Today's Trends in Credit Regulation

Using Academic Factors to Reach the Invisible Borrowers: Could It Run Afoul of ECOA?
By Latif Zaman and Katie Hawkins

Robust credit markets play a crucial role in maintaining a healthy national economy. The 2008 financial crisis both underscored the importance of the credit market to the economy and left new obstacles for its ongoing sustainability. Since 2008, many creditors have tightened their underwriting standards, practices, and procedures and have avoided providing loans to individuals with limited credit histories since 2008 due to the difficulty in ascertaining the risk of such extensions of credit. This leaves many Americans standing outside of the credit market without feasible options for building the credit history required for entry. Accessing this segment of consumers, who are potential borrowers, while still mitigating risk, would promote the growth of the credit industry and be beneficial for the economy as a whole. Increasingly, the credit industry is responding by applying nontraditional factors when reviewing an applicant for credit. This article will explore those factors, specifically those factors related to an applicant's academic record, and the risks associated with utilizing such factors, especially the potential for claims of disparate impact. It is not clear how widely these practices are used today, but they may become more prevalent in the near future. We expect this will be an ongoing topic of interest both for creditors and consumers and their respective advocates, along with the regulators and government lawyers who likely already have the topic on their radar.

Who are the Invisible Borrowers?

The Consumer Financial Protection Bureau (CFPB) recently published a report finding that 26 million Americans are "credit invisible." This figure indicates that one in every 10 adults does not have any credit history with a nationwide consumer reporting agency. The CFPB also found that an additional 19 million consumers, or 8.3 percent of the adult population, had credit records that were treated as "unscorable," meaning that the individuals had credit histories that were not sufficient to generate a credit score by the widely used scoring model that the CFPB utilized for its report. Generally, a credit record may be considered unscorable for two reasons: (1) it contains insufficient information to generate a score, meaning the record either has too few accounts or has accounts that are too new to contain sufficient payment history to calculate a reliable credit score, or (2) it has become "stale" in that it contains no recently reported activity.

A consumer's credit history is his or her track record of obtaining and repaying debt of all sorts, including, for example, student loans, credit cards, mortgages, and car loans. The nationwide consumer reporting agencies (Equifax, Experian, and Trans Union) use such information to create consumer credit reports and related credit scores that predict a consumer's future likelihood of repayment. In turn, banks and other financial institutions that extend credit use the credit reports and credits scores to make decisions about which applicants should be approved for a loan, credit card, or other form of credit.

Much of the decision on whether to extend credit to an applicant, and at what interest rate, depends on those credit reports and credit scores. To the extent that past behavior is predictive of future behavior, credit reports and credit scores are invaluable underwriting tools. However, a CFPB report on "credit invisible" Americans shows that huge segments of the population are underserved by a credit industry reliant on underwriting models that largely base credit decisions on repayment history. A number of creditors have sought to update traditional underwriting criteria by considering non-financial factors in an effort to reach this untapped market of applicants with limited or no credit history. Specifically, some creditors have begun to consider measurements of academic achievement as part of their underwriting process in an effort to mitigate the risk of lending to individuals without enough credit history to satisfy traditional guidelines, and to make credit on reasonable terms available to a wider group of consumers.

The use of academic achievement as an underwriting factor, was, for the most part, previously only used in the student lending industry. By its very nature, student lending functions differently than much of the credit industry. Because student loan applicants frequently have thinly developed credit histories and limited or no earnings while in school, standard credit factors, such as credit score and debt-to-income ratios, may be of little assistance in determining a student's creditworthiness. Student loan lenders must therefore make credit decisions informed more by potential to repay than on credit history. To that end, student loan lenders necessarily utilize different underwriting criteria than mortgage or auto lenders. Private student loan lenders, for example, will generally consider academic factors in determining whether to extend credit. Academic factors may include schools attended (including a school's Cohort Default Rate, which is defined and discussed below), grade point average (GPA), standardized test scores (such as the SAT), and college major. The state of the student loan industry today begs the question of how effective such factors are in determining a student's ability to repay, especially as the country continues to pull out of the recent economic downturn. That is a topic of great interest, but one that we will not delve into here.

Use of similar factors in non-student-loan lending would potentially allow creditors to provide credit to younger or inexperienced applicants while minimizing the risks associated with lending to such applicants. This is appealing because increasing access to credit without sacrificing industry stability would benefit lenders, consumers, and the economy at large. Creditors are noticing this, and looking to this method of applicant review as an alternative with a potentially great return.

In general, an approach to underwriting that considers an individual's achievement, ability and potential would be a positive development for the lending industry. However there are inherent regulatory risks in moving away from traditional underwriting standards that have been implicitly accepted by regulators and courts. Academic factors are not widely used by creditors and may not be understood by regulators and courts in the context of a underwriting. Furthermore, regulators and courts may consider academic factors (or other non-traditional factors) more subjective than the standard debt-to-income ratio or repayment history, and lenders are unlikely to have internal data to supports its use of non-traditional factors, if this is in fact still early in the use of such factors.

In addition, and as discussed below, the use of academic factors in underwriting decisions may specifically open lenders to risk based on a disparate impact analysis under the Equal Credit Opportunity Act (ECOA). Academic performance metrics have been heavily scrutinized in relation to higher education admissions for allowing the exclusion of underrepresented minorities. There is a very strong chance that the use of academic factors in underwriting will disproportionately affect students of certain races and ethnicities.

Historically, census data has shown that educational attainment has varied greatly by race and ethnicity. The achievement gap is widely discussed, and data continues to show that it persists despite some progress. While the college matriculation rate for underrepresented minorities has increased in the past few years, the college graduation rate still lags behind. Similarly studies by the National Center of Statistics found a disparity in college GPA among different races and ethnicities. Colleges and universities have long been criticized for overreliance on standardized testing, and the SAT in particular, for an admissions decision. Similar to GPA, studies have found a disparity in SAT scores among different races and ethnicities. This is another indicator that academic factors may represent more about an applicant than meets the eye - and that could be problematic.

In the context of private student loans, the CFPB has scrutinized the use of so-called "Cohort Default Rate" (CDR). CDR is a statistic released by the United States Department of Education that measures the federal student loan repayment history of a particular group or "cohort" of borrowers. For each school, the CDR is the percentage of the school's borrowers entering repayment on federal student loans during a particular period who default prior to the end of the period. CDR effectively, measures how likely students from specific schools are to repay loans. The CFPB has stated in a study on private student lending that "[p]rivate student lenders' use of CDR at very low default levels may present fair lending concerns . . . racial and ethnic minority students are disproportionately concentrated in schools with higher CDRs." It is important to note that the CFPB, despite its seeming reservations about the practice, has not restricted the use of CDR in student loan underwriting. However, it is safe to assume that the CFPB will also continue to scrutinize the use of CDR if it becomes more prevalent outside of student lending.

Applying the Equal Credit Opportunity Act

We often hear about disparate impact in the context of various types of lending - e.g., mortgages and (increasingly) auto loans. The theory of disparate impact was recently in the spotlight when a closely divided United States Supreme Court held that the Fair Housing Act (FHA) recognizes a disparate-impact theory. Consumer advocates and government lawyers viewed this decision as a victory, and the Supreme Court's decision may fuel more activity in the area of disparate impact claims. ECOA and its implementing regulation, Regulation B, prohibit the consideration of race, sex, marital status, age, or other prohibited factors in any aspect of a credit transaction. Additional prohibited factors include color, religion, the fact that a consumer receives income from a public assistance program, and the fact that a consumer has in good faith exercised rights under the Consumer Credit Protection Act. See 15 U.S.C. § 1691(a); 12 C.F.R. § 1002.4(a).

ECOA, which applies to all creditors, has two principal theories of liability: 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 treatment is easier to spot than disparate impact, and use of the academic factors discussed in this article are not of the type that would likely amount to disparate treatment.

As discussed above in Section I, correlations between race and measurements educational attainment and success are well documented in a variety of statistical surveys. Accordingly, the use of academic factors in credit decisions could potentially negatively affect applicants of specific races. It follows that the use of academic factors for underwriting purposes would likely lead to a disparate impact challenge, even if such factors are applied in an ostensibly neutral manner. Disparate impact occurs when a creditor employs facially neutral policies or practices that have an adverse effect or impact on a member of a protected class. If such use is shown to meet a legitimate business need that cannot reasonably be achieved by means that are less discriminatory in their impact, use of such factors may be acceptable. The impact of using academic factors in considering an applicant for a loan (of any kind) could raise the eyebrows of regulators and mobilize consumer advocates and government lawyers.

The legal analysis associated with disparate impact has been developed by courts (originally in the employment field) to address factors that, although neutral on their face, unfairly disadvantage applicants on a prohibited basis. Regulation B contains a number of specific rules designed to implement the general prohibition against discrimination on a prohibited basis. See, e.g, 12 C.F.R. § 1002.6(b). Further, the legislative history to the ECOA indicates that Congress intended to apply an "effects" test to its anti-discrimination provisions. Under this effects test, a creditor's actions are subject to a three-part analysis. First, does the challenged practice have a disproportionately negative impact on a protected group? If so, the burden shifts to the creditor for the second step. Second, does the creditor's practice meet a legitimate business need? Creditors must be able to establish a compelling business justification for the practice. If there is no such justification, the practice is unlawful. If a business justification exists, the burden shifts back to the plaintiff for the third step. Third, could the creditor's business need have been met by other means that are less discriminatory in their net effects? If not, then the creditor's challenged practice is legal. In determining which factors to take into account when making a decision on an application, creditors must be well aware of this three-part analysis in order to address a potential claim of disparate impact following a denial of credit.

Creditors frequently use some form of applicant-evaluation system to make or aide in making credit decisions. It is these applicant-evaluation systems, along with the practices and procedures of the creditor, that will be reviewed to determine whether factors taken into account may, or do, raise issues under ECOA. Frequently, creditors will hire an outside attorney to review their applicant-evaluation system, practices and procedures, and issue an opinion on compliance with applicable law and regulations.

It is important for creditors to be aware of the potential impact of their applicant-review and decision practices because it is not difficult for a plaintiff to make a prima facie disparate impact claim against a creditor. Many commonly used underwriting criteria can have a disproportionate adverse impact on a protected group. In fact, many widely-used and accepted credit criteria, including income and credit history, do disfavor a protected group. As discussed earlier, it is very likely that the use of academic factors as underwriting criteria will be found to have a disproportionate adverse impact on a protected group.

Evaluating compliance with Regulation B's specific rules can be more difficult, especially if the evaluation system directly considers certain information about an applicant. This may include consideration of an applicant's age, income, or a spouse's information. Requiring co-applicants or co-signers, and obtaining signatures of non-applicants can also present complicated compliance assessments. Whether this part of the analysis is relatively simple or more complex depends on the details of the creditor's applicant-evaluation system.

The assessment of the second prong of the disparate impact analysis, which relates to business purpose, provides the greatest challenge but may also be where non-traditional considerations (such as academic factors) "fit" into a creditor's applicant-review process, especially where an underwriting system employs factors, including academic considerations, that are not widely used by creditors and understood by regulators and courts.

If the second question is reached, it becomes the creditor's burden to demonstrate it has a compelling business justification for use of the factor. Here, creditors may assert arguments based on the type of information discussed earlier in this article, such as the creditor's desire or attempt to reach the invisible borrower. Generally, this involves demonstrating that the factor has a clear relationship to creditworthiness and that, through its use, the creditor is better able to assess credit risk in its approval and pricing decisions. Using the GPA example, a creditor might show that applicants with GPAs below a certain level are significantly less likely to repay their student loans, perhaps due to their more difficult time finding suitable employment. Once the creditor demonstrates this business justification, however, the factor can still be successfully challenged if the plaintiff shows that the creditor could have met this business need equally well in a way that was less unfavorable to the protected group. If the creditors using or considering the use of academic factors can make a strong case that there is a business justification for using such factors, we may see academic factors used more and more in credit decisions. Alternatively, if creditors are not successful in proving to regulators, government lawyers, or the courts that there is a business justification for use of such factors, we may never see these factors in wide use.


With some companies beginning to test the waters with nontraditional analysis of creditworthiness, this topic is sure to attract heightened attention in the coming years. The need for credit is as high as ever, but the ability to build a credit history is increasingly difficult. It is likely too soon to see a court weigh in on whether the use of nontraditional factors, such as the academic factors discussed here, amounts to unlawful discrimination because of a disparate impact on one or more protected groups. In the meantime, regulators may be paying more attention to this type of activity by creditors. Without a doubt, this is an area to watch in the coming years.

The authors are young lawyers, and as such, we would be remiss if we did not point out something obvious (and, perhaps pessimistic) - at least from where we sit. These academic factors are only as good as the economy. Before the economic downturn and credit crisis of 2008, an applicant who attended and succeeded at a college or university with a well-established record and went on to attend law school would easily have been considered a good credit risk. Sure, young lawyers are all-too-frequently saddled with debt, but lawyers graduate from law school, get jobs, and have high earning potential. Or, so we used to think. The past several years have seen record unemployment among law school graduates and high-paying jobs (that are commensurate with the amount of student debt incurred) are few and far between. This is just one example - one that happens to be near and dear in the legal community - but, modern times have seen economic uncertainty that has turned notions of success and earning potential on its head. This isn't to say that academic factors are not sufficiently predictive, but it is worth a mention and mindfulness in the credit industry.

Latif Zaman is an associate in the Hanover, Maryland office of Hudson Cook, LLP. Latif can be reached at 410-782-2346 or by email at

Katie Hawkins is an associate in the Portland, Maine office of Hudson Cook, LLP. Katie can be reached at 207-210-6836 or by email at

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