Richard M. Todd - Vice President, Community Development
Published December 1, 2002 | December 2002 issue
Editor's note: Another version of the following article appears in Community Dividend (Issue 2, 2002), a publication of the Minneapolis Fed's Community Affairs Department.
Numerous complaints of so-called predatory lending have been reported in recent years. According to these reports, certain lenders exploit unsophisticated borrowers by inducing them to agree to disadvantageous loan contracts. A disadvantageous contract, in this context, means a loan that is overpriced or overly restrictive after adjusting for risk, in the sense that the borrower could easily do better by shopping around a little or, in extreme cases, by simply doing nothing. The extreme cases include loans seemingly rigged to yield default and foreclosure, so borrowers lose their homes or home equity to the lenders.
By its nature, predatory lending is difficult to track and measure, but growing anecdotal and circumstantial evidence has convinced many observers that it is a serious problem. In 2000, a national task force organized by the U.S. Department of Housing and Urban Development and the U.S. Department of the Treasury collected information about predatory lending from around the country. The task force reported that "there is a growing body of anecdotal evidence that an unscrupulous subset of ... actors ... engage in abusive lending practices."1 Some policymakers have recently modified consumer regulations and laws in an attempt to curb predatory lending, providing further evidence that the problem is perceived as a serious one.
However, regulations and laws intended to curb predatory lending may have undesired consequences. They may impede the operation of legitimate credit markets, making it difficult for financially vulnerable individuals to access credit. Partly for that reason, policymakers are exploring other approaches to reduce predatory lending. Increasing the financial knowledge of borrowers is one appealing approach. If successful, it could make borrowers less susceptible to predatory loan offers and improve the operations of legitimate credit markets. With these hopes in mind, Federal Reserve System governors, the secretary of the Treasury, leading members of Congress and others have endorsed financial literacy training as a promising antidote to predatory lending.
It seems logical that delivering appropriate financial training to vulnerable borrowers will help them ward off predatory lenders. But is there evidence that this approach actually works? Unfortunately, direct evidence on training aimed at preventing predatory lending is hard to find, due in part to the difficulties involved in monitoring predatory lending. So, this article focuses on a more limited question: Does financial literacy training, of any kind, bring about positive behavioral change? Several recent studies examine the effectiveness of certain forms of financial literacy training, and a review of these studies supports cautious optimism about the ability of well-designed educational programs to bring about responsible financial decision making. This optimism, in turn, supports further exploration of financial literacy training as a tool for reducing abusive lending practices.
For decades, financial literacy training has been offered in many different forms and settings to many different audiences. Efforts to measure the effectiveness of this training are typically organized around its subject matter and audience. Accordingly, this review of the research on financial literacy training is organized into three commonly studied categories:
General financial literacy offered to high school students;
Training related to retirement and savings planning, offered by
employers to employees; and
Home buying and homeownership training, offered to mortgage applicants
or to homeowners who are having difficulties making
High school financial literacy training
Basic financial literacy education has been available for decades in many high schools, but only recently has its effectiveness been studied. The recent studies are far from comprehensive, but they suggest both short-term and long-term effects.
Evidence of short-term effects comes from studies of students exposed to the High School Financial Planning Program® (HSFPP) curriculum between September 1997 and January 1998. For the studies, which were conducted by researchers from the University of Minnesota and the University of Wisconsin, over 4,000 students from 188 high schools across the United States returned surveys after completing the HSFPP curriculum. More than 400 of those students completed a follow-up survey three months later, and their teachers were also surveyed.
The studies have some limitations, since their results are based entirely on the students' and teachers' subjective assessments, and no control group was used to benchmark the results. Notwithstanding these limitations, the authors concluded that "teaching personal finance in high schools can positively impact the financial knowledge, behavior, and self-efficacy levels of teens."2 Immediately after completing the HSFPP curriculum, almost half of the students in the study reported increases in their financial knowledge. Of special note, "the area where the most students increased in knowledge was in understanding the cost of credit,"3 which could help reduce their subsequent susceptibility to predatory lenders. In addition, about a third of the students reported changes in behavior, especially in tracking expenses and setting and achieving money-management goals. Teachers generally agreed with their students' self-assessments, indicating a "marked change in knowledge and behavior in students after participating," with "the most changes in the areas of consumer credit, car insurance, time value of money, and tracking expenses."4 And of the subset of students who completed follow-up surveys three months after their training, nearly 40 percent had started saving money, and 31 percent reported that opening a savings account was the most important financial planning activity they engaged in after completing the course.
In many areas, at least half of the surveyed students did not report gains in their financial knowledge or changes in their behavior. Although this may seem discouraging, the authors indicate that it is partly due to the fact that many students had already adopted responsible financial behaviors before their training. In other words, the gains reported for this curriculum in large part reflect a "leveling up" of the knowledge and behavior of individuals who were not already financially savvy. This theme runs through many of the studies summarized here.
Reports that the benefits of financial literacy training persist months later are encouraging. But the benefits need to persist for years or even decades to be effective against predatory lending. At least one study suggests that they do. The study, conducted by researchers B. Douglas Bernheim, Daniel M. Garrett and Dean M. Maki, takes advantage of the fact that, historically, some states have at times mandated financial literacy education in high schools.
The study is based on financial and demographic data collected in 1995 from a national sample of 2,000 individuals between the ages of 30 and 49. Allowing for other factors that affect financial behavior, it found that adults who attended high school when their states mandated financial literacy training generally save more and accumulate more wealth than other adults. Their net worth is higherby an amount equivalent to one year's earningsthan the net worth of adults who attended high school when their states did not mandate financial literacy training. In other words, exposure to state-mandated financial literacy education appears to be associated with more frugal adult financial behavior, even 30 years later.
As with the short-term benefits of high school financial literacy training, the long-term benefits may result from leveling up the knowledge of some individuals. When the researchers measured the effects of mandated training, they made a distinction between "individuals whose parents did and did not save more than average."5 They found that the long-term benefits of financial literacy training are concentrated among individuals who reported that their parents' savings rates were at or below the average. The researchers concluded that "the consistency of this pattern ... provides considerable support to the view that financial education at school is a close substitute for financial education at home."6 In other words, high school financial literacy training appears to be especially effective for individuals who did not learn the basic habits of household saving from their parents.
Workplace financial literacy training
Many firms offer employees financial literacy materials or training, usually with a focus on retirement savings plans. Surveys conducted in the 1990s found that roughly three-fourths of companies provided some financial education in the workplace, in the form of summary plan descriptions, newsletters, one-on-one counseling or participatory workshops. The vast majority of workplace financial training covered topics such as asset allocation and retirement income.7 These surveys also indicate that a key reason why employers provide financial literacy training is to boost their employees' savings plan participation and contribution rates. This may be partly due to the fact that, under many retirement savings plans, contribution limits for highly compensated managers and executives are eased if other employees' participation and contribution rates increase.
Well-designed programs of workplace financial training seem to change
behavior, especially among employees who are not highly compensated.
A number of studies of workplace savings plans generally agree on
the following points:
Providing generic information, especially in written form, is
the least effective method of delivering training and sometimes
appears to have little or no effect.
The more specific the information is to the firm's plan or the
individuals' situations, and the more frequently and personally
it is offered, the more effective it is.
Well-tailored information, especially if it is offered frequently
or in person, can raise overall employee retirement plan participation
and contribution rates at least as effectively as generous employer-matching
With the exception of employer matching and financial education,
retirement plan provisions have relatively isolated and limited
effects on employee behavior.
The effects of workplace financial training are concentrated among nonhighly compensated employees and appear to be reduced or nonexistent for highly compensated employees.
These studies provide consistent evidence that financial literacy training in the workplace can induce more prudent retirement savings behavior, at least among employees whose participation and contribution rates are initially low. However, many of the studies have significant gaps, such as failing to provide information about employees' savings behavior outside the workplaceleaving open the possibility that increased participation merely reflects a shift of existing savings into employers' plans. A few studies attempt to fill these knowledge gaps, and they bolster the view that the positive effects of workplace financial training are real and extend to the employee's household generally. For example, a study that measured all forms of savings found that the median total savings rate for employeesincluding savings outside the workplaceis about 20 percent higher when the employees can obtain financial training at work.9 The study also found that spouses of these employees tend to participate at higher rates in their own employers' plans.10
Home buyer training
According to Roberto G. Quercia of the University of North Carolina and Susan M. Wachter of the University of Pennsylvania, homeownership education and counseling (HEC) programs, which provide information about the financial aspects of buying and keeping a home and are usually directed at low-income individuals, "evolved from the implementation of the 1968 Housing and Urban Development Act."11 The Act authorized "public and private organizations to provide counseling to mortgagors" affected by certain federal programs.12 Subsequent federal legislation, including the Fair Credit Reporting Act of 1970, provided additional impetus by setting standards for granting credit and encouraging consumer education. By 1993, more than 1,000 organizations were receiving homeownership education funding from foundations, federal housing authorities and states.
Federal funding of HEC helped stimulate studies of its effectiveness, beginning with a flurry in the 1970s that has since tapered off. Recent reviews of these studies conclude that almost all are flawed and that, as a result, "it is astounding to consider what little empirical evidence there is to determine how well HEC works."13
Several factors make it difficult to accurately assess whether HEC leads to positive behavior changes by enhancing home buyers' knowledge. In the first place, it is even difficult to define an appropriate measure of success. One indication might be increased home buying rates for low-income clients. But increased home buying alone can be a misleading indicator. If buyers are not prepared for the ongoing financial burdens of homeownership, increased home buying could result in increased mortgage delinquencies and defaults a few years later. So a complete measure needs to consider both home buying rates and subsequent delinquency and default rates, with success indicated by some combination of more home buying and fewer defaults per buyer.14 Many studies consider only one of these two factors.
Even if an appropriate measure of success could be established, studies of HEC's effectiveness often cannot adequately control for certain factors outside the training that affect the results. For example, completion of HEC is often required to obtain some kinds of private or public low-income mortgage financing. Low-income would-be borrowers who are organized and disciplined enough to complete the required HEC training differ, at least by those traits, from low-income buyers who avoid or fail to complete the training. Even if they learn nothing at all in their classes, HEC graduates will tend to be more successful, on average, than low-income would-be borrowers who do not complete the program. So when HEC graduates disproportionately succeed as homeowners, it is difficult to know whether their success is due to the training they received or merely to HEC's ability to "screen in" individuals who are already well suited for homeownership.15
Although assessing the overall educational success of HEC programs is difficult, a recent study of HEC delivery methods reinforces the common-sense view that outcomes improve when financial literacy training is delivered face to face. The study, conducted by Abdighani Hirad and Peter M. Zorn of Freddie Mac, tracked delinquency rates on 40,000 mortgages originated under a program for risky borrowers that requires participants to complete HEC. It found that borrowers who received classroom instruction or one-on-one counseling had significantly lower delinquency rates than borrowers who received training via telephone counseling or self-study.16 Because classroom and one-on-one instruction may require more commitment from borrowers than the alternatives do, the researchers cannot say for sure whether the lower delinquency rates result from better education or simple screening effects. In addition, lower delinquency rates are only a partial measure of home buying success, since they do not indicate the number of people who were turned down in their attempts to purchase homes. Nonetheless, the study is generally consistent with other results supporting the idea that face-to-face training is associated with desirable outcomes.
A review of the research on the effectiveness of financial literacy training shows that training offered by high schools and workplaces is associated with improved financial knowledge and behavior. These associations are especially strong for low-income or less-educated recipients, supporting the idea that financial literacy training has the potential to curb predatory lending.
However, the efficacy of HEC is less clear, due to the difficulties discussed above. Many predatory lending practices involve mortgages, and the lack of solid evidence about the success of HEC casts some doubt on the idea that financial literacy training can be an antidote to those practices.
So, although little is yet known about financial literacy training specifically targeted against predatory lending, the existing evidence on other forms of financial literacy training is partly encouraging and partly discouraging. However, the special factors that raise doubts about the effectiveness of HEC, like screening effects, might be overcome by developing delivery channels that reach across the population of individuals at risk for predatory lending. For this reason, and because of the favorable evidence on other forms of financial literacy training, the overall body of evidence seems generally supportive of the idea that well-designed, appropriately delivered financial literacy training should be considered as a tool to prevent predatory lending.
1 Curbing Predatory Home Mortgage Lending, U.S. Department of Housing and Urban Development-U.S. Department of the Treasury (2000), p. 13.
2 Catherine A. Huddleston-Casas, Sharon M. Danes and Laurie Boyce, "Impact Evaluation of a Financial Literacy Program: Evidence for Needed Educational Policy Changes," Consumer Interests Annual, vol. 45 (1999), p. 113.
3 Sharon M. Danes, Catherine Huddleston-Casas and Laurie Boyce, "Financial Planning Curriculum for Teens: Impact Evaluation," Financial Counseling and Planning, vol. 10, no. 1 (1999), p. 32.
5 B. Douglas Bernheim, Daniel M. Garrett and Dean M. Maki, "Education and Saving: The Long-Term Effects of High School Financial Curriculum Mandates," Journal of Public Economics, vol. 80 (June 2001), p. 460.
7 Patrick J. Bayer, B. Douglas Bernheim and John Karl Scholz, "The Effects of Financial Education in the Workplace: Evidence from a Survey of Employers," Working Paper 5655 of Working Paper Series, National Bureau of Economic Research Inc., July 1996. Similar findings appear in B. Douglas Bernheim, "Financial Illiteracy, Education and Retirement Saving," Living With Defined Contribution Pensions (University of Pennsylvania Press, 1998), p. 62.
8 In employer-matching programs, employers supplement their employees' contributions to a retirement savings plan, up to a specified limit. For example, an employer might contribute an extra 50 cents for each dollar contributed by an employee, up to a fixed percentage of the employee's salary.
9 B. Douglas Bernheim and Daniel M. Garrett, "The Effects of Financial Education in the Workplace: Evidence from a Survey of Households" (August 2001), p. 19.
10 Ibid., p. 18.
11Roberto G. Quercia and Susan M. Wachter, "Homeownership Counseling Performance: How Can It Be Measured?" Housing Policy Debate, vol. 7, issue 1 (Fannie Mae Foundation, 1996), p. 178.
13 George W. McCarthy and Roberto G. Quercia, "Bridging the Gap Between Supply and Demand: The Evolution of the Homeownership, Education and Counseling Industry," Report 00-01 (The Research Institute for Housing America, May 2000), p. 27.
14 Quercia and Wachter, pp. 197-198.
15 Researchers continue to devise statistical procedures to adjust for screening effects and correct other study flaws, but it is still difficult to define and measure the success of HEC programs. (This difficulty need not imply that HEC programs are without merit, for the screening function itself may be valuable. See the McCarthy and Quercia study referenced above for comments on how the screening provided by HEC programs has helped facilitate increased lending to low-income communities.) Screening effects are also a problem in some studies that focus only on recipients of high school or workplace training. However, in these cases, the gap is covered by other studies that focus on whole populations for whom training was available, without differentiating between the individuals who chose to pursue the training and those who did not. Some of these studies also provide evidence that even the availability of training was not correlated with any pre-existing interest in or tendency toward financial prudence. For example, see the Bernheim, Garrett and Maki study of high school training and the Bernheim and Garrett or Bayer, Bernheim and Scholz studies of workplace training discussed above.
16 Abdighani Hirad and Peter M. Zorn, "A Little Knowledge Is a Good Thing: Empirical Evidence of the Effectiveness of Pre-Purchase Homeownership Counseling," Low-Income Homeownership Working Paper Series (Joint Center for Housing Studies of Harvard University, August 2001), p. 14.