Published : 2022-03-30

What do consumers know and understand about effective interest rates? Evidence from a debt literacy survey in Poland

Abstract

The key parameter in borrowing is the interest rate. However, research shows that many consumers have very low levels of debt literacy, including knowledge and understanding of effective interest rates. This article uses data obtained from a sample of 1,055 borrowers and a three-question debt literacy test to learn which properties of the effective interest rate notion and the calculation thereof are particularly difficult for consumers to comprehend. To this end, logistic regressions were applied which showed that, of the three aspects of the effective interest rate examined, the largest gaps in knowledge and understanding relate to the concept of the time value of money. Unlike the other two aspects, in this case knowledge gaps are more egalitarian – they affect women and men equally and they do not depend significantly on the level of education. Answers to the time value of money question are also differently related to non-cognitive factors compared to answers to the other two questions in the applied debt literacy test. Treating incorrect and “don’t know” responses as separate categories in multinomial regressions confirms these observations, but also suggests that each of these two response categories may convey different informational content.

Keywords:

effective interest rate, annual percentage rate, annual percentage yield, financial literacy, debt literacy, financial education, Poland



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Cwynar, W. . (2022). What do consumers know and understand about effective interest rates? Evidence from a debt literacy survey in Poland. Forum Scientiae Oeconomia, 10(1), 118–146. https://doi.org/10.23762/FSO_VOL10_NO1_7

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