Remember the Interest

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1 STUDENT MODULE 7.1 BORROWING MONEY PAGE 1 Standard 7: The student will identify the procedures and analyze the responsibilities of borrowing money. Remember the Interest Mom, it is not fair. If Bill can have a new truck, why will you not let me have one too? His parents love him more than you love me. Otherwise, you would buy me a new car. I hate driving Dad s old car. It IS NOT fair. I want a truck. All my friends have new trucks, and I want one too. Alright, Rik. If you want a new truck, go pick out one, and we will see how much it really costs to buy that new truck. Rik went online to customize the one he wanted. It was only $28,800 suggested price, with a $2,000 rebate. Lesson Objectives Explain why people borrow money. Identify the rights and responsibilities of borrowing money. Demonstrate appropriate situations to borrow money. Evaluate the impact of borrowing money. In 72 months, he figured he could pay it off at $375 a month ($26,800/ 72=$347). If you add a little for interest, it would be about $375. Is Rik right?

2 Student Module 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 (i.e., 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 (i.e., 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.

3 Student Module Introduction People borrow money for many reasons: to buy a car or a house; to remodel their home; to pay for college expenses; to open a business; and, in some cases, to pay their bills. Borrowing money allows us to get what we want today or to pay for things when we do not have enough cash. While that sounds great, we must remember that borrowed money must be paid back. Making poor decisions about loans can affect our finances for a long time. Borrowing money does not mean that we have more money. In fact, it is the opposite. Borrowing money means we are using tomorrow s income to buy things today. If we are not careful, we will borrow too much leaving us with a big stack of bills and no money to pay them! Lesson A ll choices have costs, and that is certainly true when borrowing money. In most cases, borrowing money involves getting a loan; in return, you promise to repay that loan. The amount you repay, however, is not just the amount you borrowed. It also includes interest. Depending upon the rate of interest and the amount of the monthly payment, it could increase the price of your purchase by double, triple, or even more. Interest is payment for using someone else s money and is stated as a percentage. The percentage charged is the interest rate. Interest and other fees increase your cost of borrowing, but they also make it possible for lenders to stay in business. U.S. Debt Consumers in the United States have $950 billion in credit card debt as of March 2008, and $1.6 trillion in auto loans and other nonrevolving debt. People who lend money expect more in return. For them, lending money needs an incentive, and that incentive is getting back more than they lent to you. The additional amount is generally called interest.

4 Student Module Why People Borrow Money People borrow money for many reasons; some reasons are better than others. How do you decide what is a good reason and what is not so good? The answer is this: It depends. To make a good decision about when to borrow, you need more information. Today, people make hundreds of loans every day from a variety of lenders, including banks, credit unions, insurance companies, mortgage companies, and other financial service providers. People also borrow thousands of dollars daily using their credit cards. Every time you use a credit card, it is a short-term loan from the company providing the card. Like other loans, it must be repaid with interest. If you have to pay interest and fees that increase your costs, why do you borrow? The answer is relatively simple: You borrow because you want or need a way to make purchases. For many people, borrowing is the only way they are able to purchase items such as cars and houses. Following are a few examples: A mortgage allows you to buy a home. A refinance loan lets you replace the original mortgage with a loan at a lower interest rate. A personal loan gives you cash for an emergency, to make special purchases, to fund a vacation, to make home repairs and for other purposes. A student loan provides money to pay for a college education. A home equity loan is money borrowed against the equity you own in your home and can be used for anything. An auto loan can help you buy a car. In the box below, rank the above reasons that people borrow money starting with the best reason and ending with the worst reason

5 Student Module Does your ranking look something like this? Home loan: A house tends to increase in value and will be worth more when we want to sell it. Student loan: Investing in ourselves or our children with a college education increases potential earnings. Refinance loan: Refinancing a mortgage reduces monthly payments and saves money in the long-run. Auto loan: Even though most of us get a loan to pay for a car, we would be much better off to save up the money and pay cash avoiding the extra interest paid on something that declines in value. Home equity loan: Borrowing against your home is high risk, unless you are remodeling or making major repairs. What if you borrow money on your home to pay for a wedding, take a big vacation, buy new furniture or spend it on other purposes then cannot make the payments? You may actually lose your home and have no place to live. Personal loan: Saving money for emergencies, vacations, and other purchases is a much better option. Personal loans tend to have high interest rates, which greatly increases the cost of your purchase. As a general rule, you should borrow money when you are investing in the future not just to buy something you want now. Borrowing to make minor purchases is a sure way to overspend or generate more debt than you can manage. Rights and Responsibilities of Borrowing Money Each loan has some kind of loan agreement, a special type of contract requiring both the borrower and the lender to do exactly what is stated in the document. Whether it is a credit card, a mortgage, an auto loan, or any other kind of loan, the loan agreement specifies the rights and responsibilities of both parties. Before deciding to borrow money, the wise borrower will comparison shop to evaluate the different terms of the loan as specified in the loan agreement. Some of the basic components of a loan agreement include: Amount the exact amount you are borrowing; Interest rate the rate of interest you will be charged; Borrowing Rule No. 1: Do not sign any loan agreement unless you read it carefully and understand everything in the agreement.

6 Student Module Payment the exact amount you are required to pay back to the lender and how frequently that payment should be made (weekly, monthly, annually, etc.); Prepayment a special clause that allows you to make additional payments and pay off the loan faster; Late fees the additional amount owed if you are late with a payment; and, Default what happens if you fail to make the payments. Depending upon the type of loan, it will include other terms or conditions. Different kinds of credit While there are many different types of credit accounts, there are only four types of credit: secured credit, unsecured credit, installment credit, and noninstallment credit. Secured credit is backed by collateral. In other words, you pledge something of value to the lender who can seize and sell it if you fail to repay the loan. Some items that might be used as collateral include cars, real estate, jewelry, investments and other assets that are acceptable to the lender. Because you have pledged something as collateral, the lender has less risk in getting something in return for the loan. As a result, secured credit is often the easiest credit to obtain. A home mortgage and a car loan are common examples of secured credit. Unsecured credit means the lender loans you money based on your willingness and your ability to repay the money. Because you pledge no collateral, the creditor is taking a greater risk of losing the money if you do fail to repay it. The lender must have more confidence in you as a person and your credit history before lending you money. Unsecured loans are based primarily on how you have managed money in the past and in your current financial situation. If you fail to repay the loan, the lender can sue and take you to court. You would be required to pay the money if the court finds you guilty and orders you to either pay or requires you to turn over some asset to offset any money the lender does not receive. Installment credit can be either secured (requiring collateral) or unsecured (no collateral). Installment credit requires you to make periodic, regular payments for a certain period of time to repay the full amount of your loan plus interest. Sometimes installment credit is called open ended or revolving credit, where each payment reduces the amount owed and allows you to borrow more. Common examples include auto, personal, and education loans. Noninstallment credit can also be secured or unsecured. This type of credit requires you to pay back the entire amount by a specific date. For example, your cell phone bill says payable in full upon receipt. That means, you owe the entire amount at

7 Student Module one time. Bills from the cable company or your doctor are types of noninstallment credit accounts that require lump sum payments. Financial Impact Making one or two payments monthly will probably not cause too many problems for your budget. However, when you continue borrowing from many different sources, the amount of debt can rise very quickly. It sounds good when the local Buy Me Now store advertises a new DVD player for only $10 a month. But that $10 on top of other monthly payments may be more than you can handle. If you have too much debt, then it becomes very difficult to make your monthly payments. Missing payments or making late payments has a negative effect on your ability to get additional credit when you really need it. Also, you will probably end up paying even higher interest rates and more late fees than people with good credit. COMPLETE: Borrow, Do Not Borrow Activity Ask your teacher to review your answers before continuing with this lesson. List three things you learned from this activity:

8 Student Module Conclusion Learning when to borrow and when NOT to borrow will improve your financial future. If you buy everything on credit, you are reducing the amount of money you will have available for future purchases. Before borrowing, stop and think about how many hours you will need to work and how many years it will take to pay off the loan. Borrowing money is based on a contractual agreement. Failing to make payments or defaulting on a loan will have a longterm negative impact on your ability to get credit for many years. Even buying things on sale is more expensive when you borrow to buy them. Depending upon the terms of the loan agreement, you may end up paying more for the sale item than when making the purchase for cash at the full price. If you disagreed with Rik s computations, you are right! When Rik talked to the new truck manager, he could not believe the payments would be $100 more than he calculated. How can that be right? $475 x 72 is over $34,000. Even though the truck price was $26,800, Rik had to include interest on his loan payment. If he lowered his payments to $375 a month, he would need to make payments for 8 years and the total cost of the truck would be more than $37,000. Rik decided that driving Dad s old car was not so bad after all -- at least for awhile.

9 Student Module Name: Class Period: Remember the Interest Review Lesson 7.1 Answer the following questions and give the completed lesson to your teacher to review. 1. Differentiate between secure and unsecured credit. 2. Discuss some of the reasons that people borrow money. 3. What is a loan agreement, and why is it important?

10 Student Module Name: Class Period: Borrow, Do Not Borrow Activity Read the following statements and decide whether you should borrow or not borrow to complete the transaction. 1. With the move to high-definition television, you decide to buy a new flat screen HDTV for your room. Borrow Do Not Borrow Why? 2. You have taken a summer job and need reliable transportation, so you decide to buy a used car. Borrow Do Not Borrow Why? 3. You are at the mall with friends and see a new pair of boots, but you do not have enough cash to buy them. Borrow Do Not Borrow Why? 4. You friend Harold just bought a new skateboard, so you want a new one too. Borrow Do Not Borrow Why? 5. You have just graduated from college and have a new job. You have enough money for a down payment on a house, but need a loan to buy a house. Borrow Do Not Borrow Why?

11 Student Module You have maxed out your credit card, so you are considering getting a loan to make your payments. Borrow Do Not Borrow Why? 7. Your friends are going on a special trip to celebrate graduation, but you do not have the money to go. Borrow Do Not Borrow Why? 8. You receive a scholarship to go to your favorite college, but it is not enough money to pay all of your expenses. Borrow Do Not Borrow Why?

12 STUDENT MODULE 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 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. Lesson Objectives Identify potential sources of credit. Compare credit sources. Evaluate credit practices. Calculate credit costs. Demonstrate the ability to make good credit choices. Then, he asked Susan to the prom; she accepted, and he had more bills than expected. 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?

13 Student Module 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.

14 Student Module Introduction If you can think of something to buy, you can find a lender to provide the money! But, not all lenders are the same. With so many different types of lenders, borrowers have a lot of options. Finding the best lender can be challenging, and it can make a big difference in the total amount you pay for your purchase. Poor credit choices are very costly and can continue causing problems for many years. Lesson B orrowing money is serious business. When shopping for a loan, it is important to compare lenders. The type of lender you choose determines many of the terms of your loan agreement. Building a good relationship with your banker can be helpful in getting your loan. Traditional financial institutions such as banks and credit unions tend to have lower interest rates than other lenders. But that is not always the case. The qualifications for borrowing money vary from lender to lender. Knowing the characteristics and requirements of different credit sources will help you make better choices when looking for a loan. COMPLETE: Types of Lenders Activity Ask your teacher to review your answers before continuing with this lesson. In the box below, explain what you learned from this activity. Answer:

15 Student Module 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.

16 Student Module The APR does not reflect the total amount of interest paid in one year. Instead, it simply standardizes rates so you can compare them from one year to the next. The annual percentage rate (APR) is the effective rate of interest that is charged on an installment loan, a loan that is repaid with a fixed number of periodic equal-sized payments. Most loans from banks, retail stores, and other lenders are installment loans. Thanks to the Truth in Lending Act in 1969, lenders are required to report the APR in boldface type on the front page of all loan contracts. This law also requires lenders to disclose the terms and conditions of the loan when you borrow the money. Even with the legislation, APR can be calculated in different ways and can sometimes cause confusion. That is the reason borrowers should read all of the fine print before signing any loan agreements and ask questions until they are comfortable with the terms. It is too late for questions after signing the papers. Calculating Interest Rates on Credit Cards Credit card interest rates are generally computed on the average daily balance. The lender multiplies this amount by the periodic interest rate to calculate how much interest you owe for the month. For example, if your total of daily balances equals $3,000 for a 30-day period, your average daily balance is $100. If the periodic interest rate is 12% (1% monthly), your interest expense for the month is $1. Most credit card companies give you a grace period before adding interest to new charges. A grace period is usually about 20 days and may apply only if you pay your balance in full. Interest rates on credit cards range from very low (even as low as zero percent on special offers) to very high (over 25 percent). Because credit cards are open-ended, card companies can increase your interest rate at any time and for almost any reason. Most card companies will notify you about 30 days in advance if they are changing the terms, so it is important to read any information sent by your lender. If you choose not to CALCULATING INTEREST To determine your average daily balance, add your daily balances for each day in a billing period, which is usually 30 days. Divide by the number of days in the billing period. The periodic interest rate is the fractional amount of an annual interest rate. It is used to calculate interest for a period shorter than a year.

17 Student Module pay the higher interest rate, then you are expected to pay the credit card in full within those 30 days. Making Minimum Payments The minimum payment on credit card debt is a percentage of your current balance. The good news is that the minimum payment drops as your balance is paid; the bad news is that making only minimum payments means you will be paying a lot of interest for a long time greatly increasing the cost of the goods and services you purchased. Minimum payments on credit cards are determined by the credit card company and vary from card to card. Suppose you have a balance of $2,400 on your credit card; you pay 15 percent interest on the balance, and your credit card company requires a 2 percent minimum payment. To calculate your minimum payment, multiply the balance by the minimum payment percent: $2,400 x.02 = $48. $48 is your minimum payment. When making credit card payments, pay more than the minimum balance! When possible, pay off your credit card bill each month to eliminate interest charges. However, part of that payment goes to pay the interest and part of it goes to pay down the total amount of the purchases. If you divide your interest rate (15) by the number of months in a year (12) and multiply that by your balance ($2,400), you can determine how much of the payment is interest. (.15/12) x $2,400 = $30) Your minimum payment is $48, and your interest payment is $30, which means you are only paying $18 a month for the charges on your credit card. Next month, your balance will be $2,400 - $18, or $2,384. At this rate, it will take you 288 months to pay off your credit card, and you will have paid $3, in interest. 288 months is only 24 years!!! And, you can do it ONLY if you do not charge anything else on your credit card. Remember, other fees and charges may be added to your bill if you are late with a payment, exceed the maximum credit limit, purchase credit insurance, or other circumstances. Here is a good rule to follow: If you cannot afford to pay off your credit card bill each month, then rethink your decision to charge your purchase. Only you can weigh the cost of buying on credit against the benefit of having it today.

18 Student Module 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.

19 Student Module 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.

20 Student Module 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.

21 Student Module Sales Finance Companies Sales finance companies were formed to lend money to customers of an associated company. For example, Ford Motor Credit Company provides loans if you want to buy a vehicle at a Ford dealership. Oftentimes, sales finance companies offer borrowers special interest rates or financing offers to stimulate business at the associated company. In those cases, their loans tend to have lower interest rates than similar loans from banks or credit unions. Loans from sales finance companies are generally convenient and relatively easy to get, and unless they are offering special incentives, you may pay higher rates than borrowing from other sources. Life Insurance Companies While you may not think about borrowing from a life insurance company, it can be a good source of funds if you own a policy with cash value. Life insurance loans have relatively low interest rates compared to rates at other types of lenders. If you decide to borrow against your insurance policy, however, any unpaid loan amount will be deducted from the face value when disbursed to the beneficiaries. Brokerage Firms Brokerage firms are a source of credit for investors who have securities on deposit in a margin account. A margin account allows you to borrow money to buy stocks, but the funds may also be used for other purposes. The maximum you can borrow depends upon the market value of your investments and the amount the brokerage firm is willing to lend. You may also have to use your securities as collateral for the loan. Pawnbrokers Pawnbrokers offer short-term, single-payment loans secured by the personal property you leave with the lender. If you do not repay your loan and the interest by the due date, pawnbrokers can sell your property to get their money. While they provide quick access to cash for people with bad credit or with no other source of funds, borrowing from a pawnbroker tends to be extremely expensive because of the high interest rates they charge. Payday Lenders Payday lenders provide short-terms loans that will be repaid when you get your next paycheck. Generally, they are small loans for amounts between $100 and $500. However, the annual percentage rates are extraordinary sometimes as high as 400%! Payday lenders are often used by individuals who have no other options because previous credit problems and low credit scores. In addition, people without bank accounts or those using check cashing services may use payday lenders because they have no relationship with any other lender. Some people view payday loans as a predatory lending practice because of unfair or abusive credit practices; however, others say they serve a purpose for those without any other options.

22 Student Module 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.

23 STUDENT MODULE 7.3 BORROWING MONEY PAGE 1 Standard 7: The student will identify the procedures and analyze the 3 responsibilities of borrowing money. Your Credit Score Julie did not understand why she was turned down from her loan application. She had several friends with more credit cards than she had. They all laughed about missing payments, even though they sometimes worried about all of those late fees. Julie decided maybe she would not worry either. She would go borrow money where they did. If they could get credit, so could she. Lesson Objectives Describe the purpose of a credit report. Define the role of credit scores. Explain the importance of a good credit score. Susan knew she had missed a couple of payments and that her debt was mounting. She had borrowed too much money, and she was getting concerned about her FICO credit score. When she got a copy of her credit report, she knew she was in big trouble. Her score was only 450, so she began taking immediate steps to improve her credit score for the future. Who was right? Julie or Susan?

24 Student Module Personal Financial Literacy Vocabulary Credit bureau: An establishment that collects and distributes credit history information of individuals and businesses. Credit history: A record of borrowing and repayments. Credit report: An official record of a borrower s credit history, including such information as the amount and type of credit used, outstanding balances, and any delinquencies, bankruptcies, or tax liens. Credit score/rating: A measure of creditworthiness based on an analysis of the consumer s financial history, often computed as a numerical score, using the FICO or other scoring systems to analyze the consumer s credit. FICO: The most commonly used credit score. The name comes from the Fair Isaac Corporation, which developed the scoring model. Introduction When people apply for loans, lenders want to be sure they will repay the money. Most lenders rely on a person s credit score to make this decision. Lenders use credit scores to determine the level of risk associated with loaning money to that person. Credit scores are based on information gathered by credit bureaus and placed in a credit file. Lesson M ost lenders know very little about you when you apply for a loan. However, they must make some conclusion about your ability to fulfill the terms of the loan agreement and repay the money you borrow. To help them make this decision, they tend to rely on your credit history. Your credit history is simply the way you have handled other loans and payments. It includes every application you have made for a loan, a charge account, or a credit card, along with the amount of credit you have, your required monthly payments, and other information about you. Lenders want to be sure you have not borrowed so much money that you cannot pay your bills, and they want to see whether or not you pay your bills on time.

25 Student Module Your credit history is compiled into a report by a credit bureau who provides information to lenders and others who need information about you. A credit bureau is a business that specializes in gathering information from various sources. Your credit file may also include information about your income, your work history, and any legal actions taken against you. Credit bureaus use the information to develop a credit score based on five major factors: your credit history, your current level of debt, how long you have used credit, the types of credit you have, and how often you apply for new credit. The most important factor is your ability to pay your bills, or how you have managed credit in the past. Second is how much debt you have currently. Following is a percentage breakdown of the credit scores and a pie chart that shows those percentages: 1) Your credit history 35% 2) Your current level of debt 30% 3) How long you have used credit 15% 4) The types of credit you use 10% 5) Your pursuit of new credit 10% Credit Scores Previous Credit Current Debt Time Credit Used Types of Credit Pursuit of New Credit Source: Lenders in the United States rely on three main credit bureaus: Equifax, Experian, and TransUnion. Lenders pay a fee to one or more of those bureaus to get your credit file and make their decisions based on your FICO score. FICO stands for Fair Isaac Corporation which developed a special software program to rate your

26 Student Module creditworthiness. Because the information reported to each credit bureau may differ, you actually have three FICO scores, one from each credit bureau. FICO scores are designed to help standardize the way lenders make decisions and give consumers more information about their ability to access credit. While your FICO score is important, it only reflects the information on your credit report. Lenders may also look at many other factors before making a final decision, such as your income, how long you have worked at your job, the kind of credit you are requesting, and any other characteristics that give them a complete picture of your ability to repay the loan. What Difference Does It Make? Your credit score impacts more than just your ability to get credit. It may determine whether or not you get a job or can rent an apartment. It also plays a major role in the rate of interest you are charged when you borrow money. A higher credit score shows you are a good money manager; you pay your bills on time; you are a responsible consumer; and you show maturity in your actions. The best way to improve your FICO score is to pay your bills on time and reduce your debt. Low credit scores show the opposite, indicating that you are a high risk as a potential borrower, renter, or employee. FICO scores range from a high of 850 to a low of 300. The higher your FICO score, the better! The table below shows how your FICO score affects the rate of interest and your monthly payment on a $150,000 mortgage. Your FICO Score Your interest rate Your monthly payment % $ % $ % $ % $ % $ % $1,024 Source: As you can see, people with lower scores pay higher interest rates and higher interest rates result in higher monthly payments. Why? People with higher scores have proven to be a better risk and more trustworthy when managing their money, so they are

27 Student Module rewarded with lower interest rates than people who have not been as reliable. Even though the table above stops in the low 600s, it does not mean people with lower scores cannot qualify for loans. Some lenders are willing to make loans to you regardless of how low your score may be, but you will definitely pay even higher interest rates and have higher monthly payments. In addition, most landlords and potential employers check your FICO score to find out how responsible you are. You can be turned down for a job or denied a place to live if you have a low score. One employer in Oklahoma City recently said they turn away four out of every ten job applicants because of low credit scores. Information NOT Included In Your FICO Score o Your race, color, religion, national origin, sex, and marital status. o Your age. o Your employer, job title, salary, or other employment history. o Your address. o Any interest rates you pay on other loans or credit cards. o Items such as child support or rental obligations. o Certain requests for your credit information, such as inquiries from potential employers or promotional offers such as preapproved credit card letters. o Any information not found in your credit report. o Any history of credit counseling. Negative or Inaccurate Information Negative information, such as late payments and loan defaults, stay in your credit files for seven years. Other information, such as bankruptcy, remains in your files even longer. Bankruptcy remains for a maximum of ten years; information about lawsuits or unpaid judgments remains seven years or until the statute of limitations expires, whichever is longer. If the information in your credit file is accurate, there is little you can do about it. However, if you believe the information is incomplete or inaccurate, you have a right to file a dispute with the credit bureau. Disputes can be filed online, by phone, or by certified letter. Both the credit bureau and the company providing the information are required by law to investigate any disputed information. If the information is inaccurate, they are also required to correct it. Even though the dispute might not be resolved to your satisfaction, you can send the credit bureau a statement explaining your side of the

28 Student Module story and ask them to provide a copy of your statement to anyone requesting information about you. However, you may have to pay a fee for this service. Before applying for a loan, it is highly recommended that you check your credit report. Getting a copy of your credit report gives you the opportunity to review what is reported and to check it for errors. You are allowed to receive one free copy of your credit report from each credit bureau annually. You can also receive a free copy of your credit report any time you are denied credit, insurance, or a job based on your credit history. Conclusion COMPLETE: Making a Loan Activity Ask your teacher to review your answers before continuing with this lesson. Your credit report is one of the most important sources of information that others use to make decisions about your creditworthiness. The information contained in your file can help determine whether or not you qualify for a loan, a job, an insurance policy, or even a place to live. The best way to maintain a positive credit history is to control your level of debt and pay your bills on time. While Julie may be able to still get credit, she will definitely be paying higher interest rates and higher payments. Susan, however, starting shredding all of the credit applications she received in the mail. She set up her bills for automatic payment from her checking account, and she quit spending until she could get a handle on her debt. When possible, she is making extra credit card payments instead of eating out every day with her friends. It will take a little time, but Susan is well on her way to improving her FICO score. Her disciplined behavior will result in lower interest rates and lower payments in the future. Way to go, Susan!

29 Student Module Name: Class Period: Your Credit Score Review Lesson 7.3 Answer the following questions and give the completed lesson to your teacher to review. 1. Explain the role of a credit bureau. 2. What is a FICO score, and why do lenders use it? 3. Why do people with high FICO scores pay lower interest rates than people with low FICO scores? 4. What should you do if you find inaccurate information in your credit report?

30 Student Module Name: Class Period: Making a Loan Activity Each of the following individuals has applied for a $10,000 loan. Would you loan the money to them? Why or why not? Matt Age 20 Merideth Age 18 Al Age 25 Matt started working at a local auto parts store when he graduated from high school. He had a credit card, but lost it and never got another one. He rarely used it and has no other credit. He listed his favorite teacher and his boss as references for the loan. He has a checking account with a low balance, lives at home with his parents, and has no savings account. He makes a $200 monthly car payment. He wants to use the money to invest in a new business. Merideth lives at home but is planning to get married this summer. She wants to use the money to help pay for the wedding because her parents have limited funds available. She has a good job, has a good credit history, and has never been late with a payment. Her future husband is unemployed, and she helps pay his bills. Al dropped out of college to work because he got into debt with credit cards. He has been working to pay off the bills, and his credit score is improving as his debt drops. He has lived in an apartment with a friend for five years, has a $25,000 loan on his truck, and makes good money working in the oil fields. He recently opened a savings account and has a retirement fund with his employer. He wants to buy a motorcycle to reduce his gasoline payments. Yes or No Explain: Yes or No Explain: Yes or No Explain:

31 Student Module Rhoda Age 30 Rhoda just recently bought a house and wants to borrow money to remodel it. She has a great job as an assistant to the president of a big company. She has one credit card, makes her payments on time, and has an excellent credit report. She owns a small house not far from work so she can walk everyday. She bought a new car five years ago, and it is now paid off. Yes or No Explain:

32 STUDENT MODULE 7.4 BORROWING MONEY PAGE 1 Standard 7: The student will identify the procedures and analyze the 3 responsibilities of borrowing money. Consumer Credit Legislation Jenna was furious. She could not believe what she read on her credit card statement. The card company had raised her interest rate. Mom, look at this. What am I going to do? This new interest rate raises my payments so high that I am not sure I can make the minimum payments any more. And they did not even tell me they were raising the interest. How can they do that? Lesson Objectives Explain key legislation related to consumer credit. Apply consumer credit legislation to specific credit problems. Jenna, are you sure you read everything they sent you? Well, I think so. Mom told her to check out the consumer protection laws to see if there was something that applied to her situation. Jenna looked again at her statement. I really cannot believe this. Given the laws, what can Jenna do if she is correct?

33 Student Module Personal Financial Literacy Vocabulary Consumer credit legislation: Any law that is designed to protect consumers, especially by assuring that consumers have access to accurate information about products and services related to financial transactions. Introduction The commitment to consumer legislation began when Congress passed the Consumer Credit Protection Act of As the economy became more complex and more people relied on credit, additional laws were passed to reduce the problems and the confusion for consumers. Lesson Several state and federal laws have been enacted to protect the rights of consumers. Some of these include the Truth in Lending Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act, and many others. T he purpose of consumer credit legislation is protecting your rights as a consumer. They are designed to provide you with good information to help you make informed decisions about financial matters. Consumer protection laws cover a wide range of topics, such as privacy rights, unfair business practices, fraud, misrepresentation, and other consumer/business interactions. Most federal legislation is enforced by the U.S. Department of Justice or the Federal Trade Commission. Enforcement of state laws varies from state to state. In Oklahoma, most consumer credit laws are enforced by the Oklahoma Department of Consumer Credit and the State Attorney General s Office. Following are some of the most important federal laws impacting consumers. The legislation is listed in chronological order, starting with the earliest legislation passed in After reading a summary of each consumer law, identify at reason you believe this legislation is important. Truth in Lending Act (1969) requires all lenders to inform potential borrowers about the cost of borrowing money, including finance charges and the annual percentage rate. Finance charges (all charges to borrow

34 Student Module money, including interest) and the APR must be placed on the forms that borrowers will sign. The law also outlines criminal penalties for lenders who knowingly and willfully violate the law. In addition, the law protects you if someone else uses your credit card without your permission. If your credit card is lost or stolen and you report it to the company issuing the card, the most you have to pay is $50. This legislation is important because: Fair Credit Reporting Act (1971) outlines your rights with credit reporting agencies. The law sets limits on who has access to your credit file; requires outdated information be removed from your file; gives you the right to know what is in your credit report; requires credit bureaus and creditors to correct any mistakes reported on your file; allows you to dispute any inaccurate information; add a 100-word statement to your report to explain accurate negative information; and requires you to be informed about why you were turned down for credit. This legislation is important because: Fair Credit Billing Act (1975) covers problems with credit card billings on open-end credit accounts such as credit cards. You are required to notify the creditor of any errors within 60 days of receiving the first bill with an error. The creditor must contact you within 30 days that your notice was received and then investigate the potential error. They cannot take any steps to damage your credit rating while a dispute is pending. This legislation is important because:

35 Student Module Equal Credit Opportunity Act (1975) ensures all individuals have an equal opportunity to receive credit or loans. It prohibits lenders from discriminating based on sex, race, marital status, religion, national origin, age, or receipt of public assistance. Lenders cannot ask about your plans for having children or refuse to consider alimony or child support payments as income. It also says that you have the legal right to know why you are denied credit. This legislation is important because: Consumer Leasing Act (1976) requires lessors (people that lease something to another person) to provide you with uniform information about consumer leases. Originally a part of the Truth in Lending Act, the Consumer Leasing Act applies to leases for personal property under $25,000 and for more than four months. A long-term automobile lease is the most common type of lease covered by the act. This legislation is important because: Electronic Fund Transfer (EFT) Act (1976) explains your rights when mistakes are made with an ATM transaction or if your ATM card is lost or stolen. If you notify the bank in a timely manner, your bank must correct the mistake and not charge you for withdrawals made by someone else with your card. If you delay in reporting your card lost or stolen, however, you can be liable for up to $500, or an unlimited amount if you do not report the problem for more than 60 days. If a financial institution does not follow the provisions of the EFT Act, you may sue for actual damages (or, in certain cases when the institution fails to correct an

36 Student Module error or recredit an account, for three times actual damages) plus punitive damages of not less than $100 nor more than $1,000. You are also entitled to court costs and attorney s fees in a successful lawsuit. Class action suits are also permitted. This legislation is important because: Fair Debt Collection Practices Act (1978) prohibits debt collectors from engaging in unfair, deceptive, or abusive practices when collecting debts. Collectors must send you a written notice with the amount you owe and the name of the business owed. Bill collectors cannot call you if you dispute the bill in writing within 30 days unless they provide proof that you owe the bill. Also, collectors must identify themselves on the phone and can call only between 8 a.m. 9 p.m. unless you agree to another time; they cannot call you at work if you tell them not to. This legislation is important because: Fair Credit and Charge Card Disclosure Act (1989) is part of the Truth in Lending Act. It requires that all credit card applications include information on the card s key features and costs, including the APR, grace period, minimum finance charge, balance calculation method, annual fees, transaction fees for cash advances, and penalty fees such as over-the-limit fees and late-payment fees. Also, card issuers must inform customers if they make certain changes in rates or coverage for credit insurance. This legislation is important because:

37 Student Module Consumer Credit Reporting Reform Act (1996) is an amendment to the Fair Credit Reporting Act. It requires free credit reports for the unemployed, persons on public assistance, and fraud victims; the full name of anyone requesting a credit report within the past year; and credit bureaus to share corrections to your file. It also clarified when the sevenyear period for negative information begins and raised the limits on what information can be reported longer than seven years (jobs paying $75K or more and loans or life insurance of $150K or more). This legislation is important because: Credit Repair Organizations Act (1996) makes it illegal for groups to make false promises or claims about improving your credit history. About the only things they can do for you are the same things you can do for yourself. For example, they can get copies of your credit report and write letters disputing inaccuracies in your report if you give them access to your records. They really have no more power than you when dealing with the credit bureaus; however, they can provide these services for you if you are willing to pay them for it. Should you decide to use a credit repair organization, the act requires that you receive a contract before the services begin, and it prohibits them from charging you any fees until services are delivered. This legislation is important because: COMPLETE: Resolving Consumer Problems Activity Ask your teacher to review your answers before continuing with this lesson.

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