Debt literacy, financial experiences, and overindebtedness

TLDR

Debt literacy is a component of broader financial understanding that measures knowledge about debt and self‑assessed financial knowledge. The study analyzes a national sample of Americans to assess debt literacy, financial experiences, and judgments about indebtedness, and estimates the national impact of debt ignorance on credit‑card costs. Participants reported experiences with traditional and alternative borrowing, investing, and self‑reported overindebtedness, which the authors used to estimate the national cost implications of debt ignorance. Debt literacy is low, with only about one‑third grasping basic interest compounding, and lower literacy is associated with higher debt loads, high‑cost borrowing, and difficulty judging indebtedness.

Abstract

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 a component of broader financial understanding that measures knowledge about debt and self-assessed financial knowledge. Financial experiences are the participants’ reported experiences with traditional borrowing, alternative borrowing, and investing. Overindebtedness is a self-reported measure. Debt literacy is low, with only about one-third of the population grasping the basics of interest compounding. Even after controlling for demographics, we find a relationship between debt literacy and both financial experiences and debt loads. Individuals with lower levels of debt literacy tend to transact in high-cost manners, incurring higher fees and using high-cost borrowing. We provide a rough estimate of the national implications of debt ignorance on credit card costs by consumers. Less knowledgeable individuals also report that their debt loads are excessive or that they are unable to judge their debt position.