Financial Literacy Tests for Borrowers

It is a fair assessment that a high majority of those people who fall into debt with loans and credit cards simply do not understand the nature of the product they are dealing with. Reading the terms and conditions before signing to say they understand and agree to them is a mockery as most fail to bother to read them with a simple shrug of ‘who does?’ The fact is that many consumers are practically illiterate when it comes to dealing with finance documents and thus cry wolf when they are stung by charges, fees, and interest rates.

Many who are pulling themselves out of credit card debt intend to keep away from them in future. People ask for legislation for pay day lenders to be closed down as usurious, when in fact their terms and conditions are clear and transparent but simply misunderstood by a large percentage of borrowers.

In the UK a review is taking place which is spearheaded by the minister of consumer affairs and will consider amongst other things if a financial literacy test should be introduced for borrowers when they apply for loan products.

The review is prompted by a survey from the UK Learning and Skills Council which showed that nine out of ten consumers failed at basic financial calculations and had no understanding of the terms of the loan products they had. The Consumer Financial Education Body also released statistics to show that 74% of those with mortgages did not understand how a basic interest rate rise of 1% would affect their mortgage payments. This is really very basic stuff yet not many are motivated enough to bother understanding the nature of the financial products they sign up for, being primarily concerned with if a loan or mortgage offer is forthcoming rather than actually acquainting themselves with the product.

It has been suggested in the UK that testing should be introduced to cover all types of loans from mortgages, bank loans and online personal loans. It has not been stated if the testing would apply to other financial products such as credit cards. Testing, if introduced, would be done after an applicant submitted a loan request and before the loan was approved. Test questions would cover such basics as the length of term of the loan and the rate of interest on the loan.

One alternative suggestion posed is that the borrower simply declares that they have read the terms and conditions of the loan, but this falls way short of being anything more than the standard box already provided which the borrower ticks to indicate they have indeed read the terms and conditions when they haven’t.

Without doubt financial ignorance has cost many people dearly when they have taken on loan products they have no knowledge of. Consumers are constantly surprised by such things as a loss of an introductory interest rate simply by failing to read the small print which states when this will happen or when penalty rates will be imposed. Others have been left shell shocked when they finally understand that a loan they co-signed for is their actual responsibility.

Financial literacy testing for borrowers is an excellent idea, though condescending in its nature to those who are more than capable of dealing with their financial affairs. However if more people were made to understand the fine print of the products they sign up to then it could well result in less default, which ultimately would reduce the cost of borrowing for everyone and less avoidable debt on the part of many consumers.