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Building credit in low-income communities

A few years ago, Ricki Lowitz noticed a problem with individual development accounts offered by Centers for Working Families and similar groups: the savings generated by low-income people in IDAs could be completely eaten up by high interest rates when they purchased a home or another major asset.

CWF clients were getting high interest rates because they had low – or no — credit scores.

In response, CWF developed a new credit-building loan program which the group says has shown “tremendous results” in its first year.

Credit scores are increasingly important according to a recent report from Woodstock Institute, which found that communities of color have far more residents with non-prime credit scores. That means those residents “likely face more limited access to economic opportunity,” said Woodstock vice president Geoff Smith.

Consumers with low or no credit scores pay higher interest rates for mortgages and consumer loans.  A low-score borrower getting a 25-percent interest rate on a $10,000, five-year car loan will pay $6,000 more over the life of the loan than a high-score, prime-rate borrower paying 5 percent.  The Credit Builders Alliance calculates that households without good credit scores will pay $250,000 in higher interest rates over their working life.

The poor pay more

Such consumers will pay more for insurance, will have to pay deposits to get utilities, and may have to pay check-cashing fees if they can’t get a checking account.  If their car breaks down they’ll call a relative rather than a tow truck — and they may end up missing work and taking out a payday or title loan to finance repairs, with interest rates as high as 400 percent.  And they may well have less access to better jobs and homes, as landlords and employers sometimes use credit scores to screen candidates.

“We encourage people to think of their credit score as their financial resume,” said Lowitz, a program officer at LISC Chicago, citing the work of CBA.  “Everybody is looking at it, but many people don’t put their best foot forward.  Number one is making sure there is good stuff there.”

Indeed, many low-income people are good money managers – they just don’t use vehicles that report to credit agencies, Lowitz said.  Just paying bills on time doesn’t help, since many utilities don’t report to credit agencies.   Building a credit score requires regular payments on open and active accounts, such as revolving credit cards or installment loans.

“In the Hispanic community, it’s common for people to be afraid of credit,” said Sugey Lozano, a financial counselor at the Center for Working Families in Back of the Yards, one of twelve centers operated by community groups in partnership with LISC Chicago. “They hear horror stories about people going bankrupt and losing everything, and they say if I don’t have the cash, I won’t buy it,” she said.

Zero to 699 in six months

She tells of a woman who came in last year with her husband, who was looking for work.  (The centers provide a holistic approach to improving low-income residents’ financial stability, offering employment services, financial counseling, and help accessing income supports.)  She had managed to save a good chunk of money working a living-wage job.  Her dream was to buy a house, but she was stymied because she had no credit score.

The new program, called Twin Accounts, was perfect for her, said Lozano.  Participants take out a $500 loan from North Side Community Federal Credit Union, which is placed in a locked savings account.  They make monthly payments on the loan, with payments matched if they are on time; after a year they’ve saved and earned up to $1,000.

They also have a year’s history of on-time payments on an installment loan that has been reported to credit bureaus, generating a credit score.  Halfway into the loan’s term, Lozano’s client had gone from no score to an impressive 699.

“It’s definitely fantastic,” said Lozano.

“It’s not a product that can stand on its own,” said Lowitz – it requires ongoing counseling and education.  After the loan is paid off, Twin Accounts clients are encouraged to continue to build credit by using their savings to obtain a secured credit card, or as a lump-sum payment to help settle a collection.  Funds can also go to education, an asset purchase, or an emergency savings account.

The concept weds the incentivization of individual development accounts – matched savings accounts designed to generate funds for home purchase, business development or schooling – with credit builder accounts, which banks sometimes offer if they’re unable to make a loan to a prospective borrower due to credit score issues, Lowitz said.

“It can work for people with no credit scores due to lack of credit history, or people with low scores who have only one or two open and active trade lines,” said Seung Kim, a consultant to CWF.   When clients with low scores have multiple open accounts, counselors help them build credit by improving on-time payments, she said.

A small group of clients has yielded impressive results in the first year of the program, said Lowitz, and CWF has funds available for many more accounts.  They are looking for a community financial institution on the South Side to participate, and Lowitz thinks commercial banks could also be interested in the product.

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Category: banks & credit

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