Filling Empty Pockets: Borrowing, Loans,
and Credit

Procedures for teachers is divided into five sections: Prep
-- Preparing for the lesson Steps -- Conducting
the lesson Extensions -- Additional activities

Prep Media Components

Computer Resources:

Modem: 56.6 Kbps or faster.

Browser: Netscape Navigator 4.0 or above or Internet Explorer 4.0
or above.

Personal computer (Pentium II 350 MHz or Celeron 600 MHz) running
Windows 95 or higher and at least 32 MB of RAM and/or Macintosh computer
running System 8.1 or above and at least 32 MB of RAM.

Software: Any presentation software such as Power Point or Hyperstudio
(optional). Microsoft Excel for student worksheets (optional).

Video Resources:

TV 411, Episode #10

Materials:

Students will need the following supplies:

Computers with the capacities indicated above

Notebook or journal

Pens/pencils

Calculators
(optional)

Teachers will need the following supplies:

TV and VCR

Board and/or
chart paper

Handouts
of Web resources if computers are not available in the classroom

Various credit card offers and advertisements from direct mailings, store
displays, etc, for use in Activity Two

Bookmarked sites:

TIP: Bookmark all of the Web sites used in the lesson and create a word
processing document listing all of the links to distribute to students.
Preview all of the sites and videos before presenting them to your class.

Practical Money Skills for Life http://www.practicalmoneyskills.com
With content for teachers, parents, and students, this Web site features
a variety of valuable resources to reinforce sound spending and saving
habits.

JumpStart Coalition for Personal Financial Literacy http://www.jumpstartcoalition.org
The JumpStart Coalition is an organization that promotes the personal
financial literacy of young adults. JumpStart has developed a set of
academic standards that cover income, money management, spending and
credit, and saving and investment.

Maryland Public Television: Sense and Dollars http://senseanddollars.thinkport.org/
This Web site, a teen-oriented resource of information related to a
responsible approach to spending and credit, is used in this lesson's
Introductory Activity.

FDIC - Money Smart http://www.fdic.gov/consumers/consumer/moneysmart/
Money Smart, a service of the Federal Deposit Insurance Corporation,
is an adult education program that builds financial knowledge and overall
"money skills."

To determine your students' starting salary for the budgets they prepare
in Activity One, refer to the Statistical Abstract of the United States:
2001, available from the U.S. Census Bureau, which lists average
salaries by state.

Begin the class by asking, “How do credit cards
work?” Conduct a brief discussion with students to determine
their level of knowledge regarding the mathematics of credit cards.
Some important topics that may be mentioned are:

Follow up with a brief discussion about what students
found. Then, move directly to Activity One.

Learning Activities:

Activity 1:
Budgeting, Saving, and Interest

Give the class an overview of the upcoming
lessons. Explain that during the next several class periods, students
will prepare a budget based on an annual salary and expenses. They
will then consider how much money is left over “for entertainment
and fun things.” Finally, they will consider the pros and cons
of delaying a purchase until enough money is saved versus buying an
item on credit.

Show the clip from TV 411, Episode 10,
that deals with a young couple consulting a counselor and preparing
a budget.

Distribute the Budget
Sheet Student Organizer, which gives a list of expenses that students
will have to consider in planning a budget.

Inform students of their annual salaries.
Allow students to say whether or not they plan to attend college.
The following table shows the average salaries for people with high
school versus college education.

Education

Salary

Income Tax

Monthly Pay (after taxes)

High School

$22,995

4,049

1,578.83

Bachelor’s Degree

40,478

7,479

2,749.92

NOTE: These figures represent national averages. In addition, they
represent the salaries of all employees, which are higher than starting
salaries. Adjust these numbers based on the economics of your region.

To determine your students' starting salary, you may refer to an excerpt
from the Statistical Abstract of the United States: 2001, available
from the U.S. Census Bureau, which lists average salaries by state.

Allow students to work in pairs. Give them
1-2 minutes to estimate the costs for various items on the list, and
then lead a discussion with the entire class about the cost of each
item; you may base your comments on the notes provided in the Guidelines
for Student Budget Sheets. Use this discussion to ensure that
students have reasonable estimates before proceeding to the next step
of the activity.

Have each pair create a monthly budget
based on the cost estimates discussed with the class. If reasonable
estimates have been used, students will need to make some tough decisions
about what they choose to spend their money on.

After students have created their budgets,
conduct a discussion in which students describe how they were able
to meet their expenses. The following are some questions you may wish
to ask.

“How did you decide on the amount to put in savings each
month?”

“After your basic expenses were covered, did you have
more or less money left than you thought you would?”

“How did you determine what ‘optional items’
to spend your money on, such as cable, CDs, and dining out?”

Elicit from students that sometimes it may be necessary to not purchase
something because of a lack of money. Continue the discussion to yield
that there are two ways to get the things you want—either by
saving enough to buy them or by purchasing on credit.

Discuss two common ways of purchasing on
credit.

Using a Credit Card: A bank or lending institution extends
a line of credit, and any amount charged must be paid back. If
the amount is not paid back immediately, the credit card user
pays interest.

Taking Out a Loan: Banks or lending institutions cover the cost
of a large expense, usually to cover an item like a car, boat,
or house. The borrower pays interest on the amount borrowed.

Ask students what the difference is between
using a credit card and taking out a loan.

The difference between a credit card and a loan is that a credit
card user does not have to apply for credit each time the card
is used. Provided the total balance on the card is below the user’s
credit limit, new purchases will be approved immediately.

Say, “At the beginning of class,
you mentioned a lot of the things you already know about credit cards
and how they work. Let’s take a closer look.” Show the
clip from TV 411, Episode 10, that discusses credit cards and interest
rates.

On the board or overhead projector, and
with the students’ help, define the following terms:

Borrow: To borrow is to take out a loan from a financial institution.

Credit: Credit is the borrowing capacity of an individual or
company.

Loan: A loan is an amount of money given by a financial institution
to a borrower. In return for the money, the borrower promises
to pay back the amount plus interest.

Annual Percentage Rate: Also known as the interest rate, the
APR is the percent interest that a borrower is charged.

Interest: The interest on a loan or a credit card is the amount
above the principal (or balance) that the borrower pays. The amount
of interest is determined by the annual percentage rate.

Compound Interest: A loan accrues compound interest when the
percent is based on the principal as well as on any interest already
accrued. For instance, a $100 loan with 5% annual compound interest
will accrue 0.05 x 100 = $5 in interest the first year, but then
it will accrue 0.05 x 105 = $5.25 the second year, since the interest
rate also applies to previous interest.

Simple Interest: A loan accrues simple interest when the percent
is based only on the principal. For instance, a $100 loan with
5% simple interest will accrue 0.05 x 100 = $5 in interest every
year.

Principal: The principal is the original amount that is invested
or borrowed.

Ask the following questions:

"Who gives credit, and why?" Elicit from students
that various entities (banks, finance companies, credit unions,
other lending institutions) give credit to customers to provide
a service and to make money.

“How do you obtain credit in the form of a loan or credit
card?” Elicit from students that an application must be
completed, and a person seeking credit must prove that they are
a good credit risk by demonstrating that they have collateral,
a wage-earning job so that they are able to make payments, and
a good credit history.

Say, “Before we go into too much
detail about how you can obtain credit, let’s take a look at
how banks and other institutions make money with loans and credit
cards.” On the chalkboard or overhead projector, display the
following problem:

If you put $1000 into a savings
account, and the bank pays you 3% interest, how much will you have
at the end of 1 year? If you re-invest the money (including the
interest), how much will you have after 2 years? After 3 years?
After 10 years?

Allow students 2 minutes to answer the
questions associated with that problem. Then, take some time to discuss
the solutions to the problem. The solution can be found in a variety
of ways.

Using Multiplication: The amount of interest can be found by
multiplying the interest rate by the amount invested. For the
first year, that gives 0.03 x 1000, or $30. For the second year,
the interest earned is 0.03 x 1030, or $30.90. For the third year,
the interest earned is 0.03 x 1060.90, or $31.83. Continuing in
this manner, students will find that $39.14 will be earned during
the tenth year, and the total amount in the account will be $1343.92
after 10 years.

Using a Calculator: By pressing 1000 [ENTER] on a calculator,
the value of 1000 will be stored. Then, pressing 1.03 [ENTER]
will give the amount in the account, including interest, after
1 year. Further, repeatedly pressing [ENTER] will give the amount
in the account after 2, 3, 4, or more, years. (This works for
two reasons. First, the calculator stores the previous result,
and hitting the [ENTER] key multiplies 0.03 times the previous
answer. Second, multiplying by 1.03 is equivalent to multiplying
the amount in the account by 0.03 and then adding that to the
amount already in the account. )

Using a Spreadsheet: Similar to the calculator, a spreadsheet
can be used to find the amount by using the formula NEXT = 1.03
* NOW. The table below gives the results generated by a spreadsheet.

Year

Amount in Account

0

$1,000.00

1

$1,030.00

2

$1,060.90

3

$1,092.73

4

$1,125.51

5

$1,159.27

6

$1,194.05

7

$1,229.87

8

$1,266.77

9

$1,304.77

10

$1,343.92

Emphasize the important point regarding
compound interest: When interest is compounded, the invested money
grows very quickly. In addition, use the example above to present
the formula for compound interest to students.
For 1 year: 1000 x 1.03
For 2 years: 1000 x 1.03 x 1.03, or 1000 x (1.03)^{2}
For 3 years: 1000 x 1.03 x 1.03 x 1.03, or 1000 x (1.03)^{3}
:
For t years: 1000 x 1.03 x 1.03 x 1.03 x … x 1.03, or 1000 x
(1.03)^{t}

This last expression result yields the generalized formula for compound
interest:

A = p * (1 + r/100)^{t}

where A is the amount after time t (years), p is the principal amount
invested, and r is the interest rate.

On the chalkboard or overhead transparency,
display the following problem:

The bank at which
you have your savings account lends your money to other people and
charges them 8% interest, compounded annually. If the bank lends
out the $1000 that you gave them, how much interest will they earn
in 1 year? In 2 years? In 10 years?

After 10 years, how much more will the bank have made loaning out
your money at 8% interest than you will have earned on the same
$1000 in interest at a 3% rate?

Have students use the formula for compound
interest to solve this problem. Give them 2 minutes to find the answers
to the questions.

When students have solved the problems,
briefly review the solutions. The following table shows the amount
of interest the bank will earn on $1000 at an 8% annual percentage
rate.

Year

Amount in Account

0

$1,000.00

1

$1,080.00

2

$1,166.40

3

$1,259.71

4

$1,360.49

5

$1,469.33

6

$1,586.87

7

$1,713.82

8

$1,850.93

9

$1,999.00

10

$2,158.92

After 10 years, the bank will have $2,158.92. After 10 years, your
$1000 will be worth $1,343.92. The difference—which is the bank’s
profit—is $815.

Explain that this is exactly why banks
lend money—because they make money in the process. They can
afford to pay interest on the money you let them hold because they
loan that money to other people at a higher interest rate. Explain,
however, that even though banks make a profit on the money you save
with them, you also make money in the form of interest. It’s
a mutually beneficial relationship.

Have students look at the budgets they
made, and, in particular, have them look at the amount of money they
allocated for savings. Have students consider how much money they’d
have in 5 years if they put their savings into an account that paid
3% interest.

Students may use a spreadsheet to perform this calculation. You may
refer to the Savings Account Worksheet
for a recommendation on how to set up such a spreadsheet. If students
attempt to complete this calculation on their own, note that the amount
of interest should be compounded monthly. Consequently, students will
need to use the formula A = p * (1 + r/100)^{1/12} to find the amount
of interest earned each month. The value t = 1/12 must be used since
there are 12 months in a year, and t represents the number of years,
not months.

Activity 2:
Credit Card Offers

Begin by setting up the activity. Explain
that a brief video will be shown involving credit card offers, and
students should take notes on the video. After the video is shown,
students will consider various credit card offers.

Watch the clip from TV 411, Episode 10,
in which credit card offers are discussed. Inform students to take
notes on the video, and encourage them to keep a list of terms they
don’t know.

Divide students into groups of 3-4. Distribute
several credit card ads to each group. In addition, have students
browse the Internet to find 1-2 additional credit card offers.

TIP: During the several weeks prior to this lesson, collect credit
card ads that you receive in the mail, and pick up brochures from
banks and lending institutions with credit card offers. In addition,
you may require students to bring in an ad that they or their parent(s)
receive in the mail; give students ample notice, and remind them the
day before that they will need to bring in such an ad.

Allow students to spend some time perusing
the ads and learning the associated vocabulary. Students should generate
a list of words that they cannot define. Using a dictionary, talking
with the students in their group, or asking the teacher, they should
attempt to define these words. After 5-10 minutes, bring the class
together for a discussion about the important parts of the credit
card ads. In addition to the words defined in Activity One, Part 11,
the following words should also be covered:

Annual Fee: An annual fee is a flat fee, paid once a year,
that a lending institution charges just for allowing a cardholder
to have a credit card.

Minimum Monthly Payment: If items are charged and the card carries
a balance, the lending institution will require the cardholder
to pay at least a certain amount each month. This minimum monthly
payment is usually equal to 2-3% of the balance, or $10, whichever
is more.

Due Date: The due date is the date each month when the minimum
monthly payment must be received by the lending institution.

Late Fee: If a monthly payment is not received by the due date,
a late fee is added to the bill and will become part of the following
month’s balance.

TIP: Based on the list of words that students generate and define,
you may wish to create a “credit dictionary” containing
all of the words that students should know, their definitions, and
examples. Let the class supply the content for this dictionary --
your role as facilitator can be to oversee the production and distribution
of the dictionary to the class.

Conduct a brief discussion that explains
how the credit card billing cycle works, and how students can get
in trouble using credit cards. For instance, explain that the minimum
monthly payment is generally small, but that it will take quite a
while to pay off a balance if only the minimum is paid each month.
In addition, making payments late incurs a late fee, which can be
detrimental to paying down the balance.

Using one of the ads, have students consider
how much money, in interest and fees, would be charged on a $1000
balance.

Have several groups report on what they
found in the ads. Allow them to compare how much the interest rate
and fees affect the overall cost.

Activity 3:
Credit History

Explain to students that in order to get a credit card
(or a loan), they will have to fill out an application disclosing
their personal financial information, including their salary. In addition,
lending institutions will investigate their credit history.

TIP: You may wish to inform students of the three main credit agencies:
Equifax, TransUnion, and Experian. Each of these agencies keeps a
history of anyone who has been given credit in the U.S.—about
170 million Americans. These three agencies can be found on the Web
at:

Define credit history.
Credit history: A consumer’s credit history is a record of an
individual’s (or a company’s) past borrowing and repaying.
It lists personal information, current debts, recently closed debts,
and risk factors such as history of late payments and bankruptcy.

Explain that it is easy to get bad credit by failing
to make payments or by continually making late payments.

On the board or overhead projector, display the following
problems.

If you have a credit card balance of $2500,
and the minimum monthly payment is 3%, how much will you have to pay?
($75, because 0.03 x 2500 = 75)

Based on the budget
you created earlier, would it be difficult for you to make that payment?

If students find that making that payment would not be difficult,
have them calculate the balance at which the minimum payment would
be difficult.

If you can’t afford to make the
minimum payment, what happens? (Initially, a late fee will
be added to your account each month. Eventually, however, your account
will be in default, and it will be closed. This negative account will
be recorded in your credit history, and it will stay in your history
for 7 years from the date you are finally able to pay off the account.)

Require students to obtain information on one “expensive”
item that they would need to buy on credit. This can be done in class
by distributing newspapers and catalogs, or you can require students
to find the information for homework. Students should have the name
and cost of the item for the next activity.

Activity 4:
Buying on Credit vs. Saving for an Item

Have students analyze the cost of purchasing the expensive
item they selected with a credit card versus the cost of saving money
and delaying the purchase. Give students the following guidelines:

Using their budgets from Activity One, students should decide
the maximum amount they could afford to pay to a credit card or
put in a savings account each month.

Students should consider how long it would take to pay off
the balance if the item was bought with a credit card.

Students should consider how long they would need to save (earning
interest) to be able to afford the item.

For example, if students designed a budget in which they have $80
left over after expenses are met, they should consider the effect
of putting $80 in savings each month, collecting 2% compound interest,
and delaying their purchase—versus buying it now on credit,
being able to only make payments of $80 per month, and dealing with
15.4% interest charges.

Give students 5-10 minutes to complete the comparison
outlined above. If access to computers with spreadsheet software
is available, have students use it to analyze this situation. Otherwise,
students can perform the calculations using a calculator.

For each calculation, students will use the following relationship,
based on the compound interest formula:

Amount of Interest Each Month = Balance * (1 + Interest Rate)
^{1/12}
– Balance

The interest is added each month before the monthly payment is made,
so the new balance in the account can be found with the following
relationship.

New Balance = Previous Balance + Interest – Monthly Payment

Have students report on what they discovered regarding
buying on credit versus saving. Ask as many of the following questions
as necessary to spark a discussion.

What is the “real cost” of the item if students
only make the minimum payment each month?

What is the “real cost” if students pay more than
the minimum each month?

Is the "real cost" reasonable?

Should they borrow money to purchase the item?

Is it a necessity or a luxury?

How can they weigh the benefits of buying the item vs. the benefits
of staying debt-free without the item?

Could the student delay the purchase and save toward buying
it without credit?

When reporting to the group, emphasize that students should use terms
and ideas that were learned during the lessons on budgeting and credit
cards.

On the chalkboard or overhead projector, create a table
like the one below. Have students indicate the “Pros”
and “Cons” of using a credit card to buy the item now
versus saving money and buying the item later.

Pros

Cons

Buying with a Credit Card

Saving and Buying the Item Later

Point out to students that, as they have already seen,
there are a variety of different credit card deals, with different
APRs, annual fees, and so on. Tell students that these differences
can have a significant impact on students' budgets.

On the chalkboard or overhead projector, display the
following problem.

Consider two credit cards with
the following rates and fees:

Credit Expense: $85 annual fee, 9% APR

PlasterCard: No annual fee, 14% APR

If you began the year with a balance of $1,000 on both of these cards,
you paid $100 each month, and the annual fee for Credit Expense
was added in June, would either of these cards have a $0 balance by
the end of the year? For which card is the total cost in interest
and fees higher?

With the class, solve this problem. Students can use
their calculators and the compound interest formula, or they can use
spreadsheet software to solve the problem. You can use the Credit
Card Worksheet as a model for how to set up such a spreadsheet.

The following table shows the results for the Credit Expense account
with 9% interest and an $85 annual fee. (The annual fee is added in
June, Month 6.) This account will be completely paid off in 12 months.

Month

Balance

Interest (and Fees)

Remaining Balance after Payment

1

$1,000.00

$7.21

$907.21

2

$907.21

$6.54

$813.75

3

$813.75

$5.86

$719.61

4

$719.61

$5.19

$624.80

5

$624.80

$4.50

$529.30

6

$614.30

$89.43

$518.73

7

$518.73

$3.74

$422.47

8

$422.47

$3.04

$325.51

9

$325.51

$2.35

$227.86

10

$227.86

$1.64

$129.50

11

$129.50

$0.93

$30.43

12

$30.43

$0.22

$0.00

For this account, the total amount paid was $1130.65 ($100 was paid
for 11 months, and 30.43 + 0.22 = $30.65 was paid the last month).
The total amount of the interest plus fees was $130.65.

The following table shows the results for the PlasterCard account
with 14% interest and no annual fee. This account will be completely
paid off in 11 months.

Month

Balance

Interest (and Fees)

Remaining Balance after Payment

1

$1,000.00

$10.98

$910.98

2

$910.98

$10.00

$820.98

3

$820.98

$9.01

$729.99

4

$729.99

$8.01

$638.01

5

$638.01

$7.00

$545.01

6

$545.01

$5.98

$451.00

7

$451.00

$4.95

$355.95

8

$355.95

$3.91

$259.86

9

$259.86

$2.85

$162.71

10

$162.71

$1.79

$64.50

11

$64.50

$0.71

$0.00

For this account, the total amount paid was $1065.21 ($100 was paid
for 10 months, and 64.50 + 0.71 = $65.21 was paid the last month).
The total amount of the interest was $65.21, less than half the amount
for the Credit Expense account.

Point out to students the interesting anomaly in the
previous problem: That the annual fee of Credit Expense outweighs
the benefit of a lower interest rate.

Have students examine the following scenarios, based
on some real statistics:

Nellie Mae claims that the average college student graduates
with a credit card balance of $2748. Paying $50/month, how long
would it take to pay off this balance, assuming a 15% interest
rate?

Credit card companies typically require a minimum monthly payment
of 3% of the balance, or $15, whichever is higher. How long would
it take to pay off a $500 balance if only the minimum monthly
payment was made each month?

Culminating Activity/Community Connection
Shopping for Credit

Implement one of the following culminating activities:

Based on information that has already been gathered
for the lesson, have students select the best credit card offer. The
final project can be a brief report explaining how they arrived at
their conclusion.

Each student must find two (or more) credit card
ads and write a report that compares them. Students should include
the APR, annual fees, and other pertinent information in the report.
You may use the report for assessment, as well as compile all of
the ads found and ask students (as a quiz or test) to decide which
credit card has the best deal.

Extensions

Have students investigate the stock market, mutual funds, certificates
of deposit, and other ways to save money besides traditional savings
accounts. Students should consider the impact of compound interest
on putting money into these types of investments.

The “Rule of 72” is a rule of thumb that accountants
use. In short, it states that an account balance will double in
(72/n) years if it is invested at an n% interest rate. For instance,
if $100 is invested in an account at 6%, in 72 ÷ 6, or
12, years, the balance in the account will be $200. Students could
use the formula for compound interest to discover this on their
own.

Students can consider a car loan of $12,000 and the interest
accrued versus how long it would take to save $12,000 to buy a
car. Students could also consider various scenarios, including:

an incentive of 0% down, no interest first year

leasing vs. buying

on a 60-month lease, how much would be saved if $20 more
than the required payment were made each month

Have students research the "Rights and Responsibilities"
of credit card holders. Students may then design a mini-brochure
containing tips on how to use credit cards wisely. Students can
investigate the information at the following Web site about responsible
credit card use: Citibank - Use Credit Wisely http://www.citibank.com/us/cards/cm/cc101.htm

Have students explore the promotions and rewards offered by
some companies that issue credit cards, such as rebates on new
car purchases, frequent flyer miles, end-of-year cash back, etc.
Sometimes these cards have higher APR and annual fees. Have students
investigate whether these higher rates are justified by the bonuses.

Provide several sample credit histories for students to examine.
Sample credit histories can be found online at the following addresses:

Explain how histories are created and maintained. Students receive
copies of a credit history, and a credit report to examine. Discuss
various aspects of credit history and credit reports.

The difference between good and bad credit.

How one gets into credit trouble.

How one finds out their own credit history by requesting
a credit report (if necessary).

Strategies for protecting one's credit history.

Why it's important to have good credit (for making larger
purchases, such as a car, house, boat, etc.).

You can get lower rate for loans if your credit history
is good.

The idea of “credit worthiness,” and answering
the question, “If you need to have good credit to be
eligible for credit cards and loans, how do you establish
credit in the first place?”

The following Web sites contain information about these topics:

In small groups, have students examine credit histories for several
individuals. As a role-playing activity, have the groups act as
loan officers or finance managers and discuss whether or not each
applicant should receive a loan. After each group completes its
decision-making process, facilitate a discussion through which
the class will reach a consensus on the loan applicants.