Most people need credit for major purchases. Whether buying a car or home or embarking on a new business venture, the average person doesn’t have enough money on hand to make this sort of purchase outright. The ability to secure credit also creates a ripple effect. It determines where you can live, what type of rates you’ll pay for insurance and other expenses, and whether you can even be considered for certain types of jobs and partnerships.
That’s why access to credit—or the lack thereof—can create wealth gaps that last for generations. According to a 2019 US Federal Reserve report on disparities in wealth by race and ethnicity, white families have a median wealth of $188,200 and a mean wealth of $983,400. Black families have a median wealth of $24,100 and a mean wealth of $142,500. Hispanic families have a median wealth of $36,100 and a mean wealth of $165,500.
Below, we talk to experts to examine the role of credit in the racial wealth gap, along with possible solutions.
Access Is Everything
According to Tomeka Lynch Purcell, a money mindset coach and author of Morgan Saves for College, there’s an obvious connection between access to credit and wealth creation. “The wealth gap between white and Black Americans is widening, and Black families now have 10 times less wealth than whites,” she tells us. “It remains harder for minorities to get the credit they need in everyday life, which makes it harder for them to make big purchases, like buying a home, which could help them build and pass on wealth.”
Purcell notes that this is a particular problem as it relates to mortgages. “Minorities find it harder to gain access to credit—especially mortgages, and the homeownership rate among minorities is on the decline,” she laments. “Homeownership among white Americans is more than 30 percentage points higher than among Black Americans.”
Purcell’s comments are supported by a recent Redfin analysis, which found that the homeownership rate among Black families is 44% versus 73.7% for white families. Minneapolis, MN(25%), Salt Lake City, UT (28%), and Milwaukee, WI (27%) have the lowest rates of homeownership among Black families. [Washington, DC (51%), Birmingham, AL (50%), and Richmond, VA (49%) have the highest Black homeownership rates.]
A house is a major investment that contributes to a larger net worth over time—and also provides significant tax deductions every year. And it can be passed on to future generations. On the other hand, the lack of an inheritance (in the form of property or money) can negatively affect generations of Black people. “Many people of color do not come from households where money is saved or gifted by their parents to fund their dreams, aspirations, or goals,” explains Shan-Nel D. Simmons, founder and CEO at Nel Tax and Financial Solutions. “Therefore, in order to acquire major purchases and/or investments, these people of color must turn to lending opportunities, such as the ability to obtain credit, to turn their plans into their realities.”
Business Dreams Deferred—Maybe Permanently
In addition to homeownership, the lack of access to credit also affects the ability to be small business owners. According to a report by the Small Business Administration, minorities are 40% of the US population but only own 20% of employer businesses—and a lack of funds is the major barrier to entrepreneurship.
In a September 2017 report to Congress on the availability of credit to small businesses, the Federal Reserve found that although Black businesses were the group most likely to apply for loans, less than 47% were approved—and this rejection rate is twice as high as that of white business owners. Black business owners were also most likely to apply for and be denied a credit card.
Attorney Michael Coles, founder and president of The Coles Firm, believes that after education, access to credit is the most important tool for generating wealth. “Starting a business with nothing but cash is not likely an option except for the smallest of enterprises,” he says. “If you need office space, inventory, payroll, or any furniture/fixtures/equipment, expect to use credit or have a credit check performed at a minimum.”
If you’re bidding on contracts or seeking a preferred vendor relationship, Coles says many large companies perform credit checks on small business owners before making a decision.
His view is shared by Karwanna Dyson, a government contract strategist and owner of She’s Got Goals. “When Black business owners are able to build a line of credit or build business credit, they’re able to pay themselves and focus on building their business and not have to worry about how they’re going to pay their bills,” she explains. “But when they don’t have credit, then they’re back to the drawing board, always struggling, trying to figure out how they’re going to make it work—it’s a Catch-22.”
Failure to Launch
Blatant modern-day discrimination plays a role in many credit denial decisions. But systemic racism, a harsh credit scoring model, and a lack of financial education are also contributing factors.
“Given the immense impact credit has on the ability to generate wealth, you might think parents would discuss credit with children,” says Coles. But in many families, he says credit has one meaning: bills—and bills represent a cost, not an opportunity. “Families that want to promote wealth must discuss how credit has benefited the family and how bad credit decisions may have hindered the family’s efforts,” he says. “Raising credit-conscious children is just as important as raising children who value education.”
And being unfamiliar with credit or the negative consequences of not handling it well can also contribute to being denied credit in the future. “There are a lot of people of color that don’t have access to credit, or maybe they were loaded up front, and then there’s a job change or something else happened, and they got behind on some payments, and now they’ve got bad credit so they can’t get more credit,” Dyson explains.
And being on the wrong side of the preferred credit score affects everything. “When you have credit, you can walk to a bank and get a loan for whatever it is that you want to do—you can go purchase a house, go buy a car, go travel if you want to.” But if you don’t have a good credit rating, Dyson says you’re always being told no. “So the solution to that is to fix your credit, and then the sky’s the limit to whatever it is that you want to achieve.”
But fixing your credit can take time—and time doesn’t stand still during this process. “The current credit scoring model ends up eliminating many African Americans, Latinos, and young people that are otherwise creditworthy, making them effectively ‘credit invisible,’ Purcell explains.
And for people in this state, the effects can be devastating. “Credit invisibility leaves a person unable to access necessities, since, besides homeownership, credit is used when a person applies for health insurance, car insurance, and even employment.” Purcell says it’s harder to get started and harder to move forward after a life-challenging event if you don’t have access to credit.
Two Steps Forward, Three Steps Back?
Even with good credit, Purcell says minorities still encounter problems. “African Americans and Latinos are far more likely to be denied conventional mortgages than whites, even when income, loan size, and other factors are taken into account,” she says.
As recently as 2018, CNN reported that Wells Fargo in Sacramento, CA, was accused of steering minority borrowers toward loans with higher costs, based solely on their race. Black borrowers who had credit scores above 660 were 2.8 times more likely to be approved for a high-cost or high-risk loan, and Latino borrowers were 1.8 times more likely to be pushed into this category compared to white borrowers with comparable scores. A year earlier, the City of Philadelphia filed a similar suit against Wells Fargo for the same predatory lending practices.
In 2017, the Consumer Financial Protection Bureau (CFPB) finalized a rule designed to stop payday loan debt traps. Although payday loans are usually small, the annual interest rates can exceed 300%, and many people end up financing the same debt over again, or they end up defaulting. Payday loans are used disproportionately by Black people—often as a result of not being able to secure a regular bank loan. However, in July 2020, most of the protections in the 2017 ruling were rolled back, allowing payday lenders to resume their previous tactics.
In April 2020, the coronavirus relief bill included billions for the Paycheck Protection Program and an additional $60 billion in PPP funding for minority-owned and rural businesses. However, a report by the House Select Subcommittee on the Coronavirus Crisis found that the Treasury Department “encouraged banks to limit their PPP lending to existing customers, excluding many minority and women-owned businesses.” The report also reveals that many banks processed larger loans much faster than smaller loans. As a general rule, Black-owned businesses reported that they weren’t able to access the loans.
Despite this, there are (very small) bright spots. “I am finding that more and more people of color are becoming more educated about how personal and business credit works, which is why more people of color are finally gaining access to lending capital that once seemed impossible to obtain,” says Simmons.
“They are learning that it requires establishing relationships with financial institutions through banking and having checking and/or saving accounts in place to create mutual trust between themselves and lenders.”
Changes All Around
There is no simple remedy for such a complex problem. However, there are several suggestions, which, when taken together, can slowly move the needle in the right direction.
“’Fixing’ credit and other quick fixes rarely work, and high-interest lenders rarely provide a stepping stone to financial independence,” warns Coles. “As access to credit has become deregulated and more open for consumers, those limited regulations have spawned opportunities for bad faith practices.” He recommends good old-fashioned budgeting. “I recommend that people build a budget for themselves, share it with their children so they understand the importance of a budget, and track their progress.” When a loan has been paid off, he recommends a small celebration—without going back into debt to do so. “That highlights for children that it can be done and that it should be done.”
Coles also recommends retirement planning as a backstop for credit needs. “Credit cards typically charge 12–18% interest,” he explains. “If you start retirement planning by including a vehicle that permits loans against the value of the asset, you will have access to lower interest rate loans without the necessity of impacting your credit rating with a credit check.” Coles also points to another advantage: access to cash within a day or two.
“This is not a resource to be used lightly, however, so be certain the need for immediate access to cash outweighs the long-term effects of borrowing from your retirement.” And he stresses that you should make it a priority to pay the money back, even if you replenish it slowly. “In a perfect world, this is the highest interest rate you will ever pay, saying goodbye to high-interest rate credit cards or using them only to the extent you can pay them the next month without accruing any interest.”
Simmons also believes that people of color have to take matters into their own hands. “More people of color have to understand that the goal is to have their credit work for them so credit creates more money-making opportunities and extends their personal and business cash flow, rather than using credit to charge the life they cannot afford without debt,” she says. “By becoming more financially savvy, this generation of people of color understands that credit is merely a tool to amass assets, not debt, that can be passed down to the next generation of benefactors.”
She believes that financial education and making credit more accessible are the 2 major factors required to close the racial wealth gap.
However, making credit more accessible may be a much harder objective to achieve. Purcell doesn’t see that happening unless there is an alternative scoring model to judge credit-worthiness. “With gentrification and an increasing shortage of affordable housing, no one can afford to be credit invisible,” she says. “Having access to credit is like having access to a better life, and if minorities are being denied that because of the current system, then other ways of ensuring access must be employed.”
For example, in 2018, Experian, TransUnion, and Equifax reported that tax liens and civil judgments would no longer be a part of credit reports. “When listed on a credit report, these pieces of public information can be a major obstacle to obtaining credit, and the bureaus have agreed to remove it from consumer credit reports and to stop reporting it going forward,” Purcell says.
Her opinion is shared by Dyson, who also recommends contacting the credit bureaus to dispute old items that should have fallen off a report by now. “Also, there are a lot of credit lines that are guaranteed that will help you lower your utilization rate, which will increase your credit score by 70 points.”
People of color can also benefit from getting creative regarding ways to grow their businesses. “I teach women and minority small business owners how to significantly grow their business with government contracts,” Dyson says.
Although many US states have laws against unfair and deceptive practices, a surprising number of states exempt most lenders or use ambiguous language. Eliminating exceptions and gaps, and adopting more stringent statutes would be a good step in the right direction.
Building Up the Black Community
In addition, increasing the number of Black-owned businesses on a community level may be the key to raising Black wealth overall. “Efforts to foster, promote, and develop Black-owned businesses must go beyond a focus on household wealth and access to capital for Black entrepreneurs,” Purcell warns. “Without wealth at the community level, existing Black-owned businesses may also struggle to maintain their financial footing during sustained economic downturns.”
Take COVID-19 as an example. A Stanford study found that the number of Black businesses dropped 41% from February to April 2020. (Latinx businesses dropped 32%, and Asian businesses fell by 26%.) “During such periods, regular clients and customers may have fewer resources to support their local veterinarian, mechanic, or contractor, even if their services are needed,” Purcell says. “Wealth at the community level is essential for the long-term success of Black-owned small businesses.”
In the wake of George Floyd’s death, many Black business owners saw a surge in sales and requests for service, but it remains to be seen if that level of support for POC businesses will continue. “Fostering the development of Black-owned businesses will not solve racial inequality, yet it remains an admirable and just policy goal,” Purcell says.
“Once established, these firms have the potential to increase wealth, create jobs, and reduce persistent shortages of essential goods and services in Black neighborhoods, including healthcare, childcare, and food.”
However, to actually create an environment where people of color can start, grow, and expand their businesses, Purcell says it will take more than entrepreneurship seminars.
Equal access to credit and other funding opportunities are a huge step in the right direction.