Personal Finance

What If You Had to Pass a Test to Get a Loan?

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When I was a teenager, I couldn’t wait to start driving a car. My first experience behind the wheel started with a series of questions, delivered by my dad, and one of them stood out:

“What are we sitting in?” he said.

“Um, a minivan?”

“Wrong. This is a lethal weapon.” Well, that’s not what I expected to hear, I thought, terrified. He continued: “If you’re not paying attention while driving, you could kill someone. Do you understand that?”

I nodded. I hadn’t even put the key in the ignition yet.

As my father so bluntly explained, driving a car can have potentially grave consequences. In the 20th century, the booming popularity of automobiles in the U.S. prompted some cities and states to test and issue licenses to motorists. It was an an attempt to keep incompetent drivers off the road, and while reckless driving hasn’t disappeared, at least people have to exhibit some understanding of car functionality and traffic laws to operate a vehicle.

Writer John Aziz recently made the argument that the same should be true for people applying for a mortgage: “People wanting to take out a mortgage or get a credit card or a loan would face compulsory basic finance literacy testing,” he suggested in an article in The Week.

He made a good point. A mortgage is a huge responsibility, and it’s not just a personal one. As the financial crisis showed, irresponsible borrowing and lending can have far-reaching consequences that ripple out into larger parts of the economy. Perhaps a competency test wouldn’t be such a bad thing.

The Credit Basics

After the housing collapse and economic recession, the government imposed more regulations on mortgage lenders, including the need to verify a mortgage applicant’s ability to repay the loan. Your credit history plays a huge part in the mortgage approval process, so in a way, the borrowing process already has a test: the credit score.

Credit history isn’t not the only factor, but you’ll have trouble getting a loan without a good one. When you’re applying for any kind of credit, you should have an idea of what your credit standing is — you can get two credit scores for free through Credit.com — because poor credit could mean loan denial or high interest rates. The more you know about your credit standing, the better your chances are for improving it, which you can learn about here.

“The standards are pretty high,” said Gerri Detweiler, director of consumer education for Credit.com. “You really have to prove yourself, not just with your credit score, but back up everything with documentation.”

At the same time, being able to afford the loan isn’t the same as understanding it. It’s up to consumers to understand what they’re getting into, Detweiler said, and homebuyer classes can be very helpful in that process. They’re not a requirement, though.

In his article, Aziz talked about financial literacy issues in the U.S. but says efforts to increase education haven’t worked. He floated the idea of putting something at stake to make the lessons stick.

“You can’t get a mortgage unless you can demonstrate you understand how interest payments, inflation, and other basic financial concepts work,” he wrote. If access to financial services depended on financial literacy, financial literacy rates would shoot up.”

Who Needs It Most?

Studying for your mortgage may not sound appealing, but if it could help, perhaps it’s worth exploring. Of course, irresponsible borrowers won’t be barred from taking out loans, because passing a test doesn’t necessarily reflect understanding.

If we’re talking about people who really need financial education before taking out student loans, perhaps we should look at education itself. Student loans are easy to get, and plenty of Americans have student loan payments that exceed their mortgage or rent payments. You’re going to have a tough time trying to get out of a student loan, too, because student loans can’t be discharged in bankruptcy.

There isn’t a simple solution to economic problems spurred by financially illiterate consumers. The best lesson is usually experience, but foreclosure shouldn’t be the way you come to understand the gravity of a mortgage. It isn’t perfect, but I’m glad we have to take driving tests. Otherwise, we’d just have people getting in cars, telling themselves, “I’ll be fine, as long as I don’t hit anything.”

If only it were that easy.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates.

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  • Ian

    Obviously if taken to an extreme there are all kinds of ways this could go wrong, but the point is good and critical: A basic level of financial literacy could fix several problems along the way for both of the main parties in the loan process. A basic knowledge of compound interest, which few can calculate in earnest, but the rule of 72 and any number of online calculators do a great job, would have been useful to any number of lenders and borrowers who had ARMs in 2008.

    I would leave it to the consumers and banks to implement this on an incentive basis, and I urge lenders to test this idea as soon as possible. Just give the consumer a study guide first so everyone starts on equal footing. We don’t want to see 70% of Americans failing the test!

  • Amirtha

    very interesting!

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