Credit Invisibility: Do You Live in a Credit Desert?

Where Americans live may be related to how much trouble they have getting credit. That doesn't mean that when someone applies for a credit card, a mortgage, or another loan, the issuer may see that they live in a low-income neighborhood and automatically decline their application. That practice, called redlining, is illegal (though it persists). It means that in some areas, many residents have either no credit score or insufficient credit history to qualify for a credit card or another mainstream form of financing.

Even if you and your neighbors have solid histories of paying your rent and utilities on time, or even your payday and auto title loans, it doesn't matter. Since the FICO® Scores that banks typically use to determine creditworthiness don't factor in these payments, potential borrowers can't get loans with an APR of 5%, 10%, or even 35%. Instead, they have to get loans with APRs of 400% or not borrow at all.

High-interest, small-dollar loans may help solve short-term money problems. However, they may also exacerbate them, and they don't provide access to two of the biggest wealth-building opportunities in American society: small business ownership and home ownership. That’s why understanding the problem of credit invisibility is so important.

The problem of credit invisibility

About 1 in 5 adult Americans, or 45.4 million people, are likely to have trouble getting approved for a bank loan or credit card because they lack a mainstream credit history. These figures come from 2010 and were published in a 2015 report by the Consumer Financial Protection Bureau (CFPB), which thinks its estimates are low.

About 11% of adult Americans have no credit history. Another 8.3% have a credit history with too few accounts or no recent transactions, making them unscoreable by the most widely used credit scoring models. (So, when you read that the average American credit score is 704, just know that this is the average score of the 81% of the adult population that actually has a score.)

Adults younger than age 25 account for a large share of this group, and they often find their way into mainstream credit reporting via credit cards or student loans. In fact, more than 90% of people generate a credit history by their mid to late 20s, according to the CFPB. But adults aged 25 and older are unlikely to transition out of this group.

Further, data from the FDIC shows that in 2017, 1 in 5 households hadn't used traditional credit in the last 12 months.

When there seems to be a relationship between where a person lives and their inability to obtain traditional credit, we have to wonder about their access to credit. That's where the concept of credit deserts comes in.

Who lives in credit deserts?

A credit desert, as defined by the CFPB, is a lower-income neighborhood (and often a minority community) where an above-average number of people don't have credit scores and lack access to mainstream, low-interest sources of borrowing money, such as bank-issued auto loans, personal loans, and credit cards. Instead, they either have no access to credit or can only get credit through high-interest alternative providers, such as payday lenders, car title lenders, rent-to-own stores, and pawn shops. A credit desert is the opposite of a credit haven, defined by think tank Demos as a neighborhood where affordable credit is widely available.

The CFPB study found that rural and highly urban areas are where credit invisibility is most concentrated. In highly urban areas, neighborhood income correlates strongly with credit invisibility, but in rural areas, it does not.

Why? Because in rural areas, a lack of high-speed internet access may prevent people from applying for credit, not to mention prevent them from learning about their options or about the pickle they're in.

Credit invisibility is a self-perpetuating problem, because you need credit to get credit. In fact, almost 45% of adults in low-income neighborhoods don't have traditional credit scores, compared with 9% in upper-income neighborhoods, according to the CFPB. Also, regardless of age, black and Hispanic individuals are more likely than white and Asian individuals to not to have credit scores.

Why do credit deserts matter?

Credit doesn't just create economic opportunity in the form of helping people start businesses and buy homes. It also facilitates economic stability. If you can smooth out times of fluctuating income and expenses with an affordable loan that has a reasonable repayment period, you're less likely to fall into a cycle of debt that's hard to break out of.

The thing is, credit invisibility could be largely resolved by using different credit scoring models that are readily available but that lenders are too stuck in their ways to use, according to a 2017 report by PERC, a think tank focused on credit invisibility. Of course, some people will have bad credit no matter what factors the scoring model considers. But others would have good credit if not for algorithmic bias -- that is, if the scoring models gave them points for paying their rent, utilities, phone bills, or even payday loans on time.

Finding a path out of the credit desert

Many people who have demonstrated financial responsibility and a desire to borrow cannot access traditional, lower-cost forms of credit. Their monthly payments don't get added to mainstream credit profiles, which means these individuals don't build the traditional credit histories and scores that conventional lenders use.

Not everyone who lacks access to credit wants access to credit. Some people prefer a cash- or debit-card-based lifestyle. But geographic concentrations of credit invisibility, or credit deserts, show us yet another way our society systematically mistreats certain groups and denies them opportunities that other groups can take for granted.