What is Redlining?

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Definition:

Redlining is when service providers (primarily mortgage lenders) refuse to offer certain government and financial services to individuals from specific neighborhoods.

🤔 Understanding redlining

Redlining is a practice that was onced used by financial institutions to deny credit and mortgage applications to individuals based on the neighborhood in which the person lived. The lenders wouldn’t consider whether the applicant was actually a good candidate for a loan. Redlining was a practice most often used against neighborhoods where racial and ethnic minorities lived. The term came from the practice in which lenders literally used a red line on a map to point out parts of town where they wouldn’t give mortgages. The 1968 Fair Housing Act passed by Congress banned the practice of redlining.

Example

One of redlining’s negative impacts was reducing the upward mobility of those who lived in the neighborhoods that banks marked with a red line. Suppose you lived in a redlined neighborhood. You’d been planning to upgrade to a nicer home, and had spent years working to save up a down payment. Even if you saved a sizable down payment, earned a high income, and had an excellent credit score, the bank wouldn’t consider your application. Because you lived in a neighborhood the bank decided was not a good fit for its services, you wouldn’t get the loan.

Takeaway

Redlining would be like if a school only educated kids from certain families…

Suppose that a local school decided it would only educate kids whose parents were highly educated and successful. The school isn’t interested in finding out the merits of individual children — It’s simply making assumptions about them based on the family from which they come. Similarly, banks used redlining as a way to make blanket assumptions about people from a particular neighborhood. Rather than looking at the merits of each individual loan candidate, they decided ahead of time that the neighborhood from which the person came meant he or she wasn’t a good candidate.

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What is redlining?

Redlining is a practice that banks and the federal government previously used to deny mortgage loans and other services to people (primarily people of color), living in what they considered to be undesirable neighborhoods. When lenders used this practice, they placed greater importance on a borrower’s current neighborhood than on their credit worthiness.

The term redlining refers to the fact that lenders would physically block off certain neighborhoods in red to point out they wouldn’t lend money to residents of that area. Congress banned the practice of redlining in 1968 with the passage of the Fair Housing Act.

Redlining was a systematic problem that prevented creditworthy minority families from getting out of poor neighborhoods. Suppose you were a family in the mid-1900s that was affected by redlining. You worked hard, had a good job, and saved enough money to make a down payment on a home. You lived in a struggling neighborhood and wanted to give your kids a chance at growing up in a better area with better schools.

You’d head to your local bank for a loan, but the bank would deny your loan simply because of your current neighborhood. And even though the practice of redlining specifically targeted certain neighborhoods, the bank might still approve the loans of white families in the neighborhood applying for loans. The result of the practice was the severe racial segregation and housing inequality that still plagues many big cities today.

What is the purpose of redlining?

The original purpose of redlining was to prevent further financial disaster in the wake of the Great Depression. Federal lenders wanted to create stability in the housing market, so they blocked off certain neighborhoods where borrowers were supposedly more likely to default on their loans.

For the next several decades, redlining became a way for lenders to discriminate against borrowers not only based on their neighborhood but on their race as well. The practice primarily affected minorities. Its use was systematic — It started with one federal organization, and other government agencies and private lenders followed suit.

What is the history of redlining?

The history of redlining in real estate dates back to 1933 with the establishment of the Home Owners Loan Corporation (HOLC). HOLC’s mission was to stabilize the housing market following the Great Depression, and in the following few years, it refinanced 10% of mortgages in the country.

To avoid any further financial disaster, HOLC took efforts to reduce risk and avoid giving mortgages to high-risk borrowers. One step it took to accomplish this was looking at individual neighborhoods and categorizing each one as either best, still desirable, definitely declining, or hazardous.

HOLC would then draw a red line around the neighborhoods it believed to be hazardous, passing those maps along to private lenders and to other government organizations such as the Federal Housing Administration (FHA).

For the next several decades, lenders across the country systematically denied loans to individuals in these primarily black and Latino neighborhoods. As a result, families living in hazardous neighborhoods were unable to get home loans, even government-backed mortgages such as FHA loans. These are mortgages for low and moderate income individuals through private banks and insured by the FHA. Unlike in other neighborhoods, the lenders wouldn’t consider the creditworthiness of these individuals, simply because of where they lived.

It wasn’t only mortgage lenders that used the practice of redlining. Others such as homeowners insurance companies followed suit, often refusing to sell policies to racial minorities and those in redlined neighborhoods. As a result, these individuals were unable to rebuild in cases where something happened to their home.

When was redlining outlawed?

The 1960s saw the rise of the Civil Rights Movement and riots across the country in heavily segregated cities. To address the riots, President Lyndon B. Johnson created the Kerner Commission, which had the job of going to these cities and digging into the root cause. One of the findings of the Commission was that local mortgage lending practices were increasing segregation and preventing minority families from moving out of poor neighborhoods.

In 1968, the federal government responded by passing the Fair Housing Act, which prohibited lenders from discriminating against homebuyers based on race, color, religion, national origin, sex, handicap, or familial status. Courts have ruled that despite the broad language, the Fair Housing Act prohibits the practice of redlining.

Even after the passage of the Fair Housing Act, racial housing discrimination in lending still took place in a less overt way. Banks were no longer hanging maps with red lines drawn around certain neighborhoods. But people in those neighborhoods were still often unable to get loans, even with the necessary credit history and income.

In 1977, Congress passed the Community Reinvestment Act (CRA), which built on the principles of the Fair Housing Act. The CRA encouraged banks to take greater steps to cater to low and moderate-income neighborhoods. It required the Federal Reserve to evaluate and rate the performance of banks to make sure lenders followed the new guidelines. A bank’s performance under the CRA was also a deciding factor in whether it’d be eligible for mergers, acquisitions, and more branch openings.

Is redlining still happening today in the United States?

Congress banned the practice of redlining in the Fair Housing Act of 1968, but some people claim it's still a problem. Though banks no longer have maps on the walls indicating redlined neighborhoods, that doesn’t mean discriminatory practices aren’t still taking place.

For example, a 2018 lawsuit against one bank in Connecticut accused the bank of denying loans in communities made up primarily of people of color. The parties settled the lawsuit the following year, with the bank promising to review its practices and make sure to be more inclusive in its lending services.

Even more prevalent than redlining, experts from the National Consumer Law Center argue that reverse redlining actually takes place in those neighborhoods today. Reverse redlining is when, rather than refusing to offer loans to individuals in those neighborhoods, banks practice predatory lending instead. In other words, they offer loans to people they know might not be able to afford them. This practice was one of the factors that contributed to the 2008 housing crash.

What are the impacts of redlining?

Regardless of whether redlining is still taking place, data shows that its effects from the past still greatly impact the same neighborhoods today. When looking at the parts of American cities that have a history of redlining, experts found that those areas have more segregation and lower property values than other parts of the city.

Since access to credit is an important factor in upward mobility and homeownership, it’s also likely that the individuals and families who experienced redlining have also experienced less growth than people in other neighborhoods. And in fact, those previously redlined neighborhoods still have lower household incomes than their counterparts in non-redlined neighborhoods.

Some previously redlined communities, however, have also gone through gentrification because of the extremely low property values. Gentrification occurs when more affluent individuals move into a poor community and rebuild the homes and businesses. This practice drastically increases the property values in the neighborhood, which forces its original inhabitants out because they can no longer afford it.

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This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Robinhood Financial LLC (member SIPC), is a registered broker dealer. Robinhood Securities, LLC (member SIPC), provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading. All are subsidiaries of Robinhood Markets, Inc. (‘Robinhood’).

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© 2022 Robinhood. All rights reserved.