It turns out a correlation exists between borrowers’ math skills and chances of defaulting on their mortgage. Columbia University professor Stephan Meier published a paper this spring detailing the ties between numeric literacy and mortgage defaults and found those with lower math skills were more likely to default on their mortgages.
In the wake of the U.S. mortgage meltdown, it’s interesting to see how the shortcomings of our education system, as well as the risky behaviors of some financial entities, contributed to the financial crisis.
Testing Numeric Literacy
The study surveyed about 340 borrowers in the Northeast who took out subprime loans. The five questions tested basic mathematic skills such as division, multiplication, addition and subtraction. Here are two sample questions:
• “In a sale, a shop is selling all items at half price. Before the sale, a sofa costs $300. How much will it cost in the sale?”
• “If the chance of getting a disease is 10%, how many people, how many people would be expected to get the disease?”
Those aren’t necessarily tough questions, but 16% of respondents answered one of the two above questions incorrectly. Overall, 21% of the respondents who ended up in the bottom quarter of the results went through foreclosure, compared to the 7% of top-quarter respondents who defaulted.
“This suggests that limited numerical ability might lead to other mistakes over the course of time, like too much spending, too little savings, or inappropriate reaction to income and/or consumption shocks,” the study said.
Many Variables to Consider
The Columbia study discounted the idea that low math skills were one of the primary reasons for excessive mortgage defaults, citing the sheer number of outside factors that came into play during the collapse of the mortgage industry.
The report did conclude, however, that improved financial literacy could help defend against future financial crises.
“Our results suggest as a policy implementation that more intensive financial education could substantially improve financial decisions later in life, and, in fact, have a profound impact on financial markets.”
To read Meier’s full paper, click here (PDF).