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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.
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.
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?
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.