FHA investigation: Are credit scores discriminatory?

by Gina Pogol
December 20th, 2010

Recently, the National Community Reinvestment Coalition asked HUD to investigate 22 lenders that impose stricter underwriting criteria than required by FHA to insure mortgages, claiming that requiring higher credit scores discriminates against minority mortgage applicants.  Current FHA guidelines allow mortgages to borrowers with credit scores above 580 with down payments equaling 3.5 percent of the loan amount, or above 500 with a 10 percent down payment.

Not easy finding FHA loans with 580 credit score

The NCRC conducted its own survey and found that 65 percent of lenders refused to consider consumers with credit scores below 620 for FHA financing and that 22 percent refused to extend credit to consumers with credit scores below 640. Only five lenders surveyed had policies in place that allowed lending to applicants with credit scores of 580 and higher.

But is this discriminatory? Some argue that it is because minorities as a group possess lower average credit scores than white borrowers. But others say that by itself this fact does not indicate that the credit scoring system is discriminatory. If low credit scores correlate to higher risk of mortgage default, then they can be considered predictive and are allowed to be used as a condition of loan approval.

Study finds that credit scores do in fact predict mortgage default

A study conducted by the Federal Reserve Bank of Cleveland concluded that lower credit scores do in fact indicate higher likelihood of mortgage default. In addition, the direction that the scores were taking (improving or worsening) was highly predictive of mortgage default. Similarly, insurers continue to be allowed to use credit scoring in setting rates despite the fact that this practice results in minorities paying more on average for insurance than whites do. That’s because of studies like one conducted by the Texas Department of Insurance, which found the average loss per vehicle for people with bad credit scores was double that of people with very good scores. Additionally, the department found that people with the best scores had 40 percent fewer accidents and that claims by those with poor scores were three times higher. Because credit scores have been found to predict insurance company costs, they continue to be used to set rates.

Back to FHA and credit limits

Mortgage lenders do face consequences even if they are insured by FHA. First, if they are brokers, the lenders that they sell loans to could pull the plug and stop buying their loans. If they are direct lenders, excess default experience could cause them to lose their FHA approval and cut off a large chunk of business. The easiest way for lenders to protect themselves is to impose higher credit score requirements on their applicants. And as long as they impose the same credit limits on everyone regardless of race, it’s hard to see how HUD will consider this discriminatory.

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