Key Economic Concepts: Credit, Decision Making, Opportunity Cost, Interest

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1 Section 2 Financial Basics Title of Lesson/Subject: Credit: Buy Now & Pay More Later Prepared by: Kate (Kiernan) Bryant Contact Information: Address: Phone: Time Required: Approximately 3-4 class periods Grade: 6-12 Lesson Description Through a group activity, article discussion, and a credit card I.Q. quiz, students analyze the costs and benefits of using credit cards to purchase goods and services. Key Economic Concepts: Credit, Decision Making, Opportunity Cost, Interest Content Standard Few choices are all-or-nothing propositions. They usually involve trade-offs, that is, getting a little more of one option in exchange for a little less of another. Objectives Determine the costs and benefits of using credit cards Analyze the decision-making process when using credit cards Identify ways and criteria needed to establish and obtain credit Introduction Credit is money that is lent to you and that you pay back over time, usually with interest. Credit allows you to buy now and pay later. Credit cards influence the way consumers purchase goods and services. In 2000, Americans charged 19% more than they did in 1999, and the number of credit cards in this country rose another 11%. Owning multiple credit cards is becoming commonplace. The April/June 2000 issue of Business and Economic Review reported that the average American household owns an average of 14.7 bank, store, and debit cards and carries an unpaid balance of $5,900 on these cards. Despite the widespread use of credit cards, many consumers do not fully understand the terms, interest rates, or added charges attached to their credit cards. To test your students' Credit Card IQ, you'll find a quiz at What's Your Credit Card IQ? (See Materials section.) Each year, the number of Americans who use credit cards increases. According to USA Education, Inc., 32% of high school students and 95% of college students had at least one credit card in Students must understand that when they use a credit card, they are taking out a loan from the issuer of the card. If the amount owed on a credit card is paid in full each month, there is no cost for using the credit card. However, if the borrower is unable or unwilling to pay the credit card bill in full, the cardholder must pay interest (finance charge) on the unpaid balance. The finance charge increases the cost of goods and services purchased with a charge card.

2 Materials If you are using computers in class, you will click on A Real-Life Decision. Otherwise, print out enough hard copies of this link for the entire class. Do the same if you are using What's Your Credit Card IQ? as a test at the end or beginning of the lesson. Procedure 1. Explain these terms: (1) Opportunity cost. The opportunity cost is the value of whatever you give up when you purchase an item with a credit card a) your future income is now reduced by the price of the item just purchased; you cannot use that portion of your future income to buy something else; b) your future income is now reduced by the cost of the interest too; that is more future money that you cannot use to buy something else. (2) The collective cost of using credit. This phrase refers to the ongoing accumulation of interest on unpaid purchases. If you continue to purchase goods or services with a credit card without paying the entire balance each month, a finance charge is computed and added to next month's balance. Interest that piles onto an existing balance increases the cost of the items purchased. (3) The use of credit cards for purchasing consumable goods. Generally, using credit cards to purchase consumable goods means that you could "use up" the purchase before you pay off the loan. This is true for living expenses such as groceries, gasoline, and restaurant meals. If you don't pay off your bill at the end of the month, you'll pay even more for something that's "gone already." However, if you pay off your bill at the end of each month, you won't be paying an additional cost for the consumed item. (4) Durable goods. You should investigate installment loans to finance large purchases, such as automobiles or appliances. The interest rates on these loans are generally lower than rates for credit cards. 2. Ask students, "Why don't people analyze all the cost(s) of using credit before they make a purchase?" List student responses on the board. 3. Distribute copies of articles Using Credit Cards and Using Credit Wisely. 4. Give minutes for students to read them silently and to highlight and areas that they would like to discuss or that they have questions on. 5. Discuss the articles and then divide students into small groups. If you are not working online, distribute hard copies of A Real-Life Decision. Discuss the situation. Then ask students to create their own examples and ask each other to fill in the boxes in the decision-making process. 6. Ask each group to present their situations and discuss them with the class. 7. Summarize the benefits and costs of using credit cards. Some Facts for Class Here are some disturbing numbers. The marketplace urges teens to spend because it's fun and satisfying. To offset that message, teens need a reality check. These numbers provide some food for thought: Teens will soon surpass the number of adults shopping online, according to Jupiter Communications. Online spending by teens and kids will reach $1.3 billion by Studies of the teen market show that o Boys spend an average of $70 on themselves per week o Girls spend $64 a week o Latino girls spend $400 a month on beauty products

3 Source: "Wooing teens to buy on line has e-tailers seeing green," Discount Store News, April 3, Baylor University marketing professor, James A. Roberts, told an audience at Baylor that o "The country's savings rate dropped to a negative 1.3% during the third fiscal quarter of But one of the most disturbing trends we are seeing is an elevated level of compulsive buying passed from the Baby Boomers to Generation X and ultimately to Generation Y. Compulsive buying is blossoming, if you will, in each subsequent generation, and that's not good." o Roberts also made this point: Credit cards are driving America's buy-now, pay-later mentality. "And worse yet, what we're finding is that marketers are focusing on younger and younger prospects. Certainly college students are major targets, and now so are high school students. The results of several experiments show that college students, when making purchase decisions, are more likely to buy and pay more for certain products when a credit card logo is present. o Roberts added that Internet taps into compulsive buying, "It represents the best and worst of both worlds. The ability to use credit cards 24 hours a day, 7 days a week. Fast food chains, like Wendy's and McDonald's, report that the cost of orders purchased using credit cards average 50% more than orders for which customers pay by checks or cash. Standards: Standard 3: Economic Systems Understand the importance of management of personal finances Standard 3: Data Analysis, Statistics, and Probability Use experiments or simulations to determine probabilities Standard 2: Students engage in the reading process Use prior knowledge and experiences to aid text comprehension Source: "Americans are 'spending' themselves into unhappiness," Baylor Business Review, Spring "The long and winding road," Credit Card Management, May Using Credit Cards Credit Cards are a great concept but they end up bringing financial ruin to many people because they do not use them properly. Too many people get a credit card and then find that it is maxed out within twelve months. Then for the rest of its existence they end up paying off interest and barely making a dent in the principal. This is not a good way to manage your money. Let s go over some of the benefits credit cards offer before we get into their detriments. A credit card can be a great convenience and provides the safety of not dealing with cash, which is more easily lost. Credit cards are also very useful in the sense that they offer protection under the Consumer Credit Act and you can often get your money back in a fraudulent purchase that you would be unable to do with any other payment method. Credit cards also offer incentive benefits such as air miles or credit toward future purchases. Credit cards also give back a percentage of your purchases to approved charities in some cases which is a really nice way to give back at the same time you are spending the money you normally would spend. Therefore there are most certainly benefits for using a credit card.

4 Given all of the above, credit cards still cause problems for most people more often than they provide benefits. Most of these problems come in the form of excess consumer debt, which arises when one carries a balance on the credit card while paying the absolute minimum each month. These problems occur when one begins looking at the credit line of your credit card as simply bonus money that you now have to spend. Instead you need to allocate existing funds for every purchase you make on a credit card. This way you know that you will be paying off that principal balance at the first of next month rather than carrying for your foreseeable future. Another problem that happens with credit cards is that people simply get too many of them. With the credit environment as it is today most people are barraged with new credit card offers practically every day of the week. And some people accept each one of those offers and end up with more credit cards than they know what to do with. With increased numbers comes increased temptation. When you have a multitude of credit cards it becomes much easier to talk yourself into carrying a balance on one of them. This is not a good idea, as discussed earlier. You also need to be wary of signing up for credit cards. While, most are legal, some companies are really towing the line between legal and not legal. Watch out for companies who charge a membership fee or have a substantial charge for late fees. So what is the correct way of approaching and dealing with credit cards? Rule #1 Never use credit cards as extra money. Always allocate money from your current funds or monthly income in order to pay whatever you finance off immediately. Rule #2 Read the fine print. Too many people simply accept the offers sent to them in the mail without reading the details of the interest rate and credit terms. While it may seem insignificant on first look over time it can create a negative financial situation for you very easily. Read the print and make sure you get the best terms available.

5 USING CREDIT WISELY Society has for decades now promoted the notion of buy now, pay later. Madison Avenue has also contributed to this feeling of entitlement by letting consumers know though their clever advertising campaigns that each of us deserves the very best and we deserve it right now, even if we can t quite afford it. Here, you will learn why we have such poor credit habits, and what we can do to use credit smartly, and wisely. Why do we have a history of poor credit habits? Much of this feeling came into play following World War II. The American people had long been denied some of the luxuries of life. Even some basic staples such as oil and nylon for hosiery were restricted as these materials were needed for the war effort. When the war ended and the baby boom began, so did an era of luxury where everyone was buying their dream home and filling it with television sets and the latest deluxe appliances. Automobiles were catering to the family and a sense of style, and the advertising that went along with these items convinced everyone that they deserved them right now. Credit has made many good things possible for people who are working hard each day to provide for their families. In many other countries around the world home ownership is only for the very wealthy because there are no mortgage lenders. This so called American dream is one of the best benefits from a system of credit. However, there are many pitfalls when it comes to credit. One step in the wrong direction can not only ruin your credit rating, but could perhaps in the long run, put you and your family out of your home. Here are some guidelines for getting smart about credit: Buying a House The general rule of thumb among financial advisors is that buying a primary residence even on credit is a smart move. Home values quickly rise and in no time at all you will have created a nice little nest egg. In choosing how much to borrow, banks will often push you to the limit of what you think you can afford. Realistically, you should not spend more than about 25-28% of your income on housing, including taxes and insurance. If you can afford a loan that is shorter than 30 years or make a little extra payment on the principle each month, then you are even better off. Paying for Education Secondly, financing an education is a good investment in the future. Your earning potential will eventually outweigh the cost of tuition, and educational loans are usually very low interest. In addition, with most student loans you do not need to begin making payments until you have graduated or stopped going to school. Again, paying it off as quickly as possible upon graduating is the best scenario.

6 Buying a Car Finally, your primary mode of transportation to and from work a car -- is an item many people need to finance. It is easy to get caught up in buying more car than you can afford. A new car loan however should be kept under 5 years, and under 3 for a used car. This payment should not be more than 10-15% of your income or you could run into trouble trying to pay for it. Remember also that the higher the price and value on the car, the higher your property taxes and insurance will be. Credit Card Debt Finally, there is credit card and other consumer debt. This is the worse type of debt of all. Interest rates on borrowing money this way will be the highest of any, mostly because there is rarely a tangible item as collateral against it. The lender can t take back that expensive meal at the city s finest restaurant if you don t pay the bill. If you must use credit for a vacation, furniture or other seemingly must have now items, then the general rule is don t charge or finance anything you can t afford to pay off in a year or less. It is also important to pay at least the minimum payment due PLUS the interest payment, or it could take you as long as 30 years to pay for that dinner out!

7 Try a Real-Life Decision Buy it? Pass it up? Charge it? These are the questions that should occur to you each time you are thinking of buying something. How do you decide? You should ask yourself a series of questions to test if and how to make the purchase. What Would you Do? Kirsten is a high school junior. Her parents gave her a credit card, but she is supposed to use it only for emergencies. She is in the mall one day and sees the perfect dress for prom in a store window. The price tag reads $125, but the store is running a One-Day-Only Sale, all items are 25% off the ticketed price. Kirsten's grandmother, a dressmaker, has offered to make Kirsten's prom dress, and Kirsten has only $50 in her savings account. What should she do? What is the need? What are all the alternatives? What's the money situation? What are the benefits of charging the purchase? What are the disadvantages of charging the purchase? A prom dress Buy the dress Don't buy dress wear the dress that Grandma sews. Call home and talk about it. Look for another dress. Doesn't have the money in her wallet to buy the dress; she'll have to use the credit card. The dress is on sale. The "sale" dress costs more than twice what Kirsten's has now in her spending money budget. Even though the dress is on sale, Kirsten will have to pay finance charges on the dress until she pays it off. Her grandmother can make a dress for the cost of the fabric. Under $35. Grandma's feelings may be hurt. Weigh the advantages against the disadvantages Kirsten will be using the credit card for other than an emergency her parents may be upset. What would you do? It may be easy for you to see what Kirsten should do. There are lots of disadvantages. In fact, there's no real advantage for Kirsten except that she loves the dress. You see that clearly because you're on the outside looking in you're not emotionally involved in the purchase. Kirsten may want to deny the answers that stare her in the face because she WANTS the dress. Remember that when you find yourself in a similar situation. Anytime you are thinking of making a purchase, run through these questions. If you answer them honestly, they will help you combat your impulses and make a good decision. Want to know more questions to ask yourself before buying?

8 What is Your Credit Card I.Q.? 1. Credit cards are accepted as cash by stores. 2. Most credit cards have a credit limit. 3. If I pay my credit card in full by the due date, I will not owe any interest. 4. There's no penalty if I pay my balance after the due date. 5. If I pay the minimum monthly payment, then I won't owe any interest. 6. Credit card companies charge merchants a percentage of the price of anything purchased with a credit card. 7. My credit report contains information on bills I have not paid.

9 Credit Card I.Q. Key 1. Credit cards are accepted as cash by stores. That's right! Credit cards are a type of loan. You borrow money from the bank. The bank pays the store. 2. Most credit cards have a credit limit. That's Right! Card holders may charge only up to a certain dollar amount set by the card company. The limit is set based on your ability to handle debt. 3. If I pay my credit card in full by the due date, I will not owe any interest. That's right! If you pay the entire balance within the grace period allowed (usually about 28 days), you will not owe any interest on your purchases. 4. There's no penalty if I pay my balance after the due date.. Credit card companies charge late fees to card holders who do not pay their bill by the due date. Not paying your bill on time can be costly. Most credit card companies charge $25 or more to credit card users who fail to meet their deadlines - regardless of whether you pay the minimum due or the whole balance. In fact, you could pay a $35 penalty fee on a $15 balance. 5. If I pay the minimum monthly payment, then I won't owe any interest.. After you subtract the minimum payment from your balance, finance charges will be added to your remaining balance. So avoid the minimum payment trap. Pay your bill in full, or as close to in full as you can. The minimum payment is the least amount of money you can pay if you want to keep using your credit card. If you pay less than the minimum payment, the credit card company will often "turn off" your card so that it cannot be used to buy anything more. The card will not work again until you have made your minimum payment. 6. Credit card companies charge merchants a percentage of the price of anything purchased with a credit card. That's Right! When you use a credit card to make a purchase, the credit card companies charge merchants a percentage of the sale. 7. My credit report contains information on bills I have not paid. That's Right! Actually, your credit report contains a lot more than that. It contains some vital non-credit facts such as your name, nicknames, maiden name, marital status, spouse's name, social security number, year of birth, current and previous addresses, current and previous employers, and estimated income. Plus, it contains detailed information for each credit account you hold, including the type of account, when it was opened, the credit limit or loan amount, the balance you still owe, and whether you have been late with any payments. It also includes information such as lawsuits, bankruptcies and liens against your property. It also contains a record of all the people who have requested copies of your credit report in the past 6 months.

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