Getting your first credit card can be very exciting, but unfortunately some people do not take the time to consider the costs associated with buying on credit. A credit card can make it easier to buy on impulse, and we do not always take the time to consider the hidden costs of buying on credit. This lesson will help kids understand the perils of making impulse purchases on credit, paying only the minimum each month, and/or making late payments.
In this lesson, students will work individually or with a partner to answer a series of questions related to buying on credit. They will first work under the assumption that they are not paying off the balance but will make the minimum payment and revolve the debt. Once they have seem how much the cost of borrowing on credit and making minimum payments effects their overall cost of the items purchased on credit, they will rework the scenario to formulate an optimal payment plan for paying off the debt within a time from of six to twelve months.
There are two options for working through this lesson. Option one is to use the Compound Interest Simulator and the second option is to use the Cost of Being Late spreadsheet to compute the interest each month. Regardless of the method chosen, you may want to walk through some practice scenarios to ensure your students have a working understanding of how interest is calculated. An alternative approach would be to divide the class in two and have one half of the students use the simulator and the other half a spreadsheet. As part of your post activity discussion you can have students discuss the benefits of one method over the other.
The primary goal of this lesson is to understand that the costs associated with buying on credit and that making only minimum payments is problematic to long-term financial health. The secondary goal is to formulate a plan to extinguish the debt quicker. This lesson will help them see the real cost of purchasing an item when interest and fees are added to the purchase price. The scenario that will be used for this lesson is based on the first year of the life of a new credit card. The student handout describes the scenario and posses a series of questions based on the use of either the simulator or the spreadsheet application.
Lesson Opener
In order to assess the level of consumer finance knowledge your students posses, consider asking students to discuss the following questions in small groups or as a whole class:
As a whole class, ask students to share what they knew about credit cards. Expect that they may share family experience or repeat what they have heard in the media. If it does not come out in the class discussion, make sure students understand that the use of a credit card creates debt and a legal obligation to pay while a debit card takes money from an existing checking or savings account to pay for purchases and does not result in a debt obligation. The terms debit card and credit card are often times mixed up by students and even some adults. If you have not already done so, this would also be a good time to share some the ads offering teaser rates or extended payment options. Be sure to point out the fine print that is usually at the bottom of these ads. The fine print will often disclose the true cost of credit based on a simple scenario.
The scenario we will use for this activity includes the charging of three retail purchases and a dinner for friends. Distribute either the Cost of Being Late: Compound Interest Simulator or Cost of Being Late: Spreadsheet Application activity sheet, depending on which method students will use.
For simplicity, no additional charges will be made over the next twelve months. The scenario will be based on a teaser rate of 10% for six months and a default rate of 22% thereafter. (The default rate is the published rate without benefit of any promotional offers. It is sometimes referred to as the posted rate.) One payment will be made late resulting in a late fee of $40 plus an increase in the APR from 22% to 28%. Our goal will be to determine the balance due at the end of one year along with the cost of using credit for that twelve-month period. If your students are struggling with the concept of compound interest you may want to consider having them work with a partner pairing a weaker student with a stronger student.
Compound Interest Simulator Option
Before you have the students begin work on the scenario you might want to walk through an example using the simulator. I would recommend using the following mp3 purchase as an example.
Have students consider the purchase of an mp3 player at a cost of $200 with payments of $20 per month and an interest rate of 22% APR. Have students enter the information into the simulator as follows (Note: Only whole numbers can be entered into the dollar fields, which means kids will need to round up or down using standard rounding rules):
It will take twelve months to pay for the player for a true cost of $222.98. That true cost will be even higher if payments are not made on time and late charges are assessed or if interest rates are increased before the debt is paid in full. In this example the cost of buying the player on credit was $22.98. Consider asking students what they could have done with that $22.98 if they had not bought the player on credit and instead waited to pay cash.
A minimum payment of 4% or $20, which ever is greater is standard but since it is an open field you can have the kids work with a variety of scenarios. You might consider having them see how long it will take to pay off if they make minimum payments of $10 or if the rate were higher or lower. Depending on the skill level of your students and time constraints you might ask the students to pose an additional example that they could use the calculator for such as a new game system or some other consumer purchase that may be of interest to them. Some students may want to simulate the purchase of a car which can be done but I would recommend using the purchase of a big ticket item such as a car as an extension activity.
Your students should now be ready to work through the scenario using the Compound Interest Simulator. I would recommend that you walk around and spot check student’s work to insure their calculations are correct and that they understand how to use the simulator.
Spreadsheet Application Option
In option two instead of using the simulator use the Cost of Being Late spreadsheet. The application provided with this activity has the formulas built in and is based on a twelve month scenario using the mp3 example described in Option 1.
| Retail Credit Card Purchase of an mp3 Player Example |
| Payment # | Initial Balance | Purchases | Fees | Monthly Payment | Annual Interest Rate | Interest Charges |
| | – | $200.00 | – | | 22% | $3.67 |
| 1 | $203.67 | – | – | $20.00 | 22% | $3.37 |
| 2 | $187.03 | – | – | $20.00 | 22% | $3.06 |
| 3 | $170.10 | – | – | $20.00 | 22% | $2.75 |
| 4 | $152.85 | – | – | $20.00 | 22% | $2.44 |
| 5 | $135.28 | – | – | $20.00 | 22% | $2.11 |
| 6 | $117.40 | – | – | $20.00 | 22% | $1.79 |
| 7 | $99.18 | – | – | $20.00 | 22% | $1.45 |
| 8 | $80.63 | – | – | $20.00 | 22% | $1.11 |
| 9 | $61.75 | – | – | $20.00 | 22% | $0.77 |
| 10 | $42.51 | – | – | $20.00 | 22% | $0.41 |
| 11 | $22.92 | – | – | $20.00 | 22% | $0.05 |
| 12 | $2.98 | – | – | $2.98 | 22% | $0.00 |
| Totals | | | – | $222.98 | | $22.98 |
The benefits of using a spreadsheet over the simulator are that the spreadsheet provides a monthly amortization (payment plan) where the simulator does not. If time permits, you may consider having students use both methods.
Answers
| | Simulator | Spreadsheet |
| 1. | $532.00 | $532.00 |
| 2. | $516.43 | $516.43 |
| 3. | $436.63 | $436.63 |
| 4. | $419.43 | $419.11 |
| 5. | $128.21 | $127.11 |
Note: Some values differ because the Compound Interest Simulator only accepts input values in whole dollar amounts.
