Wednesday, April 24, 2013

The Borrowers

A surprisingly large number of Americans borrow money from "alternative financial services," a term coined by researchers to describe the murky world of payday loans, auto title loans, refund anticipation loans, pawn shops, and rent-to-own stores. In the last five years, a quarter of the population has used at least one of these high-cost methods of borrowing, including 32 percent of 18-to-24-year-olds and an even larger 35 percent of 25-to-34-year-olds. The question is why.

The answer may be because they don't know any better. The root of the problem, according to NBER researchers Annamaria Lusardi and Carlo de Bassa Scheresberg, is a lack of financial literacy. The researchers discovered this by asking a representative sample of the American public to answer three financial literacy questions and then probed the survey respondents' use of the five types of alternative financial services (AFS) listed above. Among those who had not used AFS in the past five years, 45 percent answered the three questions correctly. Among those who had used AFS, only 26 percent answered all three questions correctly. Financial literacy remained a statistically significant determinant of the use of AFS after controlling for all sorts of demographic and economic factors.

"One way in which we may affect AFS use is through promoting financial literacy and financial education," conclude the authors. "This could be particularly important among the young, who are shown to be making heavy use of alternative financial services."

Source: National Bureau of Economic Research, Financial Literacy and High-Cost Borrowing in the United States, NBER Working Paper 18969 ($5)

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