8 November 2013

Low financial literacy puts home deposit guarantors at risk

Thousands of parents and family members could risk bankruptcy because they do not understand the risks involved in acting as guarantor for someone needing help to secure the 20 per cent minimum deposit needed to buy a home.

Katherine Percy, Chief Executive of adult literacy and communication specialists Workbase, says around half of New Zealand adults have literacy and/or numeracy gaps that may affect their financial literacy. Furthermore, many highly literate and tertiary educated people also can find it difficult to understand complex and unfamiliar financial information.

“Having problems understanding financial information is currently the norm in New Zealand rather than the exception,” she says.

This has serious implications for the anticipated spike in people acting as guarantors for would be borrowers caught out by the banks’ new requirement of a minimum 20 per cent deposit on home loans.

“It is absolutely vital that every effort is made to ensure that guarantors fully understand the risks and that guaranteeing someone’s loan means they are responsible for paying the debt if the borrower defaults.

“Unfortunately history is littered with cases of guarantors being bankrupted by debts when the person they were helping did not pay. These guarantors can lose everything, including their home,” says Ms Percy.

Anyone who is considering acting as a guarantor can help to protect themselves by seeking legal advice before committing to anything. Free advice is also available through organisations such as the Citizens Advice Bureau and various budgeting services.

The onus, however, should not fully rest on guarantors because people “don’t know what they don’t know” about financial literacy, says Ms Percy.

Although some positive steps are being made to help improve New Zealanders’ financial literacy, the finance industry can be doing far more to provide borrowers and guarantors with clearer and more straightforward information about their services and products.

The term ‘financial literacy’ describes an individual’s ability to understand financial information. Financial literacy issues are caused as much by the complexity of the financial information as it is a product of people’s skills and knowledge.

Ms Percy notes that New Zealand’s financial service providers create high financial literacy demands for people because their products and services are unnecessarily complex – just as has been the case with telecommunication services.

“There are a huge number of financial products with little difference between them, which makes it very difficult to compare what’s on offer and make informed choices”.

Financial services providers could also help New Zealanders make informed financial choices by making their fee structures more transparent and ensuring customers such as guarantors understand the potential risks. Rather than hiding fee information in separate documents, fees and risks should be clearly stated alongside key product information so that people can quickly and easily make comparisons.

It is likely to be time consuming and difficult to lift more than a million adult New Zealanders’ financial literacy skills to the levels needed to competently engage with and understand complex financial information as it currently exists. A more sensible and cost effective approach is for financial services providers to reduce product and service complexity, and to make information more accessible to their customers, says Ms Percy.

Financial services providers can help to build their customers’ financial literacy skills by giving them simpler information that includes explanations of important financial concepts and terms.

Financial services personnel can also ask open-ended questions to check that customers such as guarantors and borrowers understand the information they have been given.

ENDS

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