Tag Archives: young

Couples Leave Money on Closing Table

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photo by Dustin Moore

Geng Li, Weifeng Wu and Vincent Yao, three Fed economists, have posted a research note, Do People Leave Money on the Table? Evidence from Joint Mortgage Applications and the Minimum FICO Rule. The authors state that there “is mounting evidence that households make suboptimal savings and investment decisions” and find that

many mortgage borrowers appear to have failed to apply for mortgages that give the lowest interest rates. Specifically, we find that nearly 10 percent of prime borrowers who applied for their loans jointly could have lowered their mortgage interest rate at least one eighth of 1 percentage point if the mortgage was applied for by the applicant with a higher credit score and an income high enough to qualify for the mortgage. Furthermore, among the joint applicants with a lower credit score below 740, for whom mortgage interest rates are most sensitive to credit scores, more than 25 percent could have significantly reduced their borrowing cost by having the individual with a higher credit score apply. This is due to the fact that when lenders price mortgages with joint applications, the interest rates are determined by the lower score of the two–often known as the minimum FICO rule. We estimate that such borrowers could reduce their annual interest payment by between $220 and $1,400. Consistent with the existing literature, we find that couples who appeared to have left money on the table tend to have lower credit scores and be much younger and less financially sophisticated. (1, emphasis added)

This note provides an example of just how complicated the mortgage underwriting process is, particularly for less financially sophisticated borrowers.

One wonders if the CFPB should take a look at this. Should lenders be required to evaluate if joint mortgage applicants would get a better rate if only one of them ended up taking out the mortgage? And when the answer is yes, should lenders be required to share that information with the applicants? I can think of a variety of reasons why that should not be the case (not the least of which is that it could leave just one member of the family holding the bag if things go south), but it might be worth exploring this question more systematically.

Wednesday’s Academic Roundup

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Who Knows The ABCs of Finance?

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Annamaria Lusardi recently posted a working paper, Financial Literacy: Do People Know the ABCs of FInance? to SSRN. The abstract reads,

Increasingly, individuals are in charge of their own financial security and are confronted with ever more complex financial instruments. However, there is evidence that many individuals are not well-equipped to make sound saving decisions. This paper looks at financial literacy, which is defined as the ability to process economic information and make informed decisions about financial planning, wealth accumulation, debt, and pensions. Failure to plan for retirement, lack of participation in the stock market, and poor borrowing behavior can all be linked to ignorance of basic financial concepts. Financial literacy impacts financial decision-making, with implications that apply to individuals, communities, countries, and society as a whole. Given the lack of financial literacy among the population, it may be important to remedy it by adding financial literacy to the school curriculum.

As I have stated previously, not only is financial literacy in bad shape, but efforts to improve it have not proven to be very effective. Lusardi’s paper has some sobering findings:

most individuals in the United States and in other countries cannot
perform simple calculations and do not understand basic financial concepts such as interest compounding, the difference between nominal and real values, and risk diversification. Knowledge of more complex concepts, such as the difference between bonds and stocks, the workings of mutual funds, and basic asset pricing, is even scarcer. Financial illiteracy is widespread among the general population and particularly acute among specific demographic groups, such as women, the young and the old, and those with low educational attainment. (3)

Because evidence does not demonstrate that additional financial education is all that effective, I take a different lesson from Lusardi’s review of survey results. The government should take an active role in regulating financial markets to protect consumers from abusive behavior and to encourage them to make good financial decisions. Financial education is no replacement for consumer protection.