Unit 4 - Good Debt, Bad Debt: Using Credit Wisely

NEFE High School Financial Planning ProgramNEFE High School Financial Planning ProgramUnit 4 – Good Debt, Bad Debt: Using Credit Wisely

Unit 4 - Good Debt, Bad Debt:Unit 4 - Good Debt, Bad Debt:Using Credit WiselyUsing Credit Wisely


What do you think?• Nearly Nearly ______of teens owe money to either a of teens owe money to either a

person or company, with an average debt person or company, with an average debt of of __________..

• About About ________of teens ages 16-18 already of teens ages 16-18 already have more than $1,000 in debt.have more than $1,000 in debt.

• __________of teens say they understand how of teens say they understand how credit card interest and fees work.credit card interest and fees work.

• __________of teens say they know how to of teens say they know how to establish good credit.establish good credit.


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What do you think? What do you think? AnswersAnswers• Nearly Nearly 33%33% of teens owe money to either of teens owe money to either

a person or company, with an average a person or company, with an average debt of debt of $230$230..

• About About 26%26% of teens ages 16-18 already of teens ages 16-18 already have more than $1,000 in debt.have more than $1,000 in debt.

• 30%30% of teens say they understand how of teens say they understand how credit card interest and fees work.credit card interest and fees work.

• 36%36% of teens say they know how to of teens say they know how to establish good credit.establish good credit.


Top 10 Questions to AskTop 10 Questions to AskBefore Signing on the Dotted LineBefore Signing on the Dotted Line

1.1. Do I really need this item right now, or Do I really need this item right now, or can I wait?can I wait?

2.2. Can I qualify for credit?Can I qualify for credit?3.3. What is the interest rate (APR) on this What is the interest rate (APR) on this

card?card?4.4. Are there additional fees?Are there additional fees?5.5. How much is the monthly payment, and How much is the monthly payment, and

when is it due?when is it due?


6.6. What will be the extra cost of using creditWhat will be the extra cost of using credit7.7. What will I have to give up to pay for it?What will I have to give up to pay for it?8.8. Can I afford to pay the monthly Can I afford to pay the monthly

payments?payments?9.9. What will happen if I don’t make the What will happen if I don’t make the

payments on time?payments on time?10.10. All things considered, is using credit All things considered, is using credit

worth it for this purchase?worth it for this purchase?


• Credit is the amount of money or something of value that is loaned on trust with the expectation it will be repaid later to lenders.

• Types of Credit– Borrow up to a predetermined limit (i.e., credit

card)– Borrow cash to be repaid by a specific date– Borrow money for a major purchase to be

repaid in regular payments over time, typically monthly (i.e., car loan, home mortgage)

The Language of CreditThe Language of Credit


• Principle - money amount you borrow • Interest - amount you pay to use

someone else’s money • APR (Annual Percentage Rate) is the total

cost to use credit in a year.• Grace period – length of time you have

before you start accumulating interest



• Universal Default allows a credit card company to increase your interest rate if you make just one late payment.

• Bankruptcy is a legal process to get out of debt when you can no longer make all your required payments.



• Debt is the entire amount of money you owe to lenders.

• Credit limit – maximum amount of credit a lender will extend to a customer

• Term is how long you have to repay a loan, often expressed in months.

• Fees are charged to use credit. Examples: Annual Credit Card Fee, Loan Origination Fee, Over-the-Limit Fee



FeesFees• Annual fee – usually charged by credit card

companies for the privilege of using credit• Origination fee – charge for setting up the loan ex.

Home loan• Finance charge – represents the actual dollar cost

of using credit to maintain a balance• Over-the-limit fee- fee for spending more than your

credit limit• Late fee – penalty for making a payment after the

due date


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Types of CreditTypes of CreditInstallment CreditInstallment Credit• Fixed paymentsFixed payments• Set period of time to Set period of time to

repayrepay• Set or varying interest Set or varying interest

ratesrates• Car loans and home Car loans and home

loans are typical loans are typical examples.examples.

Revolving CreditRevolving Credit• No stated payoff timeNo stated payoff time• Limit to creditLimit to credit• Minimum monthly Minimum monthly

paymentspayments• Interest rates vary or notInterest rates vary or not• Finance chargesFinance charges• Credit cards most Credit cards most

typical exampletypical example


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Sources of CreditSources of Credit• BanksBanks• Credit UnionsCredit Unions• Department StoresDepartment Stores• Automobile DealersAutomobile Dealers• Oil Companies (for gas stations)Oil Companies (for gas stations)• Federal Government (for student loans)Federal Government (for student loans)• Others?Others?


Credit: The Good and the Bad

Rewards Credit Offers• Convenience• Protection• Emergencies• Opportunity to build credit• Quicker gratification• Special offers• bonuses

Potential Risks• Interest• Overspending• Debt• Identity theft


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WHEN YOU BUY “STUFF”WHEN YOU BUY “STUFF”

In fact, you bought $500 worth of “STUFF” with your credit card.In fact, you bought $500 worth of “STUFF” with your credit card.You bought “STUFF” with your credit card.You bought “STUFF” with your credit card.

Your APR is 18%.Your APR is 18%.You plan to pay $10 a month to pay it off.You plan to pay $10 a month to pay it off.

You will pay $431 in interestYou will pay $431 in interest

Final cost of your purchases = $931.40Final cost of your purchases = $931.40

And it will take SEVEN YEARS and NINE MONTHSAnd it will take SEVEN YEARS and NINE MONTHS

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How Long Will It Take???

APR = 18%APR = 18%

Payment: 4% of current balancePayment: 4% of current balance

You owe $3,000.You owe $3,000.

Finance Charge $1715.69Finance Charge $1715.69

Total cost of original Total cost of original $3,000 loan = $4715.69$3,000 loan = $4715.69

After you’ve made the last payment, will what you purchased still be around???

And it will And it will take take

nearly nearly 11 YEARS 11 YEARS to pay off!to pay off!

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The Cost of Using Credit

APR = 24%APR = 24%


$700 for a Game System$700 for a Game System

Finance Charge $550.04Finance Charge $550.04Your CD player REALLY Your CD player REALLY cost $1,250.04cost $1,250.04

After you’ve made the last payment, will your CD player still be around???

And it will And it will take overtake over7 years 7 years

to pay off!to pay off!

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The Cost of Using CreditThe Cost of Using CreditInterest Rate = 24%Interest Rate = 24%

Payment = 4% of Current BalancePayment = 4% of Current Balance

BALANCEBALANCE TIME TO TIME TO PAY OFFPAY OFF

INTEREST INTEREST CHARGEDCHARGED

TOTAL TOTAL COSTCOST

$2,000$2,000 11 YEARS11 YEARS6 MONTHS6 MONTHS $1,850$1,850 $3,850$3,850

$6,000$6,000 16 YEARS16 YEARS1 MONTH1 MONTH $5,850$5,850 $11,850$11,850

$10,000$10,000 18 YEARS18 YEARS2 MONTHS2 MONTHS $9,850$9,850 $19,850$19,850

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The Cost of Using Credit

APR = 21%APR = 21%


$3,000 Charged to Credit Account$3,000 Charged to Credit Account

Finance Charges $2,220.57Finance Charges $2,220.57

You Owed You Owed $3,000$3,000

butbutYou PaidYou Paid$6,065+$6,065+

Includies annual feesIncludies annual fees

Annual Credit Card Fee: $65Annual Credit Card Fee: $65

Paying the minimum, it will Paying the minimum, it will take you 11 YEARS and 11 take you 11 YEARS and 11 MONTHS to pay off your debt.MONTHS to pay off your debt.

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• Could put you in a state of overspending and perpetual debt, where you get used to carrying a balance and paying extremely high interest rates.

• Could adversely affect your credit rating, making it harder to get loans when you really need them.

Financial Consequences of Debt1 of 2

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What if you took the $120 monthly payment in the last example and INVESTED $120 a month for the 12 years it took to pay off the $3,000 debt, and your investment got an 8% rate of return?

Instead of $6,000 paid out for $3,000 worth of “stuff”, your $120 monthly investments would amount to $28,799 in your pocket!

Financial Consequences of Debt2 of 2

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Are you worthy?

Information you need to apply for credit:• Social Security number• Driver’s license number• Date of birth• Address and phone number• Name of employer• Monthly income amount• Total monthly payment on other debts• Amount of monthly rent or mortgage payment


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The Four “The Four “CCs” of Credits” of Credit

CollateralCollateralCapitalCapital

CapacityCapacityCharacterCharacter


Collateral • Asset of value that lenders can take from

you if you don’t repay the loan as promised


Capital • In the event you don’t pay your bills,

lenders want to know if you have items they can sell to repay the loan


Capacity • Whether you are able to repay a loan• Creditworthiness and employment history


Character• Are you trustworthy?• Measured by your credit score, a history of

paying bills on time shows that you are responsible


• Credit History is a record of your behavior related to borrowing and repaying loans.

• Credit Report is a detailed record of your personal credit and financial transactions.

• Credit Score is a rating used by credit reporting companies to help lenders decide whether and/or how much credit can be extended to a borrower.



How Credit Scores Are DeterminedHow Credit Scores Are Determined• Your payment historyYour payment history

– Information about how you make your Information about how you make your payments on credit cards, store accounts, car payments on credit cards, store accounts, car loans, finance companies, mortgagesloans, finance companies, mortgages

– Accounts in collection or past due, and how Accounts in collection or past due, and how long past duelong past due

– Information in public records, such as Information in public records, such as bankruptcy, judgments, liens, wage bankruptcy, judgments, liens, wage attachments or child supportattachments or child support


How Credit Scores Are DeterminedHow Credit Scores Are Determined• Your overall debtYour overall debt

– How much you owe on all your accountsHow much you owe on all your accounts– How much credit you have available to useHow much credit you have available to use

• Your credit account historyYour credit account history– When you opened and used each of your When you opened and used each of your

accountsaccounts– How recently you applied for new creditHow recently you applied for new credit– Recent good credit history following past Recent good credit history following past

payment problemspayment problems


How Credit Scores Are DeterminedHow Credit Scores Are Determined• Types of CreditTypes of Credit

– The different types of credit accounts you The different types of credit accounts you havehave

– The total number of accounts you haveThe total number of accounts you have


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Get and Keep a Good ScoreGet and Keep a Good Score• Make sure your credit report is accurate.Make sure your credit report is accurate.• Pay all your bills on time.Pay all your bills on time.• Apply for credit only when you need it.Apply for credit only when you need it.• Lower the balances on all your credit Lower the balances on all your credit

accounts.accounts.• Pay off debt rather than moving it around.Pay off debt rather than moving it around.


Credit Score Ranking


http://denverareamortgagenews.files.wordpress.com/2012/05/fico-credit-score-distribution-usa.jpg


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Protect Yourself Against Protect Yourself Against Inaccurate Credit ReportsInaccurate Credit Reports

• Get a copy of your free credit reports from Get a copy of your free credit reports from all credit rating agencies.all credit rating agencies.

• Examine it thoroughly.Examine it thoroughly.• If you find something that is incorrect, ask If you find something that is incorrect, ask

the agency to investigate the information.the agency to investigate the information.• If that doesn’t resolve the issue, you can If that doesn’t resolve the issue, you can

attach a short statement to your credit attach a short statement to your credit report.report.


70%70%Living ExpensesLiving Expenses

10%10%Pay Pay Off Off

DebtDebt

20%20%Save or InvestSave or Invest

Rule of ThumbRule of Thumb


How to avoid pitfalls• Always read fine print of credit card or loan

application before signing• Avoid higher interest rates of credit cards• Be choosy about your credit and don’t apply for

more than you need• Pay as much as you can every month• Pay a bill at least a week before it’s due • Arrange automatic payments for monthly bills• Get into a saving mode so you rarely need credit or

loans for your purchases


Bankruptcy • Legal process to get out of debt when you

can no longer make all required payments• Chapter 7 – effectively allows you to erase

most of your debt• Chapter 13 – allows you to repay many of

your debts over a period of time around 5 years

• Bankruptcy does not erase – student loans, child support or alimony


Exercise 4G

Exercise 4H

Unit 4 - Good Debt, Bad Debt: Using Credit Wisely

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