Are we as smart as we think we are?

Try this quick quiz. If a bank requires you to buy mortgage insurance with your home loan, who is that insurance there to protect – you or the bank?

Or how about this question. Will it be cheaper to borrow $20,000 for a new car through a personal loan, or by adding it onto your mortgage?

When these were put to consumers in a recent survey by ME, a bank, four out of five people got the first question wrong (the correct answer is mortgage insurance only protects the bank, even though you pay for it).

Three in four people also got the second one wrong (extending your mortgage will give you a lower rate, but it's also about the length of your loan - if you pay it off over 25 years rather than five you'll pay a lot more interest).

And this was part of a broader trend: many people misunderstood key concepts in banking, covering products including home loans, deposits and credit cards. Only 40 per cent of respondents answered more than half the questions in the survey correctly.

Yet of the 1500 respondents, just 13 per cent thought their financial knowledge was "below average".

"The majority of people feel pretty confident about their finances and their financial knowledge, but that perceived knowledge is not actual knowledge," ME's head of deposits and transactional banking, Nic Emery, says.

That gap – between what we think we know, and what we actually know about finance – is a reflection of problems many people have with financial literacy.

The Organisation for Economic Development and Co-operation also found last month that financial literacy among 15 year-old Australian school students had declined in recent years.

We shouldn't imagine that improving financial literacy is some sort of silver bullet, or a substitute for strong regulation of financial products and the people who sell them.

But it is a reality consumers today are expected to make financial decisions that can have big consequences.

The stakes are arguably higher than for previous generations, because households have more debt

Not only that, they are bearing much more of the risk for their financial futures through the superannuation system.

However, Emery says much of the population is disengaged, because many of us find finance dull, or overwhelming and too complex to deal with.  Such disengagement can raise the risk of being ripped off, or taking out a product that's not right for you.

Credit cards are a case in point.

They are a everyday product, but the federal Treasury has in recent years accused banks of charging very high interest rates because they know few people pay much attention to their rate, as they (often wrongly) assume they won't pay interest. Instead, we're often distracted by reward schemes that can be of dubious value.

The survey supported this, showing only a quarter of respondents chose the right answer when asked how long it would take to pay back $3000 at a 15 per cent interest rate by only making the minimum repayment. The answer is 18 years.

A key lesson for customers from all this is the importance of checking facts on financial products, rather than relying on marketing materials from financial institutions.

The Australian Securities and Investments Commission website MoneySmart is a useful tool here. Emery argues some understanding of finance is a "good life skill, like cooking".

But Fiona Guthrie, chief executive of Financial Counselling Australia, also cautions against putting too much emphasis on financial literacy, which she says is not the main reason why people get into financial distress.

Guthrie points out that financial literacy is on the school curriculum these days, but the responsibility should not only lie with consumers. 

"We need safe, affordable products in the first place," she says.

It makes sense for consumers to do their research, but banks also have a role to play in removing the many traps that they know consumers will fall into.

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