Impact of Financial Education Mandates on Younger Consumers' Use of Alternative Financial Services

• Published date: 01 September 2019
• Author: Melody Harvey
• Date: 01 September 2019
• DOI: http://doi.org/10.1111/joca.12242

FALL 2019VOLUME 53, NUMBER 3731

MELODY HARVEY

Impact of Financial Education Mandates on Younger

Consumers’ Use of Alternative Financial Services

Over one-quarter of American adults used credit-based alternative

nancial services (AFS) in the past ve years, which carry a typical APR

of 300%. Young adults are especially more likely to use AFS yet are

also more likely to be exposed to personal nance education in schools.

In this study, I use data from pooled 2012 and 2015 waves of National

Financial Capability Study to examine whether state-mandated nan-

cial education impacts young adults’ use of AFS. I nd that nancial

education mandates signicantly reduced the likelihood and frequency

of payday borrowing in particular. Additionally, I show that exposure

to required personal nance courses could affect payday borrowing

through increased nancial literacy and improved nancial planning

practices. These ndings suggest that policymakers and other stake-

holders need to understand the full benets of nancial education when

making cost–benet analysis comparisons as to whether or not to imple-

ment.

Alternative nancial services (AFS) include auto title loans, pawnshop

services, payday loans, tax refund anticipation loans, and rent-to-own

nancing (RTOs). These services provide credit options to those who

would otherwise be unable to secure it from traditional banking institutions

and credit unions. Exorbitant fees and interest rates make it difcult for

borrowers to pay off these loans in a timely manner. For payday loans in

particular, almost half of borrowers roll overtheir loan at least once (Burke

et al. 2014). Nevertheless, over one out of four American adults reported

using these services. Of the consumers who use AFS, approximately 46%

are young adults between the ages of 18 and 34. To mitigate the negative

Melody Harvey (maharvey3@wisc.edu) is a National Poverty Fellow at Institute for Research on

Poverty, University of Wisconsin-Madison. I thank Katherine Carman, Jeremy Burke, Trey Miller,

and Crystal Hall for their initial guidance. I am also grateful for the comments and suggestions

provided by Robert Mayer, Gery Ryan, J. Michael Collins, Jeffrey Smith, Jeffrey Wenger, Noelwah

Netusil, anonymous reviewers at the FINRA InvestorEducation Foundation, anonymous reviewers at

the Journal of Consumer Affairs, and seminar participants at the RAND Labor and Population Brown

Bag Seminar, the All-California Labor Economics Conference, the APPAMFall Research Conference,

the ACCI Annual Conference, the Cherry Blossom Financial Education Institute, and the Universityof

Wisconsin-Madison Center for Financial Security’sHousehold Finance Research Seminar. An earlier

summary of this paper is in Harvey (2017), and an earlier version of this paper is in Harvey’s(2018)

dissertation.

The Journal of Consumer Affairs, Fall 2019: 731–769

DOI: 10.1111/joca.12242

Copyright 2019 by The American Council on Consumer Interests

732 THE JOURNAL OF CONSUMER AFFAIRS

TABLE 1

Overview of Fees and Costs by Type of AFS Loan vs. Traditional Credit

Product TypeLoan FeesAPR Range

Amount

BorrowedLoan PeriodCollateral

Unsecured credit

cards

N/A13–30%Up to credit

limit

Greatly

variable

Credit score

Auto title loans$25 per $100

borrowed

300%$100-$5,5004 weeksVehicle

Pawnshop loans$2 to $25 per $100

borrowed

12–300%Upto$1504 weeksPhysical

collateral

Payday loans$10to $20 per

$100 borrowed

up to 1,950%

mean =391%

$100–$500

mean =$375

2 weeksFuture

paycheck

Refund

anticipation

loans

$100 per loan70–500%$300- $1,0001– 2weeksTax refund

Rent-to-own

nancing

N/A57–230%Upto product

price

12–24 monthsPurchased

product

Sources: Bradley et al. (2009); Bhutta, Goldin, and Homonoff (2016); Consumer Financial Protection

Bureau (2013); Federal Trade Commission (2014); Galperin and Weaver(2014); McKernan, Ratcliffe,

and Kuehn (2013); Robb et al. (2015).

impact that using credit may have in general, some states haveestablished a

variety of nancial education mandates on high school students. This paper

examines whether or not such mandates impact AFS use among young

consumers.

On average, the annual percentage rate (APR) for all AFS products is

substantially higher than for traditional credit methods as illustrated in

Table1. While the maximum APR on unsecured credit cards is 30%, the

typical APR on AFS loans is approximately 300%, of which the mean APR

for payday loans is nearly 400% (Robb et al. 2015). For traditional credit,

the APR charged depends on a consumer’s credit score, and their credit

limit is typically based on some combination of household income and

creditworthiness. For AFS products, however, the APR charged depends

on the loan fee and amount borrowed.1Good credit scores are not required

to use these products, nor do they determine the APR charged.

The AFS industry is regulated at the state level, and payday loans have

been a particular product of interest to policymakers. Currently, 35 states

allow some form of payday lending (Consumer Federation of America

1. Some credit unions provide payday loans (sometimes known as payday alternative loans) but

at rates substantially less than payday lending institutions (National Credit Union Association 2017;

National Federation of Community Development Credit Unions 2015). To qualify, consumers must

have been a member of the issuing credit union for at least one month; loan terms cannot be less than

one month; and no rollovers are allowed. Some credit unions also require a credit check.

FALL 2019VOLUME 53, NUMBER 3733

2018; Morton 2016). In some of these states, however, local jurisdictions

are allowed to prohibit payday lending (Mayer and Martin 2017). In June

2016, the Consumer Financial Protection Bureau (CFPB) proposed federal

regulations that would curtail payday lending and in October 2017, they

issued a nal rule requiring payday and auto title lenders across the nation

to assess a borrower’s ability to repay the loan based on the borrower’s

income and expenses.

In addition to regulatory interventions, formal, classroom-based nan-

cial education may also be a way to improve the use of AFS. Financial

education mandates are state-level policies that require teaching personal

nance in public high schools. Personal nance courses typically cover

topics such as credit and loans, savings, insurance, investments, and nan-

cial planning. A few states also cover topics on postsecondary nancing

and AFS.

This study focuses specically on state mandates that require students in

public high schools to complete a personal nance course to graduate. This

policy has substantial political and stakeholder support. As of 2014, a total

of 21 states required high school students to take personal nance courses

for graduation (Urban and Schmeiser 2015). Yet, it is unclear to what

degree nancial education mandates have improved students’ nancial

capability as they age.

There are conicting ndings about the efcacy of nancial educa-

tion mandates. These studies typically examine effects of mandates on

middle-aged adults’ savings rates, investment behavior or wealth accumu-

lation, and on young adults’ credit behavior. The age division in the litera-

ture corresponds to the life cycle, where we would expect to see older adults

investing and building wealth, and young adults borrowing to smooth out

consumption. Regardless of age group and its corresponding behaviors,

these studies nd that mandates either improve nancial decisions, or have

no effects.

Little research has focused on the impact of mandates on AFS in par-

ticular. Moreover, studies on the impact of nancial education mandates

do not consider whether mandating nancial education in high school is

particularly effective for improving decision making of economically vul-

nerable young adults. Fernandes, Lynch, and Netemeyer (2014, 1873) rec-

ommend “‘just-in-time’ nancial education tied to a particular decision”

so that the concepts are more relevant. Even though the mandates may not

be “just-in-time” for AFS consumers, the course may have salience for

them because younger consumers are both more likely to use these prod-

ucts than older consumers and are more likely to have received personal

nance instruction in school.