Using Credit Cards: Key Points cards can be more convenient than carrying cash, but remember, you always have to pay the • Credit money back. general, people spend more when they use credit cards instead of cash. It can be easy to get in over • In your head with credit card debt before you know it! a general guideline, never borrow more than 20% of your yearly net income. That’s the amount of • As money you take home in a year after taxes and other deductions. A second guideline is that less than 10% of your monthly income should go toward paying off credit card bills. • Tokeep your credit card spending under control, try this strategy: use cash or your debit card for everyday purchases. Save your credit card for buying larger, more lasting items. But before you actually use your card, think through what you want to buy and how you’re going to repay the money. • Loans are called “installment” credit, meaning you receive the money once and pay it back over time in installments. Credit cards are called revolving credit because as you pay the money back, your credit becomes available for you to use again and again. • Everytime you use your credit card, you’re actually borrowing money from the financial institution that issued you the card. The financial institution pays the debt to the store for what you bought. In turn, you pay the money back to the financial institution. • Asa reminder, when you use your debit card, the money is deducted directly from your checking account. When you use a credit card, you receive a monthly bill you have to pay. • Many financial institutions offer credit cards. Some will charge you an annual fee to have one. When you apply for a card, they’ll check your credit history and decide whether or not to give you a card. They’ll also decide how much you’re allowed to borrow, or “charge.” This is called your credit limit. If the credit card company issues you a card, they’ll let you know what your credit limit will be. you haven’t established a good credit history yet, some lenders offer secured credit cards. These are • If ideal for people who are starting out on their own or need to rebuild their credit. To qualify, you’re normally required to open a savings account with a balance equal to the credit limit of the card. For example, if you want a credit card with a five hundred dollar limit, you must have five hundred dollars in your account. This gives the lender security that you can pay them back, and some lenders will pay you interest on this balance. By establishing a good payment history with your secured credit card, you can improve your qualifications for unsecured credit in the future. always a good idea to shop around for the credit card with the lowest interest rate and lowest annual • It’s fee you can find. Compare the two examples below. In both cases, customers used a credit card to purchase a large-screen TV with a $500 price tag, and made a $100 payment each month. But note how the difference in the interest rate affects the total amount of interest each customer paid: What percentage of the total price is the interest paid for the TV at 8%? (2%) At 18% (20%)? What is the difference in the time it took to pay off the TV? (4 times longer) • Remember that if you pay off the purchase by paying your first credit card statement in full, you’ll pay no interest, plus you’ll have your full credit limit available to use again; but if you decide to pay for your purchase over time, you’re going to be charged interest on the unpaid balance each month – in other words, on the amount you still owe. So even though your monthly payments may be low, the total amount you end up spending for that new TV is quite a bit higher! It definitely pays to get a credit card with a low interest rate, and to pay off your bill as quickly as you can. Tips for using credit cards wisely • For now, have just one credit card with a low spending limit. This will help you start to get comfortable using credit and paying it back, and stop you from getting into big trouble with debt. • Get a credit card with a low interest rate and pay off the balance or as much as you can every month. • Make at least the minimum payment each month. • Don’t use your credit cards to buy things you really can’t afford. Follow your budget. • Stay within your credit limit. Track your credit card charges throughout the month. • Pay your credit card bills on time. • Some credit card companies may offer you a cash advance. Avoid this option except in emergencies. You’ll be charged a fee and the interest rate is usually much higher! • If you’re getting into trouble with debt, get help early. Consider talking with a credit counselor, an experienced professional, who can help you get out of debt. Student Activities Use these or similar activities to give students an opportunity to apply what they have just learned to real life scenarios. 1. Suppose you have a credit card balance of $350 and the Annual Percentage Rate (APR) for your card is 15%. You decide not to use the card again and you make the minimum payment of $10. Using the credit table below, what is the amount of interest you end up paying? How long will it take you to pay off your debt? Using the credit tables below, compare the interest payments and repayment schedules on the same amounts at different interest rates. Example 1: Borrowing $350 at 15% APR, making a minimum payment of $10 monthly. Month Minimum Payment Interest Paid Principal Paid Remaining Balance 1 $ 10.00 $ 4.38 $ 5.63 $ 344.38 6 10.00 4.01 5.99 315.18 12 10.00 3.55 6.45 277.66 18 10.00 3.05 6.95 237.24 24 10.00 2.51 7.49 193.69 30 10.00 1.94 8.06 146.77 36 10.00 1.31 8.69 96.23 42 10.00 .64 9.36 41.76 47 10.00 .04 3.14 0.00 Total Interest $ 113.15 Now, suppose you have a credit card balance of $350 and the APR for your card is 18%. You decide not to use the card again and you make the minimum payment of $10. Using the credit table below, what is the amount of interest you end up paying? How long will it take you to pay off your debt? Example 2: Borrowing $350 at 18% APR, making a minimum payment of $10 monthly: Month Minimum Payment Interest Paid Principal Paid Remaining Balance 1 $ 10.00 $ 5.25 $ 4.75 $ 345.25 6 10.00 4.88 5.12 320.41 12 10.00 4.40 5.60 288.05 18 10.00 3.88 6.12 252.68 24 10.00 3.31 6.69 213.99 30 10.00 2.69 7.31 171.69 36 10.00 2.00 8.00 125.44 42 10.00 1.25 8.75 74.87 48 10.00 .44 9.56 19.57 51 .01 0.00 0.01 0.00 Total Interest $ 150.01 Comparing these two examples, what can you conclude about the different Annual Percentage Rates? What can you conclude about paying only the minimum amount of payment? What would be the impact if you paid $20 each month instead of the minimum $10? 2. Create problems that compare buying goods on credit to saving for the items over several months. Go to www.handsonbanking.org “click to enter program” click “young adults” option click “user options” th click 4 button down – “credit calculator” o enter “amount borrowed” – have student enter the cost of something they would like to have, like a car, TV, etc. o enter annual % rate (8% is a good rate) o enter monthly payment they can afford o click “calculate” -- student will see number of months to pay off the loan, total to be paid and amount of interest paid. 3. Suppose you purchased goods totaling $5,000 on your credit card. At 18% annual interest (1.5% monthly), paying $135 a month, it would take you 55 months, or over 4 ½ years, to pay off the $5,000. Defend your decision to do this. On the same $5,000 purchase, if you paid $200 a month at 18% annual interest (1.5% monthly), it would take you 32 months, or over 2 ½ years, to pay off your credit card. Explain why you would choose one payment plan over the other. 4. You want to buy a used car that costs $10,000. The bank will give you an auto loan for 36 months at 7% interest, and you will pay $308.78 every month to repay the loan. If you take the loan for 60 months, you will pay $198.02 a month. • What is the difference in the amount of interest you will pay between the two options? • Why might you choose each of these options? 5. A friend decides to take a loan out to help pay for home improvements. She qualifies for a $10,000 loan at 15% yearly interest. If she pays the loan back over 10 years, she will pay $161.34 a month. If she pays the loan back over 15 years, she will pay $139.96 a month. • How much interest will she pay if she pays the loan over 10 years? • How much interest will she pay if she pays the loan over 15 years? 6. You decide to use your credit to purchase some new furniture. You charge $5,000 on your credit card that charges 18% annual interest. The minimum payment to pay off the $5,000 in 5 years is $126.97 a month. The chart below shows the amount of interest and the amount paid toward the principal amount if you pay $126.97 for each month in the first year. Use this chart to answer the questions below. Month 1 2 3 4 5 6 Payment 126.97 126.97 126.97 126.97 126.97 126.97 Interest paid this month 75.00 74.22 73.43 72.63 71.81 70.98 Total interest paid 75.00 149.22 222.65 295.28 367.09 438.07 Principal paid this month 51.97 52.75 53.54 54.34 55.16 55.98 Total principal paid 51.97 104.72 158.26 212.60 267.76 323.74 Balance 4948.03 4895.29 4841.75 4787.41 4732.25 4676.27 Month 7 8 9 10 11 12 Payment 126.97 126.97 126.97 126.97 126.97 126.97 Interest paid this month 70.14 69.29 68.43 67.55 66.66 65.75 Total interest paid 508.21 577.51 645.93 713.48 780.14 845.89 Principal paid this month 56.82 57.68 58.54 59.42 60.31 61.21 Total principal paid 380.56 438.24 496.78 556.20 616.51 677.72 Balance 4619.44 4561.77 4503.23 4443.81 4383.50 4322.28 a. What do you notice about the amount of interest paid in subsequent months? b. What do you notice about the amount paid toward the principal in subsequent months? c. How much of the principal balance of $5,000 would you pay off in one year paying $126.97 a month? d. How much interest would you pay in one year paying $126.97 a month? e. How much interest would you pay in month 13? f. How much interest will you pay over the 5-year life of the loan if you pay $126.97 each month? To do this computation, use the credit calculator found on the User Options panel of the Hands on Banking program.