Financial education and its limits
Many borrowers understand very little about their mortgages. That was the predictable but dismaying finding of a study published last fall by the Federal Trade Commission. The results were recapped in a recent article at Forbes.com:
Of those surveyed, 25% could not identify the annual percentage rate of their mortgage, and 25% could not identify the amount of settlement charges. Half could not correctly identify the amount of the loan. Two-thirds were unaware of prepayment penalties that could be charged during refinancing. Three-quarters did not recognize that the loans included charges for optional credit insurance.
That's not good. And it has occurred to some people that better-educated borrowers might be less likely to take loans they can't afford. Therefore the Senate held a hearing last week, entitled: "The More You Know, the Better Buyer You Become: Financial Literacy for Today's Homebuyers." You can read some of the testimony. It basically expands and elaborates on the hearing title.
I don't doubt this is true. One of the great mysteries of American life is why so few public high schools provide any kind of financial education. Sex education, driver's education, but no how-to-balance-a-checkbook education. Go figure.
But it's also important to understand the limits of education. Mortgages are by their nature highly complex financial instruments. Mortgage sellers are full-time experts. Borrowers only borrow once every so often. So there's an inherent imbalance.
Even harder to overcome is that many borrowers simply aren't susceptible to education.
I remember a speech by a senior federal banking regulator in the spring of 2006. It already was clear that many borrowers were taking inappropriate risks. It was widely agreed that borrowers often didn't understand those risks -- that they were taking adjustable rate loans, for example, without a clear understanding that their payments would increase. Julie Williams, chief counsel to the comptroller of the currency, told a Charlotte audience that the answer was improved disclosures.
Specifically, Williams said new mortgage disclosures should be modeled on nutritional labeling, the federally required information on the side of every package of food. Williams described those labels as the great success of federal disclosure regulations, a worthy model for the way information should be disclosed to borrowers.
And I remember sitting in the audience and thinking, My God. We live in the fattest nation on Earth, and Julie Williams thinks nutritional disclosures are a success story.
The bottom line to my mind is this: You can sit in the school that says people should be allowed to get fat and suffer the consequences. You can sit in the school that says the government should prevent people from getting fat so they don't suffer the consequences. But I don't believe in the existence of the school where everyone can go and learn to stay skinny.
How about you?
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When banks told people they couldn't afford the houses they wanted, people complained. Then when banks stopped telling people they couldn't afford the houses, people complained that they should have told them. The fact is that there is a segment of the population that believes they deserve to live the life they see on MTV Cribs but are not willing to work for it. You are never going to educate these people on a subject that they do not want to understand.
It's not a bad metaphor, really. Most people do have someone, at some time, warn them of eating too much, not exercising, and also spending more than they have. Money and food can be handle rationally, and not become a negative issue in people's lives. But both of those things have a tendency to be highly emotional for a lot of people, and the bad emotional habits override logic, even after education.
A friend of mine recently told me about a debate he had with someone over which was more important in school -- phys ed or financial education. His opponent went with phys ed due to the obesity epidemic. Personally, I think that's a little nuts because I haven't noticed phys ed making people thin, and that is taught every year. I think even just one class on finance could at least help some people!
what are lmts?
[Ed. Note: Thanks for the correction. Apparently I could use some other kinds of education, too.]
Sorry-I couldn't help myself since it was a headline! I love your columns and here's what I think about financial education.
A) The consumer cannot be financially educated, particularly when it comes to the nation's mortgage system, because today's system is a patchwork of financial engineering, immune to explanation. It's incoherent, inefficient and overly complex. The solution is to simply require every single lending institution, of every stripe and color, to hold what they book. No more bundling off portfolios to third parties. Tighten the rules for every financial institution and make them the same. Then lending institutions will only book what they know to be a good asset. Mortgage brokers would be a thing of the past. And if the institution makes a mistake, it will be forced to fix it with the borrower. And the borrower will know at all times who owns the loan.
B) There is an inherent bias in the system, being capitalistic, against real education. The system doesn't really want consumers to be skinny or financially smart. Drug companies, hospitals, health care providers don't make any money if people don't get sick, and being fat is a great way to increase your odds of all sorts of conditions that require medication. If it wasn't so, the so-called obesity epidemic would have been stemmed and reversed by now through an avalanche of education, prevention and outreach dollars. That hasn't happened. Why? Because they make much more money letting everyone get fat!. Likewise, I have yet to see any statistics on the fees and interest earned by financial institutions in the run-up to today's problems., vs. principal lost due to shoddy lending practices. My bet is that far more money was earned than lost. That's why there hasn't been any new regulation of the industry. I don't think there is an easy answer to inherent systemic bias other than living by "Buyer Beware" standards at all times. That covers everything we buy, rent, consume, put in or on our bodies, surround ourselves with, support or associate with. And the first thing to being wary, is being aware. Another word for that is self-education. It's every man for himself.
It doesn't matter how available the information is, there are too many people who choose to remain ignorant and make excuses.
People still eat at McDonalds and they still get fat. People still smoke even though they know the risks. People will always make bad choices because we live in a country where those who make good choices have to compensate those who make bad choices.
I don't doubt your (and the authors') main thrust, that people are financially illiterate. One thing though, many people may not know the interest rate on their loans (especially if they are ARMs) but many of them may know their monthly mortgage loan payment, since they write the check out, every month.
People borrow these days based on payment, not on loan amount or salary considerations. At least that's been my experience.
Thanks to all for the thoughts. It is one of my favorite things about blogging that the combination of a post and its responses often forms a more complete and interesting piece than anything I can write on my own.
John, I agree that people buy homes based on the payment. The problem is that they often don't appreciate that the monthly payment may increase, not just if the rate is adjustable, but because of taxes, etc. Nor, in my experience, do many payment-based buyers understand the additional costs of ownership.
This blogger might want to review your comment before posting it.
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