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Debt Literacy, Financial Experiences, and Overindebtedness

  • Annamaria Lusardi

    ()

    (Dartmouth College and CeRP-Collegio Carlo Alberto, Turin)

  • Peter Tufano

    ()

    (Harvard Business School)

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 selfassessed 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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Paper provided by Center for Research on Pensions and Welfare Policies, Turin (Italy) in its series CeRP Working Papers with number 83.

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Length: 50 pages
Date of creation: Feb 2009
Date of revision:
Handle: RePEc:crp:wpaper:83
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  1. Annamaria Lusardi & Olivia S. Mitchell, 2008. "Planning and Financial Literacy: How Do Women Fare?," CeRP Working Papers 72, Center for Research on Pensions and Welfare Policies, Turin (Italy).
  2. James J. Choi & David Laibson & Brigitte C. Madrian & Andrew Metrick, 2004. "For Better or for Worse: Default Effects and 401(k) Savings Behavior," NBER Chapters, in: Perspectives on the Economics of Aging, pages 81-126 National Bureau of Economic Research, Inc.
  3. Maarten van Rooij & Annamaria Lusardi & Rob Alessie, 2007. "Financial Literacy and Stock Market Participation," NBER Working Papers 13565, National Bureau of Economic Research, Inc.
  4. Annamaria Lusardi & Olivia S. Mitchell, 2006. "Financial Literacy and Planning: Implications for Retirement Wellbeing," DNB Working Papers 078, Netherlands Central Bank, Research Department.
  5. John Y. Campbell, 2006. "Household Finance," Journal of Finance, American Finance Association, vol. 61(4), pages 1553-1604, 08.
  6. Christelis, Dimitris & Jappelli, Tullio & Padula, Mario, 2008. "Cognitive abilities and portfolio choice," CFS Working Paper Series 2008/35, Center for Financial Studies (CFS).
  7. Haipeng (Allan) Chen & Akshay R. Rao, 2007. "When Two Plus Two Is Not Equal to Four: Errors in Processing Multiple Percentage Changes," Journal of Consumer Research, University of Chicago Press, vol. 34(3), pages 327-340, 06.
  8. James J. Choi & David Laibson & Brigitte C. Madrian, 2004. "Plan Design and 401(k) Savings Outcomes," NBER Working Papers 10486, National Bureau of Economic Research, Inc.
  9. Victor Stango & Jonathan Zinman, 2009. "Exponential Growth Bias and Household Finance," Journal of Finance, American Finance Association, vol. 64(6), pages 2807-2849, December.
  10. repec:use:tkiwps:2323 is not listed on IDEAS
  11. James J. Choi & David Laibson & Brigitte C. Madrian & Andrew Metrick, 2003. "Optimal Defaults," American Economic Review, American Economic Association, vol. 93(2), pages 180-185, May.
  12. Justine S. Hastings & Lydia Tejeda-Ashton, 2008. "Financial Literacy, Information, and Demand Elasticity: Survey and Experimental Evidence from Mexico," NBER Working Papers 14538, National Bureau of Economic Research, Inc.
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