The Destructiveness of Redlining

By: JT Martin

The term “redlining” is defined as when “an institution provides unequal access to credit, or unequal terms of credit, because of the race, color, national origin, or other prohibited characteristics of the residents of the area in which the credit seeker resides.” Put simply, redlining is denying people credit based on stereotypes of the person or the area they are from rather than their own credit worthiness. This can occur for credit types like mortgages, student loans, or business loans and was a major problem in the United States banking system especially in the 1930’s.

The name redlining for this loan discrimination came from how lenders draw “red lines” around an entire neighborhood or area and refused to invest in it because of the demographics of that area. These tactics greatly hurt the African American specifically of many wealth brackets and forced them to agree to unfair pricing for houses and housing contracts because they had no other access to credit. This exploitative tactic is known as reverse redlining, which is when lenders target areas and populations that are redlined and offer them predatory mortgages and loans that they know the borrows are forced to take from a lack of opportunity. These discriminative practices were outlawed in the Fair Housing Act of 1968 which prohibited any racial discrimination for lending assessments. However, despite the legislation similar statistics show that this discrimination as a whole has not completely disappeared and can still be seen throughout the country. This was seen specifically during and after the 2008 financial crisis when the loan approval rate dropped far higher for African Americans when compared to the overall drop of loan approvals.

Redlining as a practice is also not beneficial to a lending institution overall as they are forgoing potentially profitable opportunities by denying groups of populations without considering their actual qualifications for their credit worthiness. Even though the logic behind redlining that the areas were unworthy of credit because of their riskiness associated with financial institutions. As you can see, this created a perpetual system in which lending was denied from a population because it was considered too risky, then the borrowers were forced to accept a loan they could not afford, and then they eventually are unable to pay back their credit as almost proof to the lenders that their redlining tactic was justified. This also had long lasting effects on the people and communities involved in redlining. Investopedia notes a study conducted in 2020 that communities that were subjugated to redlining tactics not only have lower property values, but also have lower life-expectancies when compared to the non-redlined communities.

Credit discrimination is illegal thanks to the Fair Housing Act, but there are legal and fair factors that lenders can measure and weigh in the structuring of credit terms or in their approval or rejection of a loan application. The first factor lenders can take into consideration is the credit history of the applicant. Typically quantified as a FICO score, credit history takes into account past defaults or missed payments to determine credit worthiness based on the future likelihood of repaying the loan. The next factor that lenders can consider is the borrower’s income, which is allowed because the lenders can compare the borrower’s size and strength of their income to determine if they will have the access to the necessary funds for the loan. Also, lenders consider factors that affect the value of property the loan is being placed on. This includes the property’s condition and the neighborhood’s amenities that can raise or lower the perceived value. Lastly lenders can consider their own loan portfolios and if a specific opportunity will strengthen or weaken their loan portfolio in regard to their own financial goals.

In my own opinion, redlining at its peak was a morally deplorable strategy that lenders used to allow their own personal prejudices and biases to devalue thousands of homes and communities across the country. While lenders based their economic logic behind this by dismissing the areas as high risk in general and therefore justified in their lending tactics, the factor of race and how minorities were so disproportionately affected by this tactic cannot be ignored. For a country that prides itself on the American dream and the idea that any American can achieve greatness, redlining seems to contradict those core values of the country. Also, regarding the economics of redlining, it is easy to see that intentionally denying an area or community fair credit would also affect the lender poorly. This is even strengthened when considering the factors that lenders can consider when determining credit worthiness. Lenders stand to gain more by finding all worth loans and opportunities to lean and will profit more if the borrow can repay the loan since defaulting negatively affects the lender. With legislation like the Fair Housing Act in place, I hope that redlining is close to if not completely extinct as a practice, but I find it disappointing to see how negatively communities were affected and are still being affected today because of the discriminatory nature of redlining.

Sources:

https://www.investopedia.com/terms/r/redlining.asp

https://www.fdic.gov/resources/bankers/fair-lending/documents/fdic-redlining-fair-lending-resources-page.pdf