Monday, July 14, 2014

Test Makers Fail Financial Literacy Test

So news was recently going around about a Financial Literacy Test made by the OECD. The Wall Street Journal provided 5 sample questions from the test and I must say that the OECD fails it's own question.

First of all I'm switching the "zeds" to $ for typing purposes. So Mrs Jones current loan balance is $7400, it has a 15% interest rate with monthly payments of $150. This means that the loan will take 78 payments (months) to payoff and TOTAL INTEREST paid over the life of the loan will be $4,178 (yes below it equals $4,180 due to rounding).


However, if she decides to take out a new larger loan of $10,000 at an interest rate of 13% while repaying at the same $150 rate then it will take 119 payments (months) to payoff and TOTAL INTEREST paid over the life of the loan will be $7,832. In other words she will be paying $3,654 MORE INTEREST.

Despite these facts OECD says the answer is as follows
Clearly A, as I showed earlier, is not correct. Therefore C is also wrong. While she is paying a lower interest RATE, she is clearly paying HIGHER INTEREST in total ($7,832 vs $4,178). B is in fact correct, she will have more money available but she will be paying interest on that money and unless she has an investment that is going to earn her more then the cost of funds (13%) she would be better off taking a smaller loan.

Why am I not surprised that the OECD would come up with this clearly incorrect answer regarding interest paid? Because they seem to encourage over-leveraged economies at every opportunity, so here they are teaching incorrect information, helping everyone become slaves to debt through bad information.

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