# MONEY... WHAT YOUNG ADULTS NEED TO KNOW

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1 MONEY... WHAT YOUNG ADULTS NEED TO KNOW Printing and distribution of this publication was made possible by the National Council of Economic Education through funding from the United States Department of Education Office of Innovation and improvement. Eighth Edition: January 2015

9 Calculating Interest When you save money, compound interest (earning interest on interest) is on your side. When you borrow money and do not pay it back quickly, compounding works against you. Two key factors that determine the amount of interest paid on a loan or credit card: u The length of time money is borrowed u The APR (Annual Percentage Rate) The longer you take to pay back a loan and the higher the interest rate, the more the credit will cost. Small amounts matter, like the example below of a \$2,000 installment loan. The table shows the total interest cost of each option. Note that there is a \$808 difference between a twoyear loan at 5% and an eight-year loan at 10%. This difference may not seem like a lot, but imagine the differences for a \$20,000 loan (for a car) or a \$200,000 loan (for a house). Cost to Borrow Money at Three Different Interest Rates and Loan Terms \$2,000 Installment Loan Time Period of Loan 5% Interest 8% Interest 10% Interest 2 years \$2,106 \$2,171 \$2,215 5 years \$2,265 \$2,434 \$2,550 8 years \$2,431 \$2,715 \$2,914 Long-term loans, like a home mortgage, cost more. For example, a \$100,000, 30-year mortgage at 6% requires monthly payments of \$ and would cost a total of \$215,842 (\$ x 360 payments) to repay. The interest, \$115,842 (\$215,842 - \$100,000), is more than the amount borrowed. It s like you borrowed money for one house and paid for two. Always look at information from at least three lenders before signing a credit application or loan contract. Shopping around for the best credit terms can save you hundreds, even thousands, of dollars over time. Five good ways to lower borrowing costs are to: The higher your credit score, the more likely you are to be approved for a loan. Credit scores influence two things: u Whether or not you get credit u What interest rate you ll pay if you get a loan or credit card Generally, if you have a high credit score (720+) you will get the lowest interest rates. Over time, the difference in cost between high- and lowinterest loans can amount to hundreds, even thousands, of dollars. Therefore, it is very important to start and keep a good credit history and take steps, if needed, to improve your credit score. Credit reports and sometime credit scores are used by landlords (to rent apartments), employers (especially for high-security jobs), and insurance companies (to set your insurance rates). u Seek and use loans and credit cards with a low interest rate u Call existing creditors and request a lower interest rate u Refinance existing debts, such as a mortgage or car loan, when interest rates go down u Try to pay credit card balances in full to avoid interest charges u Borrow money for the shortest time possible (for example, a three-year loan instead of a five-year loan) Effective February 2010, young adults under age 21 must have a cosigner or prove that they have available income to repay credit card debt. There are also limits on the amount that they can charge. For further information about credit card rules for young adults, see What Young Adults Need To Know About Money 9

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