Theme 4: Borrow

Topic Connections: This connects to Money Smart lessons in class: Lesson 7 (Credit), Lesson 8 (Credit Cards), Lesson 9 (Understanding Money Ratios), Lesson 12 (College and Student Loans), and Lesson 13 (Understanding the Economy).

Topic Overview:
Life brings many big expenses, like paying for college, buying a home, or fixing a car after an accident. Sometimes people need to borrow money for these big costs. This is normal, but there are things to think about before taking out a loan. One helpful tool is knowing your "debt-to-income ratio," which compares how much money you owe to how much money you earn.

From the Classroom

What is credit? How do you become creditworthy?
Credit means using someone else's money now and paying a fee for it later. People borrow money for many reasons, like a student loan to pay for college or a mortgage (a loan for buying a house) to purchase a home. Being "creditworthy" means you can prove to lenders that you will pay back money on time. Lenders look at four things: capacity (can you afford the payments?), capital (what valuable things do you own?), character (have you paid your bills on time in the past?), and collateral (do you have valuable things you could give up if you can't pay back the loan?).

How do you manage your credit? What is bad credit?
Managing credit well means paying back what you borrowed the way you agreed to. For credit cards, a smart plan is to pay off your full balance by the due date each month and not use up all the credit you're allowed. Bad credit happens when you miss payments, pay late, let your credit card balance grow too high, or use one credit card to pay off another. Also, if you owe a lot of money compared to your card's limit, your credit score will likely go down.

What is the difference between credit and debit cards?
Credit cards and debit cards look alike, but they work very differently. With a credit card, you're borrowing money that you must pay back later—plus extra money called interest if you don't pay the full amount by the due date. A debit card is different. It's given to you by your bank and is connected to your own checking or savings account. When you use a debit card, you're spending money you already have, so you never pay interest. But you need enough money in your account at the time of purchase, since the money comes out right away.

How do you pay for college?
Besides using savings and looking for scholarships, you can also apply for federal financial aid. The process starts with filling out the FAFSA (Free Application for Federal Student Aid). Types of aid include: grants and scholarships (money you don't have to pay back), student loans (money you must pay back with interest), and work-study programs (jobs that let students earn money while going to school).

How do financial ratios affect me?
Financial ratios give a quick picture of how someone handles money, and lenders use them to decide if you're creditworthy. One common ratio is called "debt-to-income." It compares how much money you owe to how much money you earn. If this ratio is high, lenders worry that you might struggle to make your monthly payments. Your debt-to-income ratio (not counting rent or mortgage) should be much lower than your monthly income. Some lenders calculate this ratio without counting rent or mortgage payments at all.

Words To Know

Credit: The ability to borrow money and pay it back later.

Credit Card: A plastic card used to borrow money to buy things.

Credit Card Accountability Responsibility and Disclosure Act: A law that stops unfair credit card practices and makes sure companies clearly explain their rates and fees, so people can compare cards easily.

Credit Report: A record showing your history of paying back money and bills. It shows how often you pay on time, how much credit you have, how much you're using, and if anyone is trying to collect money you owe.

Credit Score: A number, usually between 300 and 800, that shows how trustworthy you are with credit. The most famous kind is called a FICO® score. It comes from a math formula that uses information from your credit report.

Creditworthiness: How well a lender believes you can and will pay back money you owe, based on your past and future ability.

Debit Card: A plastic card used to take money directly out of your bank account, like at an ATM or a store.

Debt-to-Income Ratio: A number that compares your monthly debt payments to your monthly income before taxes. To find it, divide your monthly debt by your monthly income. Example: If you pay $200 a month for a car loan and $1,000 a month for a home loan, your total monthly debt is $1,200. If your monthly income is $4,000, your debt-to-income ratio is 30% ($1,200 ÷ $4,000).

Financial Ratios: Numbers that help show how well someone is doing with their money.

Free Application for Federal Student Aid (FAFSA): A free form used to apply for government help paying for college, such as grants, loans, and work-study jobs.

Student Loans: Money borrowed to help pay for college, which must be paid back later along with extra interest.

Conversation Starters … Ask Your Child:

• When you want to borrow something from someone, how do you show them you can be trusted?
• Where do you think money comes from? What's the difference between cash, credit, and debit?
• What do you think it would be like to live in a world without cash?
• How can you tell if a credit offer is real or fake?
• How much would it cost to go to the college you'd like to attend?

What if My Teen Wants To…

What if my teen wants to get a credit card or debit card?
You might worry about your teen spending too much, especially with online shopping so easy to do. A law called the Credit CARD Act of 2009 says anyone under 21 needs a co-signer (someone who agrees to help pay if needed) to get a credit card, unless they can prove they can pay it back on their own. This law protects young people from getting stuck with too much credit card debt. It's also a great chance to teach your teen how to use credit responsibly. If you co-sign for your teen's credit card, make a written agreement about paying on time. As a co-signer, you must pay the debt yourself if your teen can't or won't. If the debt isn't paid, it could hurt your own credit report too.

Debit cards are also great tools for learning how to budget and choose between things you need and things you want. If you think your teen is ready to make their own spending choices, you could open a joint checking account together. This lets you help your teen keep track of their money. It's also a good chance to talk about the choices they make when spending, how to use online banking, and how to read bank statements. Young people often misjudge how far their money will go, especially at first. These lessons matter, even when they're bumpy—and it's better to learn them now, at home, than later when mistakes can cost a lot more.

What if my teen wants to take out a student loan?
Fill out the FAFSA together if you haven't already. This helps the school figure out how much aid your teen can get from the government. Then, research different kinds of aid together, like work-study jobs, grants, scholarships, and loans. There are several types of federal student loans, and you can learn more at https://studentaid.ed.gov/sa/types/loans. Think about the smallest payments needed to pay off the loan, and compare that to how much your teen might earn in the future.

What if my teen wants to borrow money?
If your teen wants to borrow money for something they want, like a new car or the newest phone, suggest they make a budget, save up, and work toward that goal instead. Remind them that borrowing money to invest in themselves, like for college, can be smart—but borrowing for things we simply want isn't always the best choice. If your teen is planning for college and thinking about loans, they can reduce how much they need to borrow by looking into scholarships, grants, and work-study programs at https://studentaid.ed.gov/.

Family Activities

Compare Colleges: If your teen wants to go to college, help them research and compare their top three choices. Use a tool like College Scorecard (https://collegescorecard.ed.gov/) to compare costs, and talk about how much money would need to be saved or borrowed for each one.

Compare Credit Cards: Save a few credit card offers that come in the mail and look at them together with your teen. Talk about the different rates, fees, penalties, and rules each credit card company offers.

Resources

Articles:

• Providing Financial Aid: Saving for a Child's Future by the Federal Deposit Insurance Corporation — tips for saving and investing for future costs like college. www.fdic.gov/consumers/consumer/news/cnfall12/parentsfinancing.html
• The Financial Aid Process by Federal Student Aid, U.S. Department of Education — an easy-to-read picture guide to applying for financial aid. www.studentaid.ed.gov/sites/default/files/financial-aid-process.png
• How Much Will College Cost in 25 Years? by Kelli B. Grant, CNBC, Detroit Free Press — how college costs might change in the future. http://archive.freep.com/article/20140913/FEATURES01/309130060/college-cost-in-25-years
• Know Before You Owe: Credit Cards by the Consumer Financial Protection Bureau — a sample credit card agreement and how interest and late payments work. www.consumerfinance.gov/credit-cards/knowbeforeyouowe/

Online Tools:

• FAFSA by Federal Student Aid, U.S. Department of Education — apply for help paying for college. https://fafsa.ed.gov/
• Federal Student Aid by Federal Student Aid, U.S. Department of Education — get help preparing for, applying to, and paying for college. https://studentaid.ed.gov/
• Compare and Pay for College by NerdWallet.com — compare colleges and explore financial aid. www.nerdwallet.com/nerdschola