The role of financial literacy in payment defaults

Abstract

Household indebtedness has increased in recent decades, and young adults have become financially independent during an era of low inflation and very low interest rates. However, recent changes in macroeconomic conditions have made it essential for individuals to understand the effects of inflation and interest rates on their net residual income. Otherwise, low financial literacy may cause individuals to make inferior financial decisions, which can be highly costly. In this paper, we study how financial literacy is related to payment defaults using Finnish survey data from early 2023. Our results suggest that financial literacy is negatively related to the likelihood of severe debt problems. We also show that being financially fragile is positively associated with the risk of default and that financial literacy substantially reduces the default risk for financially fragile individuals.