where you are able to qualify for lower interest rates and loans that meet your needs," McClary said.

But in order for the system to really change, policymakers will have to address the issue with proactive measures to make sure lenders of all kinds are providing loans fairly and the credit score system gives all borrowers a chance at affordable credit, Garon said.

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If rent payments were included in credit scores, for example, that may better help reflect people's ability to pay their obligations, she said.

Moreover, other policies could address the racial wealth gap, such as universal baby bonds, progressive childhood development accounts, tuition-free public universities, as well as first-time homebuyer assistance, Garon said.

Bank of America recently announced it is launching new mortgage products with zero down payment and zero closing costs for certain markets, including majority Black and/or Hispanic/Latino neighborhoods, in Charlotte, North Carolina; Dallas; Detroit; Los Angeles; and Miami. Other financial institutions including Citi are also providing programs aimed at making their lending practices more inclusive.