More and more cases of over-indebtedness: Financial literacy could save many from the debt trap – economy

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Almost every tenth citizen is worried about their own financial situation. If you want to get out of trouble, you have to start early. A guest post.

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Many households have fallen into the debt trap due to job loss and loss of income. This causes immense stress for those affected. According to the Federal Statistical Office, around 588,000 people were advised in debtor and insolvency advice centers in 2020, 6,000 more than in 2019 – despite the limited personal advice options. But behind the numbers are not just individual fates; unpaid loans can also jeopardize financial stability.

If you look into the wallets of Germans, they are filled very differently after more than a year of pandemic. Many are in the comfortable position of having saved quite a bit of money. Less trips, closed shops and a good dose of consumer caution have made them spend less in many cases. This is clear from the noticeably higher savings rates and correspondingly lower consumer spending.

But then there is the other side: those who have had to accept a loss of income due to Corona or have even lost their job. The self-employed and low-wage earners are particularly affected, but also all those for whom the short-time allowance is not sufficient to finance daily life.

Corona has made wallets full – or emptied

Existing and new loans then threaten to become problematic. Even before the pandemic, around ten percent of Germans were over-indebted, often after they lost their jobs. According to current data from the Socio-Economic Panel (SOEP) from the beginning of the year, almost one in ten respondents is currently very worried about their own economic situation. That is why it is now more important than ever to think about how we can both help those affected and prevent future cases.

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In order to find out from over-indebtedness, it is first of all necessary to get an overview of the financial situation. A step that can be accompanied by great fears and is made even more difficult by complex credit conditions. What is my financial situation and how much is my debt? When and how can you reschedule? Which loan do you pay off first?

Financial education can target and help here. First and foremost, being financially literate means having a basic understanding of interest rates, inflation and risk diversification. In 2018, more than a third of households in the SOEP-IS survey stated that they were unable to save regularly. Those with a higher level of financial literacy were almost twice as likely to save five percent of monthly income on a regular basis. First of all, this shows that financially literate people were better prepared for crises. But financial literacy also means having the knowledge and the ability to manage debts efficiently. It also means learning to get help in the worst-case scenario. People with more financial knowledge are more likely to use professional advice.

Knowledge helps against over-indebtedness – at every income level

Financial literacy has been shown to help protect against over-indebtedness and at any income level. Financial education is therefore a means of prevention. A high level of financial literacy makes it more likely to save more, invest in stocks and invest in a more diversified manner, i.e. take less individual risk.

Financial education is very unevenly distributed in Germany. In particular, low-wage earners, people with less education and women do worse in surveys. It is precisely these groups that have lower reserves. A financial literacy strategy is needed to improve the financial resilience of the most vulnerable groups.

But financial education is not the only way to go. It goes without saying that there must also be consistent consumer protection in credit agreements. For those who are already in financial straits, the resources for abstract financial knowledge are insufficient. The non-profit advice centers are an important point of contact for them. In Berlin, for example, the debtor and insolvency counseling service provides information about state aid in the context of the corona crisis, options for deferring payments, e.g. for rent debts, helps with debt rescheduling and offers free individual advice by phone and email. It is important to make these debt counseling and insolvency advice even better known and to guarantee that they are adequately financed.

Jana Hamdan is a research assistant in the World Economy Department at the German Institute for Economic Research (DIW) Berlin.

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