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Financial literacy and subprime mortgage delinquency: evidence from a survey matched to administrative data

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  • Kristopher Gerardi
  • Lorenz Goette
  • Stephan Meier

Abstract

The exact cause of the massive defaults and foreclosures in the U.S. subprime mortgage market is still unclear. This paper investigates whether a particular aspect of borrowers' financial literacy—their numerical ability—may have played a role. We measure several aspects of financial literacy and cognitive ability in a survey of subprime mortgage borrowers who took out mortgages in 2006 or 2007 and match these measures to objective data on mortgage characteristics and repayment performance. We find a large and statistically significant negative correlation between numerical ability and various measures of delinquency and default. Foreclosure starts are approximately two-thirds lower in the group with the highest measured level of numerical ability compared with the group with the lowest measured level. The result is robust to controlling for a broad set of sociodemographic variables and not driven by other aspects of cognitive ability or the characteristics of the mortgage contracts. Our results raise the possibility that limitations in certain aspects of financial literacy played an important role in the subprime mortgage crisis.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2010-10.

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Date of creation: 2010
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Handle: RePEc:fip:fedawp:2010-10

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References

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  1. Annamaria Lusardi & Olivia S. Mitchell, 2009. "How Ordinary Consumers Make Complex Economic Decisions: Financial Literacy and Retirement Readiness," CeRP Working Papers 90, Center for Research on Pensions and Welfare Policies, Turin (Italy).
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Citations

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Cited by:
  1. van Rooij, Maarten C.J. & Lusardi, Annamaria & Alessie, Rob J.M., 2011. "Financial literacy and retirement planning in the Netherlands," Journal of Economic Psychology, Elsevier, vol. 32(4), pages 593-608, August.
  2. Jason Allen & Robert Clark & Jean-François Houde, 2012. "Price Competition and Concentration in Search and Negotiation Markets: Evidence from Mortgage Lending," Working Papers 12-4, Bank of Canada.
  3. Steffen Huck & Tobias Schmidt & Georg Weizsäcker, 2014. "The Standard Portfolio Choice Problem in Germany," SOEPpapers on Multidisciplinary Panel Data Research 650, DIW Berlin, The German Socio-Economic Panel (SOEP).
  4. Klapper, Leora & Lusardi, Annamaria & Panos, Georgios A., 2013. "Financial literacy and its consequences: Evidence from Russia during the financial crisis," Journal of Banking & Finance, Elsevier, vol. 37(10), pages 3904-3923.
  5. Meier, Stephan & Sprenger, Charles D., 2013. "Discounting financial literacy: Time preferences and participation in financial education programs," Journal of Economic Behavior & Organization, Elsevier, vol. 95(C), pages 159-174.
  6. Leora F. Klapper & Annamaria Lusardi & Georgios A. Panos, 2012. "Financial Literacy and the Financial Crisis," NBER Working Papers 17930, National Bureau of Economic Research, Inc.
  7. Elsa Fornero & Chiara Monticone & Serena Trucchi, 2011. "The effect of financial literacy on mortgage choices," CeRP Working Papers 121, Center for Research on Pensions and Welfare Policies, Turin (Italy).
  8. Alan L. Gustman & Thomas L. Steinmeier & Nahid Tabatabai, 2010. "Financial Knowledge and Financial Literacy at the Household Level," NBER Working Papers 16500, National Bureau of Economic Research, Inc.
  9. Jason Allen & Robert Clark & Jean-François Houde, 2013. "The Effect of Mergers in Search Market: Evidence from the Canadian Mortgage Industry," NBER Working Papers 19126, National Bureau of Economic Research, Inc.
  10. Benjamin Levinger & Marques Benton & Stephan Meier, 2011. "The Cost of Not Knowing the Score: Self-Estimated Credit Scores and Financial Outcomes," Journal of Family and Economic Issues, Springer, vol. 32(4), pages 566-585, December.
  11. Annamaria Lusardi & Olivia S. Mitchell, 2013. "The Economic Importance of Financial Literacy: Theory and Evidence," NBER Working Papers 18952, National Bureau of Economic Research, Inc.
  12. Jappelli, Tullio & Padula, Mario, 2013. "Investment in financial literacy and saving decisions," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2779-2792.
  13. Miller, Margaret & Reichelstein, Julia & Salas, Christian & Zia, Bilal, 2014. "Can you help someone become financially capable ? a meta-analysis of the literature," Policy Research Working Paper Series 6745, The World Bank.
  14. Annamaria Lusardi, 2012. "Numeracy, financial literacy, and financial decision-making," NBER Working Papers 17821, National Bureau of Economic Research, Inc.

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