Credit Cards Not Color Blind?

By Eva Norlyk Smith, Ph.D.

As a nation, we pride ourselves in having overcome many of the racial barriers that marred America in the past. However, according to a recent study by economist Ethan Cohen-Cole at the Federal Reserve Bank of Boston, when it comes to getting approved for a credit card, race may still matter.

Based on an analysis of the credit files of 285,780 individuals, the study found evidence that credit card companies may base their decision about who to approve for credit cards in part on the racial composition of the neighborhood in which the applicant lives. In other words, two individuals of the same age, earning a similar salary, with similar credit histories and credit scores may receive a different reply when they apply for a credit card. An individual living in a predominantly Black neighborhood is less likely to get approved for a credit card than the individual in a White neighborhood, even when the neighborhoods have identical community characteristics. In addition, for individuals who do get approved for credit cards, the amount of credit they get approved for is also likely to vary. Someone living in a White neighborhood is likely to get started out with a higher line of credit.

In today’s society, credit cards are an important first step up the financial ladder. For most consumers, they are the first form of credit obtained, and the first step on the path to building a credit history and a good credit score.

As a result, any disparities in access to credit cards might get magnified down the road by making it more difficult later in life for the same consumers to get access to other forms of credit, most notably a mortgage, because their credit history is too incomplete. For this reason, the differential access to credit cards could reinforce current disparities in home ownership.

Many studies over the past decades have highlighted the fact that despite federal legislation prohibiting discrimination among home-buyers, minorities still face significant barriers to buying homes. One of the key factors that contributes to the difficulties faced by minorities is having an insufficient credit history, which lenders more cautious about approving loan applications. Even when people with incomplete credit histories do get approved for a loan, they face more stringent terms, including higher interest rates and monthly payments.

If, indeed, the results of the Boston Federal Reserve Bank study are correct and it’s harder for minorities to get approved for credit cards, these disparities are likely to persist. Without regular use of credit cards to show a reliable payment history, it is much more difficult to build up the good credit history necessary to buy a house. Credit histories, of course, are also used in approving people for car loans, for car insurance rates and in job applications.

The disparity in access to credit cards has another drawback. Many card users feel that credit card interest rates to the tune of 25% APR or higher amount to little less than usury. However, these rates are nothing compared to the 300+% charged by the payday loan market, where consumers without credit cards often are forced to go when needing extra cash.

Of course, a single study is just that, and not conclusive evidence. Still, the study speaks to the need for greater transparency in the credit card industry and more regulatory study of the factors that impact the credit decision process.

Published: November 3, 2009