Theme 4: Borrow

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

Topic Overview:
Life is full of big expenses — college costs, buying a home, unexpected car repairs, or medical bills. Borrowing money for these big-ticket items is common, but there are things you should think about before taking out a loan. One helpful tool for keeping track of how much debt (money you owe) you have is your debt-to-income ratio, which compares what you owe to what 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 to do so. People borrow money for many reasons — for example, a student loan to pay for college or a mortgage (a loan) to buy a home. Being creditworthy means you can prove to lenders that you'll pay back borrowed money when you promised to. Lenders usually judge creditworthiness by looking at four things: capacity (can you afford the payments?), capital (how much valuable stuff do you own?), character (have you paid bills on time in the past?), and collateral (do you have valuable items you could give up if you can't repay the loan?).

How do you manage your credit? What is bad credit?
Managing credit well means paying back what you borrow according to the agreed terms. For credit cards, a smart strategy is to pay off your full balance by the due date and avoid maxing out your available credit. Bad credit happens when you miss payments, pay late, let your credit card balance keep growing, or use credit to pay off other credit (like using a credit card to make a loan payment). Also, owing a large amount compared to your credit limit can lower your credit score.

What is the difference between credit and debit cards?
Credit and debit cards look alike, but they work very differently. A credit card lets you borrow money that you must pay back — plus interest, if you don't pay the full balance by the due date. A debit card, on the other hand, is linked to your checking or savings account at your bank. When you use it, you're spending your own money, so you never pay interest. Because a debit card pulls money directly from your account, you need enough money already there to cover the purchase.

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

How do financial ratios affect me?
Financial ratios give a quick picture of someone's money habits, and lenders often use them to decide if you're creditworthy. One common ratio is the debt-to-income ratio, which compares how much debt you have to how much money you earn. A high debt-to-income ratio warns lenders that a borrower might struggle to make monthly payments. Your debt-to-income ratio — not counting rent or mortgage payments — should be much lower than your monthly income. Some lenders calculate this ratio without including 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 goods or services.
• Credit Card Accountability Responsibility and Disclosure Act: A law that bans unfair or abusive credit card practices and requires companies to clearly show their rates and fees, so people can compare cards and understand costs.
• Credit Report: A record of your credit history and bill payments. It shows how often you pay on time, how much credit you have and use, and whether any debt collectors are trying to collect money you owe.
• Credit Score: A number, usually between 300 and 800, that measures how creditworthy you are. The best-known type is the FICO® score, calculated using information from your credit report.
• Creditworthiness: How well a lender believes you can and will repay money you borrow, based on your past and future ability.
• Debit Card: A plastic card linked to your bank account, used to withdraw or spend money you already have — 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 gross income. For 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 measure how well someone is managing their money.
• Free Application for Federal Student Aid (FAFSA): The free form used to apply for federal grants, loans, and work-study jobs to help pay for college.
• Student Loans: Money borrowed to help pay for college, which must be paid back later along with 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 which credit offers are real and which might be scams?
• How much would it cost to attend the college of your choice?

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 overspending, especially with how easy online shopping is. The Credit CARD Act of 2009 says that anyone under 21 who wants a credit card must either have a qualified co-signer (an adult who agrees to be responsible for the debt) or prove they can repay the debt on their own. This rule is meant to protect young people from piling up too much credit card debt — but it also gives you a chance to teach your teen how to use credit responsibly. If you co-sign a credit card for your teen, it helps to set clear expectations in writing about paying on time. Remember: as a co-signer, you're responsible for paying the debt if your teen can't or doesn't. If the debt goes unpaid, it can hurt your own credit report.

Debit cards are also great tools for teaching budgeting and helping teens tell the difference between needs and wants. If you think your teen is ready to manage their own spending, you might set up a joint checking account so you can help monitor how the money is used. This creates a great chance to talk about the kinds of things your teen buys, the ups and downs of managing money, how to use online banking, and how to read account statements. Keep in mind that young people often misjudge how far their money will go, especially at first. These learning moments — even the tough ones — are lessons that stick. It's better for your teen to make these mistakes now, at home, than later, when financial mistakes can have bigger consequences.

What if my teen wants to take out a student loan?
Fill out the FAFSA together if you haven't already — it helps schools figure out how much federal and state aid your teen can get. Then research different kinds of aid together, including work-study jobs, grants, scholarships, and loans. There are several types of federal student loans; you can learn more at https://studentaid.ed.gov/sa/types/loans. Think about the minimum payments your teen would need to make after graduating, and compare that to what they might realistically earn.

What if my teen wants to borrow money?
If your teen wants to borrow money for something they simply want — like a brand-new car or the newest cell phone — encourage them to make a budget, save up, and work toward that goal instead. Help your teen understand that while borrowing money can be a smart choice for things like a college education (an investment in yourself), borrowing for wants isn't always the wisest decision. If your teen is planning for college and thinking about loans to cover tuition, they can reduce how much they need to borrow by researching scholarships, grants, and work-study programs at https://studentaid.ed.gov/.

Family Activities:

• Compare Colleges: If your teen is interested in 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 option.
• Compare Credit Cards: Save a few credit card offers that come in the mail and go over them with your teen. Discuss the different interest rates, fees, penalties, and terms each card 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 — a simple infographic showing the steps to apply for and get 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 — a look at how college costs may change over the next 25 years. 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 explaining how interest works and what happens with late payments. www.consumerfinance.gov/credit-cards/knowbeforeyouowe/

Online Tools:

• FAFSA by Federal Student Aid, U.S. Department of Education — complete the Free Application for Federal Student Aid to get 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 options. www.nerdwallet.com/nerdschola