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Indiana University

IU study: Credit scores a factor in home-buying disparities

March 1, 2010
Bloomington, Indiana --

Credit scores, developed to make loan processing faster and fairer, account for some of the racial disparities in the types of houses that Americans buy and the neighborhoods in which they live, according to a new study by an Indiana University researcher.

Writing in the Journal of Policy Analysis and Management, Ashlyn Aiko Nelson, an assistant professor in the School of Public and Environmental Affairs at IU Bloomington, shows that higher credit scores are associated with the purchase of higher-priced homes near higher-quality public schools, even after adjusting for household income and other factors.

Ashlyn NelsonPrevious research, including a 2007 study by the Board of Governors of the Federal Reserve System, has shown that credit scores are lower for blacks and Hispanics than for Asians and non-Hispanic whites with comparable incomes and assets. "People tend to think of credit scores as a proxy for income. They absolutely are not," Nelson said.

The study, "Credit Scores, Race, and Residential Sorting," is the first to combine credit scores, race and precise household location in a residential sorting model and the first to specifically examine the extent to which credit scores explain racial disparities in where people buy homes.

"All else equal," Nelson writes, "households with higher credit scores choose relatively expensive housing in school districts with higher average home prices that are closer to urban/metropolitan centers. Simulation results show that, for a given household, an increase in credit score is associated with increases in the consumption of desirable housing attributes, including higher-priced homes in more expensive school districts, higher-quality public schools and proximity to urban-metropolitan areas."

Credit scores came into widespread use in the early 1990s as lenders sought ways to streamline the loan application, approval and pricing process. The three-digit scores, based on credit history and loan use and repayment behaviors, allowed for loan approval in minutes; and they reduced the role of bias by loan officers. But some research has found racial discrepancies in credit scores and access to loans.

To undertake the study, Nelson obtained a mortgage bank dataset containing 16,805 confidential mortgage records for homes purchased in Southern California between 1998 and 2002. The data include such information as each homebuyer's race, marriage and dependent status, and credit score. Geo-coding was used to match the location of each home to information about average home value, local school quality, urban amenities, neighborhood racial composition, crime rates and other factors.

Using a residential sorting model, the study found that, all else equal, households with higher credit scores purchase more expensive homes located in neighborhoods with relatively expensive housing, higher-quality public schools and better access to jobs. This makes sense, because high credit scores translate to lower mortgage rates, which enable home buyers to purchase more expensive housing.

There were surprises, however. For example, black households with higher credit scores were more likely to live in segregated areas with high concentrations of black and Hispanic households. Nelson says more research is needed to determine if the trend results from discrimination, preferences or other factors.

The study concludes with policy recommendations, including an expansion of federal Home Mortgage Disclosure Act reporting requirements; more research on the relationship between credit scores, loan decisions and housing purchases; improved credit counseling and other services to empower borrowers; and exploration of alternative credit scoring systems.

To speak to Nelson, contact Jana Wilson at the School of Public and Environmental Affairs, 812-856-5490 or wilsonjs@indiana.edu, or Steve Hinnefeld at University Communications, 812-856-3488 or slhinnef@indiana.edu. To receive a digital copy of the study, e-mail slhinnef@indiana.edu.



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