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Opinion

Clarity in Personal Finance

July 8, 2015
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4min read

Knowledge is a powerful weapon, especially when it comes to financial products. Consumers generally know much less than the companies servicing them, and providers use this information asymmetry to their advantage. Lenders, for instance, possess a much deeper understanding of their products than the average borrower, and more than one predatory lender has taken advantage of this. Similarly, insurance companies exploit the wildly complex nature of insurance markets to peddle misinformation about what their products should cost.

The sad truth is that many people don’t have access to the facts they need to make informed financial decisions. When providers do a poor job – or no job at all – educating them, the consequences can be crippling.

The New York Times’ Ron Lieber elucidates this point nicely in a column on student loan debt. The problem is simple but pervasive: most borrowers don’t know what they’re getting into. Though students with federal loans are required to take counseling sessions, these tend to be uselessly obscure, written with the assumption of much more background knowledge than any high school student has.

Lieber cites one Department of Education-supplied module loaded with lines like, “Graduation before exceeding your maximum eligibility period protects Direct Subsidized Loans received from interest subsidy loss.” Others contained calculators that required students to enter the sum they intend to borrow, the interest rates, and how much they expect to earn after graduation. Students generally had no idea how to proceed.

The result of shoddy counseling is all too often debt. Lieber notes a 2014 study examining students’ financial literacy at the University of Iowa. It offers some disheartening figures:

One eighth of students in the current study reported no student debt when, in fact, they had a loan. Over a quarter of the students underestimated the amount they owed by less than $10,000, and nearly one tenth of students underestimated the amount that they owed by more than $10,000.

Student loans generally represent a person’s first interaction with complex financial products. When we fail to prepare consumers as students, we set them up for a lifetime of difficulty. This is especially true for the poor, who are perhaps at the greatest risk of – and require the greatest protection from – predatory lending.

The Center for Public Integrity and the Seattle Times released a grim investigation of predatory lending by a “mobile-home empire.” It’s a lengthy, compelling story; the lede alone speaks to the scale of the problem:

After years of living in a 1963 travel trailer, Kirk and Patricia Ackley found a permanent house with enough space to host grandkids and care for her aging father suffering from dementia.
So, as the pilot cars prepared to guide the factory-built home up from Oregon in May 2006, the Ackleys were elated to finalize paperwork waiting for them at their loan broker’s kitchen table.
But the closing documents he set before them held a surprise: The promised 7 percent interest rate was now 12.5 percent, with monthly payments of $1,100, up from $700.
The terms were too extreme for the Ackleys. But they’d already spent $11,000, at the dealer’s urging, for a concrete foundation to accommodate this specific home. They could look for other financing but desperately needed a space to care for her father.
Kirk’s construction job and Patricia’s Wal-Mart job together weren’t enough to afford the new monthly payment. But, they said, the broker was willing to inflate their income in order to qualify them for the loan.
“You just need to remember,” they recalled him saying, “you can refinance as soon as you can.”
To their regret, the Ackleys signed.
The disastrous deal ruined their finances and nearly their marriage. But until informed recently by a reporter, they didn’t realize that the homebuilder (Golden West), the dealer (Oakwood Homes) and the lender (21st Mortgage) were all part of a single company: Clayton Homes, the nation’s biggest homebuilder, which is controlled by its second-richest man — Warren Buffett.

As the Times points out in an editorial released in April 2015, the Dodd-Frank Act requires that “lenders provide borrowers of complex, high-cost loans with written disclosure of the loan rate and maximum monthly payment as well as the consequences of default.” It further requires lenders to supply mortgage applicants with a list of financial counseling groups. These rules are designed to prevent predatory tactics by companies like Clayton Holmes, which is now under scrutiny.

The rules themselves are under scrutiny too. The Times notes with great dismay that the House of Representatives recently passed two bills that would “effectively exempt loans for manufactured homes from the new anti-predation rules.” Similar measures are currently working their way through the Senate – their sponsors argue that Dodd-Frank imposes “‘regulatory burdens’ that unduly restrict credit.” In fact, the new measures unduly target low-income homeowners Dodd-Frank is meant to protect.

It seems like a no-brainer: lenders should be required to inform their borrowers. Consumers should be protected from deceptive practices. Though we understand why a large company might see value in obfuscating its customers, we believe – we know there is magnitudes more value in educating them.

We are lucky to live in a digital age that makes education easy and accessible. Forget college: if you want a crash course in trigonometry, head over to Khan Academy; if you’re looking to invest in mutual funds, Investopedia has got you covered.Codecademy will teach you how to code, and Coursera opens university seminars to the rest of us. It’s a great time to be alive, and an even better time to be bored on the internet.

But not everyone has access to these resources, and the ones who don’t are often the ones who need them most. When they are targeted by bad actors, everyone suffers. This is precisely why financial providers should be required to educate their customers. The free market depends on it.

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