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Filling Empty Pockets

Students will  explore the concepts of borrowing and credit with an emphasis on credit cards.  They will learn important concepts  including how to preserve their access to credit and how to avoid "credit trouble." Students also consider the real cost of buying on credit, weighing the costs and benefits of credit purchases against the option of budgeting and saving. Finally, students will consider various real offers made by credit providers and decide which offer, among several, is the best.

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Lesson Summary

Overview

In this lesson, students explore the concepts of borrowing and credit with an emphasis on credit cards. Students learn how credit works, why banks and other corporations extend credit, and what credit consumers need to know, including how to preserve their access to credit and how to avoid "credit trouble." Students also consider the real cost of buying on credit, weighing the costs and benefits of credit purchases against the option of budgeting and saving. Finally, students will consider various real offers made by credit providers and decide which offer, among several, is the best.

Objectives

Students will be able to:

  • Understand how credit works
  • Define terms such as credit, loan, annual percentage rate, interest, and principal
  • Compare various credit offers to understand the ramifications of making purchases with credit
  • Learn how to be a responsible credit consumer
  • Compare the “real costs” of purchasing on credit versus delaying a purchase until enough money has been saved

Grade Level:

9-12

Suggested Time:

(3) 45-minute class periods

Media Resources:

Digging Out of Debt MPEG 4 Video

A college student learns a valuable lesson about excessive credit card debt and how to deal with the problem in this video from Your Life, Your Money.

Moving Out QuickTime Video

In this video segment from What’s Up in Finance? college student Eddie Romero consults a financial planner to find a way to pay his bills, pursue a music career, and save for the future.

Materials:

Web Sites:

Sample Credit Histories:

These sample credit histories may be referenced as students learn about credit histories in Activity Two.

With content for teachers, parents, and students, this Web site features a variety of valuable resources to reinforce sound spending and saving habits.

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.

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.

This page contains useful tips and information for beginning credit consumers.

Money Smart, a service of the Federal Deposit Insurance Corporation, is an adult education program that builds financial knowledge and overall "money skills."

Credit Card Payment Calculators:

Before The Lesson

Bookmark the website used in the lesson on each computer in your classroom. Using a social bookmarking tool such as del.icio.us or diigo (or an online bookmarking utility such as portaportal) will allow you to organize all the links in a central location.

Preview all of the video segments and websites used in the lesson to make certain that they are appropriate for your students, currently available, and accessible from your classroom.

Download the video segments used in this lesson onto your hard drive, or prepare to stream the clips from your classroom.

Additional Prep:

To determine your students' starting salary for the budget 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.

2001 Statistical Abstract of the United States

The related files are located in articles 619 (Average Annual Pay by State) and 620 (Average Annual Pay by Selected Metropolitan Area) of "Section 12. Labor Force, Employment, and Earnings." You may download the file here:

http://www.census.gov/prod/2002pubs/01statab/labor.pdf.

You should also consider the cost of the items included in the Budget Sheet Organizer when determining your students'starting salary. Guidelines for Student Budget Sheets can help you estimate students' total expenses.

The Lesson

Introductory Activity:

1. 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:

  • Annual Percentage Rate (APR), or interest rate
  • Minimum monthly payment

2. For a quick example of why credit cards can cost more in the long run, have students pull up the following Web site:

3. Give students 3-5 minutes to read the page and play the Charge! game on the website a few times. Follow up with a brief discussion about what students found. Then, move directly to Activity One.

Learning Activity 1: Budgeting, Saving, and Interest

1. Tell students that during the next several class periods, they will first 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.

2. Next, tell students they are going to watch a video about Eddie, a college student who consults a financial planner to find a way to pay his bills, pursue a music career and save for the future. While watching the video, ask students to remember the two strategies the financial planner suggests and what Eddie learns once he applies those strategies. Play Moving Out.

3.After watching the video, take student responses and discuss.

A: The two strategies the financial planner suggests to Eddie are to create a budget and to keep track of everything he spends for the next 30 days.

A: After applying the strategies, Eddie realizes he spends too much on entertainment.

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

5.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.

Table # 1

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.

2001 Statistical Abstract of the United States

The related files are located in articles 619 (Average Annual Pay by State) and 620 (Average Annual Pay by Selected Metropolitan Area) of "Section 12. Labor Force, Employment, and Earnings." You may download the file here: http://www.census.gov/prod/2002pubs/01statab/labor.pdf.

Also refer to the Guidelines for Student Budget Sheets.

6. 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.

7. 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.

8. 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 want 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?

9. 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.

10. 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.

11. With the class, review some of the ideas students already have about credit cards and how they work.

12. Next, tell students they are going to see a video about Amanda, a college student who has accumulated a great deal of credit card debit. While watching, ask students to pay attention to how much more people spend when they use credit cards rather than cash when making a purchase. Play Digging Out of Debt MPEG 4 Video.

13. Discuss with students how much more someone pays on the average when using a credit card instead of cash. A: On the average people spend 30 to 100% more when using a credit card rather than cash.

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.

14. Ask students what kind of organizations lend money and why.

Various entities banks, finance companies, credit unions, and other lending institutions give credit to customers to provide a service and to make money.

15. Next ask students how they would obtain credit in the form of a loan or credit card.

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.

16. Tell students that they're going to 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?

17.  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.

Table # 2

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

19. 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?

20. 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.

Table # 3

  • 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.

21. 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.

22. 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.

23. 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.

Learning Activity 2: Credit Card Offers

1. Watch the video Digging Out of Debt again. While watching, ask students to pay attention to what Beth Kobliner says about credit card offers. After watching the video, initiate a discussion about things to look for when considering a credit card offer.

When you're comparing credit card offers you want to get the lowest interest rates possible and you don't want to pay annual fees.

2. Next, divide students into groups of 3-4. Have students browse the Internet to find 1-2 credit card offers. In addition, distribute several credit card ads to each group.

3. 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.

4. 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.

5. 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.

Learning Activity 3: Credit History

1. 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 want 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:

Equifax

TransUnion

Experian

2.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.

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

4.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?

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

6. 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.)

7. Ask 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.

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

1. Ask students to 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.

2. 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

3. 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.

4. 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.

Table # 4

5. 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.

6.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?

7. 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.

Table # 5

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.

Table # 6

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

8. 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.

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

#A - 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?

#B - 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 Connections:

Shopping for Credit:

Implement one of the following culminating activities:

1. 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.

2. 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:

1. 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.

2. 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.

3. 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
  • 4.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

5. Ask students to 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.

6. Provide several sample credit histories for students to examine. See the sample credit history weblinks in the Website section of this lesson.

7. 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 a 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?"

8. 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.

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