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Debt Literacy, Financial Experiences, and Overindebtedness

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  • Annamaria Lusardi
  • Peter Tufano
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    Abstract

    We analyze a national sample of Americans with respect to their debt literacy, financial experiences, and their judgments about the extent of their indebtedness. Debt literacy is measured by questions testing knowledge of fundamental concepts related to debt and by self-assessed financial knowledge. Financial experiences are the participants' reported experiences with traditional borrowing, alternative borrowing, and investing activities. Overindebtedness is a self-reported measure. Overall, we find that debt literacy is low: only about one-third of the population seems to comprehend interest compounding or the workings of credit cards. Even after controlling for demographics, we find a strong relationship between debt literacy and both financial experiences and debt loads. Specifically, individuals with lower levels of debt literacy tend to transact in high-cost manners, incurring higher fees and using high-cost borrowing. In applying our results to credit cards, we estimate that as much as one-third of the charges and fees paid by less knowledgeable individuals can be attributed to ignorance. The less knowledgeable also report that their debt loads are excessive or that they are unable to judge their debt position.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14808.

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    Date of creation: Mar 2009
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    Handle: RePEc:nbr:nberwo:14808

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    1. James J. Choi & David Laibson & Brigitte C. Madrian & Andrew Metrick, 2002. "For Better or For Worse: Default Effects and 401(k) Savings Behavior," JCPR Working Papers, Northwestern University/University of Chicago Joint Center for Poverty Research 256, Northwestern University/University of Chicago Joint Center for Poverty Research.
    2. Maarten van Rooij & Annamaria Lusardi & Rob Alessie, 2007. "Financial Literacy and Stock Market Participation," CeRP Working Papers, Center for Research on Pensions and Welfare Policies, Turin (Italy) 66, Center for Research on Pensions and Welfare Policies, Turin (Italy).
    3. Lusardi, Annamaria & Mitchell, Olivia S., 2008. "Planning and financial literacy: How do women fare?," CFS Working Paper Series, Center for Financial Studies (CFS) 2008/03, Center for Financial Studies (CFS).
    4. Victor Stango & Jonathan Zinman, 2009. "Exponential Growth Bias and Household Finance," Journal of Finance, American Finance Association, American Finance Association, vol. 64(6), pages 2807-2849, December.
    5. Annamaria Lusardi & Olivia S. Mitchell, 2011. "Financial Literacy and Planning: Implications for Retirement Wellbeing," NBER Working Papers, National Bureau of Economic Research, Inc 17078, National Bureau of Economic Research, Inc.
    6. Dimitris Christelis & Tullio Jappelli & Mario Padula, 2008. "Cognitive Abilities and Portfolio Choice," Working Papers, Department of Economics, University of Venice "Ca' Foscari" 2008_19, Department of Economics, University of Venice "Ca' Foscari".
    7. Choi, James J. & Laibson, David & Madrian, Brigitte C., 2004. "Plan Design and 401(k) Savings Outcomes," National Tax Journal, National Tax Association, National Tax Association, vol. 57(2), pages 275-98, June.
    8. Campbell, John, 2006. "Household Finance," Scholarly Articles, Harvard University Department of Economics 3157877, Harvard University Department of Economics.
    9. Justine S. Hastings & Lydia Tejeda-Ashton, 2008. "Financial Literacy, Information, and Demand Elasticity: Survey and Experimental Evidence from Mexico," NBER Working Papers, National Bureau of Economic Research, Inc 14538, National Bureau of Economic Research, Inc.
    10. James J. Choi & David Laibson & Brigitte C. Madrian & Andrew Metrick, 2003. "Optimal Defaults," American Economic Review, American Economic Association, American Economic Association, vol. 93(2), pages 180-185, May.
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