Personal Financial Education: Making Sense of Money

No matter who you are, there's a lot to learn about money. On the face of it, this sounds straightforward, but technological innovations and a profusion of financial products make money management more complex—and financial education more important—than ever before.

Consider this. Even when choosing basic financial products such as checking and savings accounts, today's consumers face a myriad of options compared to the traditional one-size-fits-all accounts of the past. Checking options include free, no interest accounts; fee-based, interest-bearing accounts; ATM-only accounts; and even plans tailored for college students, just to name a few. Savings options can include no fee, low interest accounts; market rate accounts with limited check-writing privileges; higher interest, higher cash balance accounts with limited transaction privileges; and indexed accounts.

Consumers often reap additional benefits when choosing financial services such as pay by phone, online banking, automatic bill pay, telephone banking, and credit card tie-ins. More decisions come into play if consumers opt to integrate checking, savings, and investment accounts into a portfolio of products. While these innovations provide consumers with greater options for tailoring personal financial plans, their complexity underscores the need for financial education. Like learning to drive a car safely, consumers must learn to navigate a complex financial road map to reach their goals.

Consumers shopping for mortgage loans or refinancing face a similar proliferation of choices that requires financial knowledge to make sound decisions. Even when choosing a standard 30-year mortgage, important financial decisions come into play such as how to evaluate interest rate and loan costs, when to lock-in a rate, and whether or not to pay points. These are not easy decisions and are especially difficult without financial knowledge.

The year 2002 marked the lowest mortgage rates in over three decades. Low rates opened the door for many first-time homeowners to enter the market with fixed- and adjustable-rate mortgages (ARMs). Some adjustable mortgages offer an initial, low "teaser" rate and accompanying low monthly payment that adjusts after a predetermined period of time, anywhere from one month to seven years based on specified indices, with or without an interest rate cap. Other mortgage choices for homebuyers include zero or low down payment options. These alternatives usually require consumers to pay higher interest rates and private mortgage insurance if their down payments are less than 20 percent of the purchase price. Another option among the many available is an interest-only loan. These loans feature lower interest rates and low monthly payments as incentives, but result in the borrower not paying down any principal for a period of time—typically five to ten years—leaving an unchanged loan balance at the end of the period.

Like basic banking products, mortgage loan variations can enhance consumer welfare for those who understand the financial trade-offs. First-time homebuyers, homeowners who are more risk-tolerant, or those who are just beginning their working careers may prefer the trade-offs offered by an ARM or an interest-only loan, but these options may not be the best choices. Over time consumers opting for these loans may incur higher interest rates and/or negative amortization.

Zero or low down payment options provide opportunities for more consumers to get into the housing market, but may pose risks due to the higher monthly payments. The bottom line when considering mortgage options or other financial products is that the complexity and variety of choices require consumers to take an active, informed role when evaluating products. Without training or education, making personal financial decisions can be a confusing, frustrating, and even dangerous road to maneuver.

All-in-One Banking, Insurance, and Securities Services

When perusing financial services offered by banks, insurance companies, and securities brokerages, consumers may observe that many of the products are similar. Facilitated by the gradual relaxation of legal and regulatory restrictions, including major banking financial modernization legislation passed in 1999, the banking industry has evolved dramatically. While banks used to focus primarily on accepting deposits and making loans, they now may affiliate under common ownership with insurance companies, securities firms, and other nonbank entities to offer their customers a complete range of financial services. As a result, today's consumers can engage in "one stop" shopping, choosing from a host of financial products including investment, insurance, retirement, college tuition, and traditional banking services. As the lines between financial service providers blur and product complexity increases, consumers need the financial know-how to decipher features, including differentiating between insured and uninsured products, to make sound financial decisions.

Banking Evolution Meets Technology Revolution

The financial services boom and its impact on the need for personal financial education would not be as explosive without the push of technology and the Internet. Consumers can bank online, shop for mortgages at lending portals, and open e-brokerage accounts for their online investment portfolios. The impact of technology behind the scenes is just as dramatic. Using new technologies, consumer preferences can be matched with product offerings for targeted marketing campaigns. Credit scoring models use sophisticated technology to develop customer credit profiles that are the industry standard for assessing consumers' credit qualifications for mortgage products and other financial services.

The use of technology to fine-tune credit profiles has opened the door to a proliferation of new financial options for consumers who may not have been able to qualify under traditional credit standards. For example, with financial innovation and market deregulation, subprime mortgage lending has grown tremendously since the early 1990s, providing new homeownership opportunities for consumers with a limited or impaired credit history. To obtain these loans, consumers pay interest rates that are higher than market rates. According to data reported by Inside B&C Lending, a mortgage finance trade publication, subprime lending originations rose from $138 billion in 2000 to $173 billion in 2001, to a record high of $213 billion in 2002.

The rapid wave of technological and financial innovation requires greater sophistication from consumers and more personal responsibility to benefit from new financial opportunities. Consumer education is critical to dissect the marketing of financial products and to understand the implications of credit scoring and financial parameters associated with specialized products such as subprime loans.

Rise in Consumer Debt and Personal Bankruptcies, Drop in Personal Saving

Significant changes in personal financial conditions on the heels of the phenomenal growth of the "new economy" highlight policymakers' concerns over the need for personal money management. Consumer credit was a primary source of consumer spending during the 1990s and continued to expand through most of 2002. As measured by Federal Reserve Board quarterly household debt-service data, consumer debt hit a 20-year high in 2001, averaging just under 14.4 percent of disposable income. This measure dropped only slightly by the third quarter of 2002 to 14 percent.

During 2002 a record number of personal bankruptcies added to the unsteady financial climate for consumers. According to data reported by the Administrative Office of the United States Courts, personal bankruptcies hit just over 1.5 million in 2002, a 6 percent increase over those recorded in 2001.

Lower personal saving may be another factor contributing to consumers' financial vulnerability. The U.S. personal saving rate has edged markedly lower since the 1980s when it averaged 8 percent according to the Federal Reserve Board's February 2003 Monetary Policy Report. In 2001 personal saving averaged 2.25 percent, rising to nearly 4 percent in 2002. Economists debate the saving measure because it doesn't reflect capital gains and pension contributions, but they clearly recognize the importance of saving as the basis for accumulating assets and mitigating personal financial setbacks.

Viewed together, all of these factors point to the need for personal financial education to help consumers plan for unforeseen economic shocks that may leave them financially vulnerable.

The new financial services marketplace offers the potential to enhance personal welfare and expand financial opportunities for knowledgeable consumers. Within this new marketplace, there is one certainty—the pace of financial and technological innovation will continue to increase and grow more complex. Sophisticated financial knowledge will be a prerequisite for consumers to take advantage of and keep pace with new financial opportunities. The challenge within this complex environment will be ensuring that everyone—regardless of their education, income, or age—has financial knowledge to benefit from these new opportunities.

Federal Reserve Financial Education Programs

The San Francisco Reserve Bank and the other Reserve Banks around the country work with financial institutions, educational organizations, nonprofits, and public and private groups encouraging them to develop financial education resources and deliver programs. "Fostering these partnerships helps the Federal Reserve support its regulatory responsibilities related to the Community Reinvestment Act, which requires banks to meet the credit needs of their local communities including low- and moderate-income neighborhoods," says Joy Hoffmann, vice president of Community Affairs and Public Information. The San Francisco Reserve Bank's involvement in personal financial education takes numerous forms. The Bank actively leads and influences change in its local communities to help develop asset-building opportunities, credit access, and banking services for underserved consumers including immigrant markets. As a natural outgrowth of local efforts, the Bank has spearheaded a number of national programs, including the development of a national outreach strategy for Native American financial training.

The Bank's financial education outreach to educators involves sponsoring workshops and programs to bring financial education into the classroom. Econ Ed and the Fed, the Bank's economic education newsletter, reaches approximately 16,000 teachers throughout the West, spotlighting financial education topics and resources.

During 2002 the Federal Reserve System took part in numerous efforts to increase the visibility of personal financial education as a critical policy issue. Federal Reserve Chairman Alan Greenspan provided testimony on the importance of improving financial literacy for consumers before the U.S. Senate Committee on Banking, Housing, and Urban Affairs during hearings on financial literacy and education in America. Partnering with the National Council on Economic Education, the Minneapolis Reserve Bank convened a national summit attended by policymakers, educators, and business and community leaders from around the country with the goal of creating a road map to raise the nation's financial and economic literacy level through effective pre-college education.

In the first quarter of 2003 the Federal Reserve launched a national initiative that includes a public service announcement (PSA) and Web-based and printed resources to help consumers and Federal Reserve employees learn more about personal financial education. Federal Reserve Chairman Alan Greenspan is featured in the PSA, which debuted first for Federal Reserve employees. Reserve Banks around the country, including San Francisco, have augmented national materials with regional financial education resources and programs to help consumers and Federal Reserve employees in their local communities. The Federal Reserve Bank of San Francisco's Web site, frbsf.org, includes a section devoted to personal financial resources in the Twelfth District, along with online consumer resources covering credit and banking topics.

Moving forward, Hoffmann says encouraging research into what works in financial education will be an important focus for the Federal Reserve and the San Francisco Reserve Bank as will continuing active support of local initiatives. "Through our own research and partnerships with organizations working on the issue, we will be able to build upon existing programs, develop new ones, and make a difference with a wide range of audiences in need of financial education."

The four programs profiled on the following pages demonstrate the Bank's commitment to financial education and illustrate common  programs, their audiences, and  goals. The programs include one aimed at Federal Reserve employees, one geared toward high school audiences, one focused on saving and homeownership opportunities in low- to moderate-income neighborhoods, and one promoting financial education for Native communities.