Financial Literacy and Mortgage Equity Withdrawals

Abstract

The recent U.S. consumption boom and the subsequent surge in mortgage defaults have been linked to mortgage equity withdrawals (MEWs). MEWs are correlated with covariates consistent with a permanent income framework augmented for credit-constraints. Nevertheless, many households are financially illiterate. We assess the unexplored linkages between "active MEW" and measures of financial literacy using panel data from the Health and Retirement Study (HRS). Findings indicate that declines in mortgage interest rates encouraged MEWs. Nevertheless, financially illiterate households were significantly more likely to withdraw housing equity via traditional first or second mortgages (including cash-out mortgage refinancings but not home equity loans). We find that the financially less savvy are 3-5 percentage points more likely to engage in this type of MEW relative to those who answered financial literacy questions correctly. Also significant were state differences in debtor versus creditor interests in bankruptcy, with loan demand effects outweighing loan supply effects across states.

Debt Literacy and Debt Literacy Self‐Assessment: The Case of Poland

“…The usage of simple questions pertaining key parameters of debt-such as interest and commission-can also be justified by findings of foreign researchers. For instance, Bucks and Pence (2008) as well as Duca and Kumar (2014) found that many borrowers have serious problems with understanding and providing information on basic characteristics of their loans, such as the interest rate.…”

The relationship between financial disputes and financial literacy

“…Schicks (2014) analyzes the overindebtedness of micro borrowers in Ghana and maintain that overindebtedness is lower for borrowers with a good debt literacy. Another case is found with mortgage equity withdrawals 6 (Duca and Kumar, 2014); people with a higher financial literacy are less likely to withdraw housing equity. Agarwal et al (2015c) use a dataset from one of the leading subprime lenders in the United States and find that borrowers from the financial industry, who have a higher financial literacy, are less likely to default.…”

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