# Standard 7: The student will identify the procedures and analyze the responsibilities of borrowing money.

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1 TEACHER GUIDE 7.2 BORROWING MONEY PAGE 1 Standard 7: The student will identify the procedures and analyze the responsibilities of borrowing money. It Is In Your Interest Priority Academic Student Skills Personal Financial Literacy Objective 7.1: Identify and analyze sources of credit (e.g., financial institutions, private lenders, and retail businesses) and credit products (e.g., student loans, credit cards, and car loans). Objective 7.2: Identify standard loan practices, predatory lending practices (e.g., rapid tax return, rapid access loans, and payday loans), and legal debt collection practices. Objective 7.3: Explain the importance of establishing a positive credit history (e.g., maintaining a reasonable debt to income ratio), describe information contained in a credit report, and explain the factors that affect a credit score (e.g., the relationship between interest rates and credit scores). Objective 7.4: Explain how the terms of a loan (e.g., interest rates, fees, and repayment schedules) affect the cost of credit. Jason did not understand how it happened. He had received a credit card application in high school, and at first, it was easy to pay the balance each month. Then, one month, his car needed TWO tires after hitting a nail-ridden board; and then, his battery failed. He could not quite pay the entire bill, but he was sure he would the next month. Then, he asked Susan to the prom; she accepted, and he had more bills than expected. Lesson Objectives Identify potential sources of credit. Compare credit sources. Evaluate credit practices. Calculate credit costs. Demonstrate the ability to make good credit choices. Now, in the middle of the summer, he was almost maxed on his credit card limit, and it would take several months to pay off the card, if he could even do it then! The interest rates were killing him, and he did not want to tell his parents because they had warned him against using credit cards. What should Jason do?

2 Teacher Guide Personal Financial Literacy Vocabulary Credit: An agreement to provide goods, services, or money in exchange for future payments with interest by a specific date or according to a specific schedule. The use of someone else s money for a fee. Collateral: Something of value (often a house or a car) pledged by a borrower as security for a loan. If the borrower fails to make payments on the loan, the collateral may be sold; proceeds from the sale may then be used to pay down the unpaid debt. Comparison shopping: The process of seeking information about products and services to find the best quality or utility at the best price. Interest: Payment for the use of someone else s money; usually expressed as an annual rate in terms of a percent of the principal (the amount owed). Installment credit: A loan repaid with a fixed number of equal payments. Interest rate: The percentage rate of interest charged to the borrower or paid to a lender, saver, or investor. Loan agreement: A type of contract between the borrower and the lender explaining the requirements of fulfilling the loan. Mortgage: A long-term loan to buy real estate including land and the structures on it. Secured credit: Credit with collateral (for example, a house or a car) for the lender. Noninstallment credit: Single-payment loans and loans that permit the borrower to make irregular payments and to borrow additional funds without submitting a new credit application; also known as revolving or open-end credit. Unsecured credit: Credit without collateral, such as credit cards.

4 Teacher Guide Calculating Interest Rates In its simplest form, the interest rate on a loan is calculated as the dollar amount of interest charged divided by the amount of money borrowed. For example, if you borrow \$1,000 that must be repaid at the end of one year at 6 percent interest, you would pay the \$1,000 plus \$60 in interest. (6% of \$1,000 is \$60) Calculating interest on most loans, however, is more complex because few loans are repaid in just one year with just one payment. Most loans require you to make a series of payments for a specific amount of time. (Note: Interest rates on credit cards are more complex and discussed later in this lesson.) Interest rates are always stated as APR, or the annual percentage rate (the percentage cost of credit on an annual basis, which must be disclosed by law). Suppose you decide to borrow that same \$1,000 at 6 percent and repay it in three months instead of one year. You would still pay back \$1,060 to the lender, but your APR would be different because interest rates are calculated for the entire year. To find your APR, follow these steps: 1. Divide the number of months in the year (12) by the number of months you are borrowing the money (3 in this example). 12/3 = 4 2. Multiply the rate of interest paid (6 percent in this example) by 4 (the answer in step 1). 6 x 4 = 24 Your annual rate of interest for this loan is a whopping 24 percent! Now, suppose you borrow \$1,000 for two years at 6 percent. 1. Divide the number of months in the year (12) by the numbers of months you are borrowing the money (now, it is 24). 12/24 =.5 2. Multiply the rate of interest paid (again, it is 6 percent) by.5. 6 x.5 = 3 Your annual rate of interest for this loan is only 3 percent.

7 Teacher Guide In the box below, describe the most important things you have learned from this lesson Has the lesson changed the way you think about credit? Why or why not? Conclusion While borrowing money is convenient, it is also expensive. Making good choices about borrowing includes borrowing only what you need, understanding the terms of the loan, and choosing the best lender. Knowing what is expected of you and the lending company will help prevent future problems. The first thing Jason should do is quit spending! The only way to get out of debt is to stop accumulating more of it. The second thing Jason should do is talk to his parents. He should explain what happened and what he plans to do to pay off the credit card. He may need to get an extra job or find a way to cut his expenses so he can pay his credit card bill. Either way, he will be glad he did and so will his parents. Jason is not the only person to have this problem, and he will not be the last. That is why it is important to take control of your spending, instead of having it control you.

8 Teacher Guide Name: Class Period: It Is In Your Interest Review Lesson 7.2 Answer the following questions and give the completed lesson to your teacher to review. 1. Which of the following types of lenders offers loans to high risk customers for very high fees? a. Payday Loan Companies b. Credit Card Cash Advance c. Home Equity Bank Loans d. Credit Unions 2. What is the definition of a periodic interest rate? a. Annual interest rate b. Fractional amount of the daily interest rate c. Fractional amount of an annual interest rate d. Annual interest rate divided by the daily interest rate 3. What is the definition of a minimum payment? a. One twelfth of your total balance b. A percentage of your current balance c. The dollar amount required to avoid foreclosure d. The dollar amount specified in the Truth in Lending Act 4. Interest rates on credit cards a. are the same for everyone. b. vary depending upon several factors. c. vary based on a person s age and income. d. are the same, regardless of which company issues them.

9 Teacher Guide Name: Class Period: Types of Lenders Activity When borrowing money, you have many choices. Following are some of the different kinds of lenders available. You can borrow from them as long as you meet their requirements. However, not all lenders are the same. Interest rates, terms of the loan, and other factors will vary from lender to lender. Before borrowing, be sure you comparison shop to find the best deal. Commercial Banks Commercial banks generally offer a greater variety of credit than other lenders, including credit cards, lines of credit, term loans, and installment loans both on a secured or an unsecured basis. Most banks make loans for several purposes: buying cars, boats, real estate, and homes; taking vacations; paying off other loans; investing in a business; paying taxes; or many other reasons. As a general rule, banks tend to be rather selective, choosing to make loans to individuals and businesses with established credit histories. While most banks prefer that you have an account with them before seeking a loan, it is not required. Credit Unions Credit unions are cooperative associations that hold deposits and make loans to their members. To borrow money from a credit union, you must meet their membership requirements and purchase a credit union share to activate your membership and use their services. Credit unions are similar to commercial banks, offering most types of consumer credit. Their rates are often lower than banks, primarily due to differences in structure and federal requirements. Also, they tend to specialize in individual loans rather than commercial or business loans, and they tend to make smaller loans than most banks. Consumer Finance Companies Consumer finance companies primarily make installment loans and second mortgages. They also make a large number of debt consolidation loans, especially to high-risk customers. Financial companies are generally more willing to make relatively small loans that most banks avoid because of the risk and expense. They are also more willing to approve loans for applicants with poor or no credit histories than banks or credit unions; however, the interest rates they charge are also much higher. In addition, they tend to charge higher fees and require collateral for many of their loans.

11 Teacher Guide Name: Class Period: Types of Lenders Activity Commercial banks A. More willing to make loans that commercial banks and credit unions frequently avoid. 2. Credit Unions B. Source of credit for investors who have securities on deposit in a margin account. 3. Consumer Finance Companies C. Generally offer a greater variety of credit than do other lenders. 4. Sales Finance Companies D. Offer short-term, single-payment loans secured by personal property left in the possession of the lender. 5. Life Insurance Companies E. A source of credit for certain policyholders who own policies that include a savings component, or cash value. 6. Brokerage Firms F. Formed to lend money to customers of an affiliated company. 7. Pawnbrokers G. Loans often for amounts between \$100 and \$500, and interest rates can be extraordinary. 8. Payday Lenders H. Cooperative associations that accept savings from and make loans to member individuals.

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LESSON 1 -- GETTING OUT OF DEBT LESSON DESCRIPTION AND BACKGROUND This lesson uses the Better Money Habits video Steps to Help You Get Out of Debt (www.bettermoneyhabits.com) to explain the concept of