Small Businesses Should Know Their Equal Credit Opportunity Rights When Applying for a Loan
This post is part of Fundera’s Know Before You Owe initiative, which seeks to educate small business borrowers on everything they need to know before, during and after they apply for a loan.
No borrower should ever be denied a loan just because of who they are.
Discrimination in credit access keeps worthy borrowers from the tools they need to reach their financial goals, and it violates the fundamental American precept that every one of us should have equal access to opportunity. But, there are many examples of lenders and brokers who discriminated against a borrower because of immutable personal characteristics, like their gender or marital status, which have no bearing on their ability to repay a loan.
Despite Progress We’ve Made, the Threat of Discrimination in Credit Access is Still Real
It wasn’t long ago that credit discrimination was a fact of credit access.
For example, as the Financial Times has pointed out, the 1935 map of Greater Atlanta in the National Archives comes in shades of blue, yellow and red. The hand-scrawled legend that accompanies it reads “light blue — best, dark blue — still desirable, yellow — definitely declining, red — hazardous”. It is a strident reminder of a dark period in U.S. history, when potential borrowers were classified not by their individual credit characteristics but by the neighborhoods in which they lived. The “redlined” neighborhoods were often poor and dominated by a racial or ethnic group. In the case of Atlanta, the aim was often to keep African-Americans from moving into neighborhoods dominated by whites.
The practice of redlining has since been outlawed with a slew of regulation, including fair lending and equal credit opportunity laws, but credit discrimination has taken on new meaning in the 21st century. The rise of big data has given those who wish to discriminate against a borrower powerful new tools to do so, often times with the borrower being none the wiser. Algorithms are becoming increasingly adept at parsing publicly available information to accurately predict everything from users’ political inclination to ethnicity and sexual orientation. In fact, according to Kate Crawford, a senior researcher at Microsoft, Facebook timelines, even when stripped of data like names, can still be used to determine a person’s ethnicity with 95 percent accuracy. So, greater knowledge of borrowers enabled by big data has created new ways to discriminate, irrespective of what a borrower willfully discloses to a creditor, and often times entirely unbeknownst to the borrower.
Whether they know it or not, borrowers have equal credit opportunity rights when seeking a loan, which every lender and broker must respect, even though some may not. That is why it is absolutely imperative that every small business borrower know their equal credit opportunity rights when applying for a loan.
The Equal Credit Opportunity Act Protects Certain Classes from Discrimination
A borrower’s right to non-discrimination in credit access is enshrined in the Equal Credit Opportunity Act (ECOA), enacted in 1974. The bill initially vested enforcement responsibilities in the Federal Reserve, but Dodd-Frank Financial Reform moved those responsibilities to the newly-created Consumer Financial Protection Bureau (CFPB).
ECOA’s purpose is to require financial institutions and other firms engaged in the extension of credit to “make credit equally available to all creditworthy customers without regard to sex or marital status.” Moreover, the statute makes it unlawful for “any creditor to discriminate against any applicant with respect to any aspect of a credit transaction (1) on the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract); (2) because all or part of the applicant’s income derives from any public assistance program; or (3) because the applicant has in good faith exercised any right under the Consumer Credit Protection Act.”
As CFPB underscores, the law has two principal theories of liability, both of which are entirely prohibited: disparate treatment and disparate impact. Disparate treatment occurs when a creditor treats an applicant differently based on a prohibited basis such as race or national origin. Disparate impact occurs when a creditor employs policies or practices or builds programs that may not explicitly try to discriminate against protected classes, but which do nevertheless have an adverse effect or impact on a member of a protected class. These policies or practices are prohibited unless they meet a legitimate business need that cannot reasonably be achieved by means that are less disparate in their impact.
That sounds like a lot of legal jargon, so what does this actually mean?
All Lenders and Brokers, Whether Offline or Online, are Bound by ECOA
There’s no question that creditors may ask borrowers for some of this information in certain situations–for example, marital status or gender. And, of course in America we promise equality of opportunity, but not necessarily equal outcomes, so it’s true that not everyone who applies for credit, even if applying as a member of one of these protected classes, will get the same terms. Factors like a small business borrower’s credit score, income, expenses, existing cash and leverage levels, and industry dynamics are just a few of the many considerations that lenders use to determine a borrower’s creditworthiness.
But, under no circumstances may creditors use this information when deciding whether to give a small business borrower credit or when setting the terms of their credit. ECOA is broadly applied in lending. In fact, any institution which extends credit, or which helps creditors find qualified borrowers, is subject to it. That means, for example, that online lenders and marketplaces, brick and mortar banks, small loan and finance companies, credit card companies, credit unions, and retail and department stores are all must ensure equal credit opportunity when extending credit. The regulation covers creditor activities before, during, and after the extension of credit.
But, even this explanation is often insufficient for borrowers to fully understand their equal credit opportunity rights in practice, so below we try to spell out specific examples of what a creditor or broker cannot do when extending credit.
Part of our analysis here draws on a helpful post from the Federal Trade Commission, which we encourage borrowers to check out.
When You Apply for Credit, Creditors May Not…
- Discourage you from applying or reject your application because of your race, color, religion, national origin, sex, marital status, age, or because you receive public assistance.
- Consider your race, sex, or national origin, although you may be asked to disclose this information if you want to. It helps federal agencies enforce anti-discrimination laws. A creditor may consider your immigration status and whether you have the right to stay in the country long enough to repay the debt.
- Impose different terms or conditions, like a higher interest rate or higher fees, on a loan based on your race, color, religion, national origin, sex, marital status, age, or because you receive public assistance.
- Ask if you’re widowed or divorced. A creditor may use only the terms: married, unmarried, or separated.
- Ask about your marital status if you’re applying for a separate, unsecured account. A creditor may ask you to provide this information if you live in “community property” states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. A creditor in any state may ask for this information if you apply for a joint account or one secured by property.
- Ask for information about your spouse, except: if your spouse is applying with you; if your spouse will be allowed to use the account; if you are relying on your spouse’s income or on alimony or child support income from a former spouse; if you live in a community property state.
- Ask about your plans for having or raising children, but they can ask questions about expenses related to your dependents.
- Ask if you get alimony, child support, or separate maintenance payments, unless they tell you first that you don’t have to provide this information if you aren’t relying on these payments to get credit. A creditor may ask if you have to pay alimony, child support, or separate maintenance payments.
When Deciding to Grant You Credit or When Setting the Terms Of Credit, Creditors May Not…
- Consider your race, color, religion, national origin, sex, marital status or whether you get public assistance.
- Consider your age, unless: you’re too young to sign contracts, generally under 18; you’re at least 62, and the creditor will favor you because of your age; it’s used to determine the meaning of other factors important to creditworthiness. For example, a creditor could use your age to determine if your income might drop because you’re about to retire; it’s used in a valid credit scoring system that favors applicants 62 and older. A credit scoring system assigns points to answers you give on credit applications. For example, your length of employment might be scored differently depending on your age.
- Consider whether you have a telephone account in your name. A creditor may consider whether you have a phone.
- Consider the racial composition of the neighborhood where you want to buy, refinance or improve a house with money you are borrowing.
When Evaluating Your Income, Creditors May Not…
- Refuse to consider reliable public assistance income the same way as other income.
- Discount income because of your sex or marital status. For example, a creditor cannot count a man’s salary at 100 percent and a woman’s at 75 percent. A creditor may not assume a woman of childbearing age will stop working to raise children.
- Discount or refuse to consider income because it comes from part-time employment, Social Security, pensions, or annuities.
- Refuse to consider reliable alimony, child support, or separate maintenance payments. A creditor may ask you for proof that you receive this income consistently.
You Also Have the Right to…
- Have credit in your birth name (Mary Smith), your first and your spouse’s last name (Mary Jones), or your first name and a combined last name (Mary Smith Jones).
- Get credit without a cosigner, if you meet the creditor’s standards.
- Have a cosigner other than your spouse, if one is necessary.
- Keep your own accounts after you change your name, marital status, reach a certain age, or retire, unless the creditor has evidence that you’re not willing or able to pay.
- Know whether your application was accepted or rejected within 30 days of filing a complete application.
- Know why your application was rejected. The creditor must tell you the specific reason for the rejection or that you are entitled to learn the reason if you ask within 60 days. An acceptable reason might be: “your income was too low” or “you haven’t been employed long enough.” An unacceptable reason might be “you didn’t meet our minimum standards.” That information isn’t specific enough.
- Learn the specific reason you were offered less favorable terms than you applied for, but only if you reject these terms. For example, if the lender offers you a smaller loan or a higher interest rate, and you don’t accept the offer, you have the right to know why those terms were offered.
- Find out why your account was closed or why the terms of the account were made less favorable, unless the account was inactive or you failed to make payments as agreed.
Lesbian, Gay, Bisexual and Transgender Borrowers are NOT Included
- There is currently no federal law that consistently protects lesbian, gay, bisexual, and transgender (LGBT) people from credit discrimination. The nation’s primary law prohibiting credit discrimination, the Equal Credit Opportunity Act (ECOA), prevents lenders and loan brokers alike from discriminating against borrowers based on immutable characteristics like race, color, religion, national origin, sex, or marital status. Even programs that may not explicitly discriminate against these protected classes, but still have a “disparate impact” on them, can be deemed unlawful.
- But, ECOA was enacted a time — 1974 — when homophobia was rampant and gay Americans were treated as second class citizens. LGBT individuals were never even considered for inclusion as protected classes. The result is that today protections available for LGBT Americans are a patchwork of state-based at best and nonexistent at worst. Only 10 states and the District of Columbia have credit nondiscrimination laws that include sexual orientation and gender identity, with an additional two states that cover sexual orientation only. It remains perfectly legal in 40 states to deny a gay or transgender borrower a loan just because of who they are.
- We feel strongly that Congress should pass the Freedom from Credit Discrimination Act (FDCA), which would amend ECOA to include sexual orientation and gender identity as federally protected classes. The bill has been introduced in the House by Congressman Steve Israel three times, and Senator Patty Murray introduced a version of it in the Senate in July 2013. But, so far, the bill has not been reintroduced in the 114th Congress.
If You Suspect a Creditor has Discriminated Against You, Take Action…
- Complain to the creditor. Sometimes you can persuade the creditor to reconsider your application.
- Check with your state Attorney General’s office to see if the creditor violated state equal credit opportunity laws.
- Consider suing the creditor in federal district court. If you win, you can recover your actual damages and be awarded punitive damages if the court finds that the creditor’s conduct was willful. You also may recover reasonable lawyers’ fees and court costs. Or you might consider finding others with the same claim, and getting together to file a class action suit. An attorney can advise you on how to proceed.
- Report violations to the appropriate government agency. If you’ve been denied credit, the creditor must give you the name and address of the agency to contact.
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