Credit Matters: Low-Income Asset Building Challenges in a Dual Financial Service System

BABC 04-1: This paper examines the nexus between the utilization of basic financial services, ownership of a transaction account, the creation and use of credit records, homeownership, and management of mortgage repayment risks. It begins with a model that captures this nexus and is followed by a section that elaborates on low-income homeownership as an asset building strategy. Broad patterns of asset ownership and credit use are then discussed. These patterns reveal that a large share of low-income households have no formal relationship with a banking institution (bank, thrift or credit union) and that a dual system of credit provision exists in which low-income communities are far more likely than higher income communities to be served by alternative (payday lender, check cashers, pawnshops, rent-to-own stores, and subprime lending specialists and brokers) than mainstream (banking institutions and prime lending specialists) financial service providers. These disparities are even greater among low-income minority households and communities. A review of the literature on what accounts for observed differences in asset ownership and financial service utilization by income, race and ethnicity of borrowers and communities follows. Next, the evolution of the credit risk evaluation and pricing system for consumer and mortgage credit is examined. The paper concludes with a discussion of interventions to reduce the number of unbanked and increase savings rates, improve the allocation and pricing of credit, improve consumer awareness, and expand the risk mitigation tools available to low-income households...