Americans who have trouble dividing 300 by 2 are much more likely to end up in foreclosure than consumers with average math skills, a new study has found. The research is among the first to directly link mortgage trouble and financial literacy, according to its authors.
The study also found that math skills were a better predictor of foreclosure than type of mortgage, a result that takes blame away from so-called "risky" mortgages, such-as interest-only loans or adjustable rate mortgages.
"There are two big takeaways. First, that numerical ability heavily correlates to mortgage default, even controlling for a lot of other things,” said Stephan Meier, one of the report’s authors. He is a behavioral economics expert and professor at Columbia Business School. “Second, defaults were not driven by the mortgage choices people make. Their mistakes come somewhere else."
The results, “Numerical Ability Predicts Mortgage Default,” were published Monday in the Proceedings of the National Academy of Sciences.
Meier and co-authors Kris Gerari and Lorenz Goette examined actual mortgage payment streams obtained from the Federal Reserve, and then contacted mortgage holders to assess their math skills. Each was asked a series of five questions (see them below) and then assigned into four "buckets." Four of those questions test the ability to perform simple division or calculate percentages, like this: "A shop is selling all items at half price. Before the sale, a sofa costs $300.How much will it cost in the sale?"
Roughly 1 in 7 test-takers couldn't answer even two such questions correctly, and landed in the lowest bucket. That group was four times more likely to be in foreclosure than consumers who landed in the top bucket by answering all five questions correctly.
The fifth question tested ability to compute compound interest. Only 1 in 8 test-takers scored in this highest group, and of those, only 5 percent were in foreclosure.
The researchers went to great pains to control for numerous outside factors, such as income, overall education level, IQ, and type of mortgage, Meier said. Math skills had the most pronounced effect on likelihood that consumers would run into trouble. For example, homeowners with no college degree but high math skills performed better than college graduates with poor math skills, he said.
"This is very specific to numerical ability," Meier said.
The study does not offer additional insight into why math skills can predict mortgage trouble. Other studies have shown that those with poor math skills save less for the future, so that might suggest the group is "more vulnerable to income shocks," Meier said. Or they might make less informed choices about credit cards or insurance.
But math skills turned out to be a much better predictor of default than type of mortgage, he said.
"Even if you gave this group a plain vanilla, 30-year fixed mortgage, this group would still have difficulties," Meier said. "I'm not saying (exotic) mortgages are good...the results suggest the problems are outside the mortgage."
Americans' trouble with math is well-documented. U.S. students’ math skills frequently grade among the poorest in the developed world (in one recent study, the U.S. ranked 31st).
Meanwhile, the most recent U.S. Department of Education's National Assessment of Adult Literacy showed that consumers are terrible at solving real-world math problems, such as calculating tips or comparing prices in grocery stores. For example, only 42 percent of U.S. adults could pick out two items on a restaurant menu, add them and calculate a tip. In a result that neatly parallels Meier’s study, only 13 percent were deemed "proficient," and only 1 in 5 could calculate mortgage interest.
But the Department of Education results are more than 10 years old, showing little progress has been made in shoring up Americans' basic math skills
The phenomenon was identified even longer ago, in 1988, by mathematician John Allen Paulos in a book called "Innumercy" -- the author's invented term for mathematical illiteracy. In the book, Paulos argues that being a math dummy in America is not frowned upon, like illiteracy -- in fact, it can be socially desirable. People often joke about their inability to balance a checkbook, he said, to the delight of friends.
"The same people who cringe when words such as imply and infer are confused react without of trace of embarrassment to even the most egregious of numerical (errors)," Paulos wrote. He goes on to poke fun at a linguistically nit-picking acquaintance who heard a weathercaster pronounces a 50 percent chance of rain on Saturday and on Sunday and concluded that there must be a "100 percent chance of rain that weekend."
While the problem may be clear, the solution is not. There are already numerous financial literacy programs run by schools, non-profit organizations, and even banks. Research has shown these have so far been ineffective. It's unclear, for example, whether consumers should be taught about mortgages during high school math class or later in life, when they are about to take out a mortgage.
Meier's research offers a hint however. His test questions don’t really invoke finance skills, but rather general math concepts, such as division. Such concepts are key to good financial decision-making, but seem like black magic to the uninitiated. It might help to stress the high-level math concepts in schools, Meier said.
"One policy implication could be if we increase numerical ability people might make better decisions … that might deal with the problem," he said.
TAKE THE MATH SKILLS TEST:
1. 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?
2. If the chance of getting a disease is 10 per cent, how many people out of 1,000 would be expected to get the disease?
3. A second-hand car dealer is selling a car for $6,000. This is two-thirds of what it cost new. How much did the car cost new?
4. If 5 people all have the winning numbers in the lottery and the prize is $2 million, how much will each of them get?
5. Let's say you have $200 in a savings account. The account earns 10 percent interest per year. How much will you have in the account at the end of two years?
Answers: 1) $150 2) 100 3) $9,000 4) $400,000 5) $242 (compounded annually)