Debt is a way of life in the UK. We borrow to buy our homes, we get our cars on finance and we’ll use a credit card to pay upfront for a holiday.
However, it seems that too many of us don’t have a full understanding of the ins and outs of how debt works and specifically how interest in calculated.
At Solution Loans, we wanted to test the financial literacy of those in the UK, asking them specific questions around debt and other financial products.
Q1 & Q2: Interest and APR
We asked the two following questions, giving five multiple choice answers for each:
- Q1: Please explain how APR works
- Q2: Please explain how compound interest works
The picture across the country
Looking at the UK as a whole, of those surveyed, we saw that just 46% of people aged over 18 know that APR stands for annual percentage rate and represents the amount of interest and other charges you’ll pay annually on any money owed.
Just 58% were clear on compound interest and able to identify it as interest added onto interest already earnt on the starting sum.
This is a worrying trend as the latest figures show as a country we owed nearly £1.6 trillion in household debt in June 2018, with the average debt per household (including mortgages) equating to £58,540.
Yet we still don’t understand the intricacies of borrowing and the interest we’re required to pay.
The plight of Millennials: Generation Debt
That’s the picture across the nation as a whole. It becomes even more worrying when we look at those aged between 18 and 34, so-called Millennials.
Often known as Generation Debt due to the way the financial crash, the property market and the rise in tuition fees has impacted their lives, they are the most financially illiterate age group when it comes to understanding debt and borrowing.
Only 35% of 25 – 34 year olds and 36% of 18 – 24 year olds understand APR. Only 36% and 40% of the same age groups respectively can explain compound interest.
| Q1: Please explain how APR works | |||||
| Correct Answer: APR stands for annual percentage rate and represents the amount of interest and other charges you’ll pay annually on any money borrowed | |||||
| 18 – 24 | 25 – 34 | 35 – 44 | 45 – 54 | 55 – 64 | 65+ |
| 36.2% | 34.9% | 42.5% | 50.8% | 60.5% | 45.8% |
| Q2: Please explain how compound interest works | |||||
| Correct Answer: Compound interest is interest added onto interest as well as the starting sum | |||||
| 18 – 24 | 25 – 34 | 35 – 44 | 45 – 54 | 55 – 64 | 65+ |
| 40.4% | 38.2% | 45.5% | 65.5% | 75.8% | 72.5% |
This is compared to 75% of those aged 55 – 64 understanding compound interest and 60% being able to explain APR.
Q3: Balance transfer credit cards
For those with credit card debts, a Balance Transfer credit card is always a good option to begin to make a dent in the money owed rather than simply paying back the interest.
Yet again, it seems to be something missed by the financially illiterate.
As a whole, the nation has a better understanding of a balance transfer, with 68% knowing that it is where part or all of the debt owed on one credit card is moved to another card.
However, Generation Debt is again lagging behind.
Just 38% of 18 – 24 year olds understand what a balance transfer credit card is, while 45% of those in the 25 – 34 age bracket know how this works.
| Q3: In relation to a credit card, what does balance transfer mean? | |||||
| Correct Answer: A balance transfer is where part or all of the debt owed on one credit card is moved to another. | |||||
| 18 – 24 | 25 – 34 | 35 – 44 | 45 – 54 | 55 – 64 | 65+ |
| 38.3% | 44.6% | 60.5% | 80.2% | 82.6% | 81.0% |
Q4 & Q5: Auto-enrolment pensions & guarantors
Financial illiteracy isn’t just about debt. We asked a couple more questions:
- Q4: Explain what auto-enrolment pensions are
- Q5: What is the responsibility of a guarantor on a financial product?
We saw that 57% of people understood that auto-enrolment makes it compulsory for employers to automatically enrol employees in a pension scheme, with the employer also required to pay into the scheme.
That means that 43% of people in the UK can’t explain what one of these is, despite nine million people having joined the workplace pension scheme since it began in 2012.
Things are a little better when it comes to understanding the responsibility of a guarantor, with 71% answering this question correctly as a person who agrees to repay the borrower’s debt should the borrower default on agreed repayments.
The picture on a UK regional basis
We broke the picture down across different regions and cities throughout the UK. On a regional basis, we can see that the South West of England has the highest financially literacy and Central England the lowest.
Here are the regional standings:
- South West England – 69% (average across all five questions)
- Scotland – 65%
- Wales – 64%
- Northern England – 62%
- Northern Ireland – 60%
- South East England – 58%
- Central England – 57%
On a city by city basis, the strongest performer was Liverpool with a combined score of 71% across each of the five questions. In second place was Bristol with 69% and Glasgow in third with 66%. The least financially literate city in the UK was Birmingham with an average score of 50% across the five questions.
The hope for the future
Our finance expert Amanda Gillam commented on the findings of our study:
“We found that when it comes to understanding how financial products work and specifically how interest and debt is calculated, as a nation our financial literacy is lagging. This is especially the case for the young. These are the people that have been hit the hardest since the financial crash, but that also seem to have the biggest gap in their financial knowledge. It’s key for future generations that this is taught, and a full understanding is achieved.
“There remains a key responsibility on behalf of the individual that when they take out a financial product, they look through the terms and conditions carefully and make sure they understand exactly what they’re signing up for. The financial service provider must also do all that they can to make sure everything is clear for the consumer.
“Unfortunately, debt simply isn’t going away. Financial literacy, therefore, has to improve.”
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Financial Literacy & Education on Solution Loans
- Guides to financial products
- Our “Money Matters” podcast that covers numerous products and financial situations
- Video explainers and guides on our YouTube channel
- Loans calculator – to help assess the impact of loan amount and repayment terms on monthly repayments
- Find a Loan tool – 4 quick questions to help narrow down the better credit options
- Our “Money Matters” blog where we regularly post on real-life money issues facing people
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You're reading the blog post Data Shows Debt Prone Millennials Have Poor Grasp of Financial Basics that was written by and first published on Getting Loans and Credit & Managing Money.
