Mortgage risks, debt literacy and financial advice

A limited understanding of mortgage contracts and the risks involved may have contributed to the origination of the financial crisis. We have designed a special questionnaire to relate mortgage loan decisions to financial literacy and financial advice. Our findings show that homeowners seem well aware of mortgage risks. Loans are perceived more risky when they are large compared to the home value, entail high mortgage payments compared to income and when they are linked to investment vehicles. Homeowners with riskier mortgages know they may encounter financial problems when housing prices or income declines. Individuals with a lower level of financial literacy are more likely to take out traditional mortgages which pay off the principal at maturity. Riskier mortgages are more prevalent among homeowners with a better understanding of loan contracts. Financially less sophisticated homeowners who consult intermediaries for professional financial advice hold more risky mortgages as well.
 
Keywords: mortgage choice, risk-taking, financial knowledge, professional financial advice.
JEL classifications: G21, D83, D12, D14.

Working paper no. 449