Grades 912
Earning Credit
Standards
Concepts
Students participate in a series of activities that provide them with a simulated credit score and an auto loan interest rate based on their credit score. Then they learn to use compound interest and amortization schedules to calculate the real cost of buying a car, and they compare the total cost of buying a car for individuals with high and low credit scores. At the conclusion, students have a second opportunity to obtain a higher credit score and evaluate how this will affect what kind of car they can buy.
Students should have some mathematical background in exponents and the idea of percents before beginning this lesson.
Time Required
90 minutes
 Procedures 1 to 24, 45 minutes on the first day.
 Procedures 25end, 45 minutes on the second day.
Will Be Able To
 Define credit score and interest rate.
 Explain how lenders use credit scores to evaluate risk.
 Explain the kinds of behaviors that affect people’s credit score.
 Explain how credit scores affect interest rates for individual borrowers.
 Compare simple and compound interest.
 Use mathematical strategies to calculate monthly payments, given principal and interest rate.
 Calculate how compound interest affects the total cost of a major purchase.
 Compare the total cost of major purchases for people with low and high credit scores.
Materials

Lesson Interactive: http://earningcredit.herokuapp.com/

Earning Credit presentation PowerPoint  pdf file

Activity 1, Exit Slip, one copy for each student

Activity 2, The Amortization Formula and the Price of Your Car, one copy for each student

Activity 2 Key, The Amortization Formula and the Price of Your Car – KEY, answer key for teacher use

Internet access for each student
 Scientific calculator, one per student
Assessment Activity
Multiple Choice

Which of the following best defines “credit”?
 [The opportunity to borrow money or to receive goods or services in return for a promise to pay later.]
 The price paid for using someone else's money, expressed as a percentage of the amount borrowed.
 Money paid regularly, at a particular rate, for the use of borrowed money.

A record of past borrowing and repayments.

Assume you are a lender. Each of the four individuals described below is seeking a car loan. To whom would you offer the lowest interest rate on a loan?
 Lebron, a high school basketball coach and golf pro; he recently borrowed $15,000 to go back to school and $200,000 to buy a new house, and he owes $2500 on his four credit cards.
 Katrina, a real estate agent who recently got a new job after 8 months of unemployment; she has $5,000 in credit card debt and missed two mortgage payments on her home this year.
 [Bonnie, a travel agent with $2500 in credit card debt and a $150,000 mortgage on her house in Hawaii; she made two late credit card payments in the past 15 years.]

Walt, a recent college graduate who just got his first teaching job; he has never taken a loan or owned a credit card.

Max borrows $10,000 to buy a new car at a rate of 5% for 72 months (6 years). Interest is compounded monthly. What will be the total cost of the car, including principal and interest, at the end of 72 months?
 $11,000
 $11,322
 [$11,595]

$13,400

Jim takes out a car loan for $23,500. Due to his strong credit score, he is approved for an interest rate of 2.6%.
 What is the principal amount he has borrowed? ($23,500)
 If Jim borrows for five years, how much will he pay in principal and interest by the end of five years? (Use the amortization formula) ($25,086)
 What is Jim’s monthly payment? ($418.10)
 How much did he pay in interest? ($1,586)
 Now assume that Johnny also takes out a car loan for $23,500. Due to his lower credit score, he is approved for an interest rate of 5%. How much will he pay in principal and interest by the end of five years? ($26,608.20)
 What is Johnny’s monthly payment? ($443.47)
 How does a better credit score affect the total cost of a new car? [A better credit score will produce a lower interest rate and will reduce the total cost of the car.]
Constructed Response
Conclusion

Pose the following questions for review:

What is a credit score? [A number based on information in a credit report which indicates a person’s credit risk.]

What is an interest rate? [The price paid for using someone else's money, expressed as a percentage of the amount borrowed.]

If you were a lender, how could you use a credit score to evaluate the risk of a borrower? [Answers may vary. A possible answer: if a loan applicant has a high score, I would be more likely to lend them money because the risk would be lower.]

If you want to have a good credit score, what should you do? [Don’t borrow too much, repay your loans on time, and don’t get too many credit cards.]

John has a credit score of 680. Amy has a credit score of 550. Who would be more likely to secure a low interest rate loan for a home purchase? Why? [John, because his credit score is higher.]

What is the difference between simple and compound interest? [Simple interest is paid on the principal only, while compound interest is paid on the principal and interest.]

Show the graph on Slide 16. Ask students what happens to the total amount of interest paid when interest is compounded more frequently? [It increases.]
 How will a low credit score impact an individual’s total cost when purchasing a large item, like a car or house? [They will pay a lot more.]

What is a credit score? [A number based on information in a credit report which indicates a person’s credit risk.]
Overview
Credit is borrowed money used to buy goods and services, which must be repaid later. Adults frequently use credit for major purchases, such as cars and houses, because they want these items at the current time and don’t have enough cash on hand to purchase them.
In order to obtain credit from a lender, applicants must provide a credit history, which includes a credit score. A low credit score, which reflects late payments or abuse of credit in the past, can result in loan denial or very high interest rates. A high credit score, which reflects ontime payments and responsible use of credit, can result in easier access to loans with lower interest rates. Loan interest rates are critical because they determine the total cost of the purchase as well as the monthly payment.
Sources

"Analyze Your Debt to Credit Limit Ratio." Yahoo Finance. N.p., n.d. Web. 14 Dec. 2013.

"CREDIT CARD HELP: The Basic Fundamentals of Credit Cards." CreditCardscom News. N.p., n.d. Web. 14 Dec. 2013.

"Credit Score Estimator." – Credit Score Calculator. N.p., n.d. Web. 14 Dec. 2013.

"How Do You Look to Lenders?" Free FICO Credit Score Check Your Credit Report Online. N.p., n.d. Web. 12 Dec. 2013.

"How Much Will Your FICO® Score save You on Your next Car?" Free FICO Credit Score Check Your Credit Report Online. N.p., n.d. Web. 14 Dec. 2013.
 "MoneyHabits." Simple Interest and Compound Interest Explained. N.p., n.d. Web. 14 Dec. 2013.
Assessment

Introduce the lesson by showing Slide 1 and ask students:
 Have you ever borrowed money from someone and not repaid it? Or has anyone ever borrowed money from you and not repaid it? [Most students have probably had this experience.]

When lending money to a friend, what factors should you consider? [Reliability, trustworthiness, how well you know them, whether they have a source of income, whether they have repaid money in the past, etc.]

Explain that in this lesson they will learn about credit scores and interest rates and analyze how current financial choices, such as borrowing money and failing to repay it, can have major costs in the future.

Display Slide 2 and ask students the following questions:

Have you ever considered how your grades or your college plans might impact your financial future? [Most students will probably say no.]

Have you ever considered how your grades or your college plans might impact your financial future? [Most students will probably say no.]

Explain that high school grades and decisions about college and career are among the many important decisions that can affect people’s financial futures. Ask students:

What important financial decisions will you make in the next few years? [Possible answers include whether to borrow money for college, whether to buy a car, how much to spend on items like clothes, food and movies, and whether to get a credit card.]

What important financial decisions will you make in the next few years? [Possible answers include whether to borrow money for college, whether to buy a car, how much to spend on items like clothes, food and movies, and whether to get a credit card.]

Explain that many of these decisions – especially borrowing decisions – can have longterm consequences.

Show Slide 3 and define credit as borrowed money that is used to buy goods and services and must be repaid later. Explain that creditrating agencies, such as Trans Union, Experian and Equifax, actually track individuals’ use of credit throughout their lives and create credit reports. Other companies use information from credit reports to compute credit scores for individuals. The most wellknown of these is Fair Isaac Corporation, now called FICO. A credit score is a single number assigned to a person used by lenders to predict the risk that a borrower will not repay.

During the next section of the lesson, students will take an online survey, which will calculate a simulated credit score for them.
Technical Note for Teacher: The survey may take several seconds to load. Before assigning students to take the survey, you must sign up as a teacher (http://earningcredit.herokuapp.com/ ). When students sign in to take the survey, they will need to enter their name and the teacher’s email address.
Tell students that they are going to take an online survey. Their reponses to the survey will be used to calculate a simulated credit score for them. Explain that being responsible is the key to having good credit as an adult – paying bills on time, borrowing only amounts that can be repaid, etc. In high school, students demonstrate their responsibility by doing well in school and other ways (please refer to the survey questions below). Each student should record his/her credit score because it will be used later in this lesson. Direct students to log in to http://earningcredit.herokuapp.com/ . Ask students to be patient while the survey is loading. Once the application has loaded, instruct students to write down their access code for future reference.
The introductory page for this application provides background information about credit and what makes up your credit score. You may decide to review this information with the students before proceeding to the survey or wait until Step 12 of the lesson, which explains in detail what makes up a credit score.
Instruct students to take the PreSurvey and to write down their credit score after they have completed it. Direct students to log in to http://earningcredit.herokuapp.com/ to take the survey. The survey includes the following questions:
 What was your score on the most recent test in this class? (Note to teacher: an estimate is OK. Teacher may need to help students recall the scores.)
 In this class, how many assignments have you missed OR turned in late? (Note to teacher: an estimate is OK. Teacher may need to look up for students)
 At what age did you first save some of your own money? The savings can be from job income, gift money, or allowance. Savings can be in any place from piggy bank to bank savings account. (Note to teacher: the emphasis is on the student’s own saving – not an account set up by the parents.)
 In how many clubs/organizations are you involved this year? These may include school sports teams and clubs, community organizations, jobs, religious and/or political groups. (Note to teacher: emphasize that any activity can be counted, including a job.)

When was the last time you asked your parents for money not for a required school activity? This does not include money for necessities, such as lunch money or college application fees. It should include requests for money to purchase personal items, clothing, movies, and gas money.

Remind students to record their score before leaving the survey. Ask students to share some of their credit scores. [Scores will range from 300 to 850.]

Explain that a lower score represents a higher risk to lenders, meaning they anticipate the borrower may be late on payments or fail to repay the loan. A higher score represents lower risk.

Show Slide 4 so that students can see the range. Ask students how the survey questions are relevant to their real credit score. [Students may object to some of the questions, saying their behavior in school is not the same as their behavior with money; others will note that reliability and responsibility are part of a credit history.]

Explain that each question on the survey was designed to simulate one of the factors used to assess risk and determine credit scores. Ask students what factors they think are included in determining actual credit scores. [Answers will vary; students may believe that income, age, race, educational level and other factors are included, but they are not.]

Show Slide 5, which lists the categories used to determine an individual credit score, and explain how each survey question related to these categories. Fair Isaac Corporation (FICO) does not release exact, specific information about how they calculate scores. This breakdown is based on general information they have released. Discuss the following:

35% Payment history—Consumers are rated on whether they make regular ontime payments on car loans, student loans, home loans and credit cards. Test scores were used for this category because they represent a consistent longterm effort. Missing one credit payment may not have a big impact—although record of this will remain on the credit report for up to seven years. Missing multiple payments is far more damaging.

30% Managing your debt—Consumers are rated on how large their credit balances are relative to their available credit; it’s best to use less than 10% of available credit (Yahoo Finance). Homework completion was used for this category because it represents your ability to keep track of obligations.

15% Length of credit history—Consumers are rated on how long they have managed credit. Savings were used for this category because making the decision to save your own money represents a first step in financial responsibility.

10% Diversity of accounts—Consumers are rated favorably for having a variety of types of credit – credit cards, a car loan, a home loan, etc. Activities were used for this category because they represent balancing competing obligations.

10% Number of credit applications—Consumers are rated negatively if they frequently seek new loans and credit cards. However, if they seek multiple estimates for a car loan, these are grouped so they are not hurt by them. Asking your parents for money was used for this category because borrowing from parents is similar to borrowing from other sources.

35% Payment history—Consumers are rated on whether they make regular ontime payments on car loans, student loans, home loans and credit cards. Test scores were used for this category because they represent a consistent longterm effort. Missing one credit payment may not have a big impact—although record of this will remain on the credit report for up to seven years. Missing multiple payments is far more damaging.

Ask the following questions for review:
 What is credit? [Borrowing money to purchase goods or services with the understanding that you will repay later.]
 What is a credit score? [A single number that represents an individual’s reliability or riskiness, used for future loans.]
 What kind of factors go into determining a credit score? [Payment history, debt management, length of credit history, diversity of accounts, number of credit applications.]

Why do credit scores matter? [Students may not be sure of this yet; this question is a segue to the next topic, but students probably understand that credit scores will affect the ability to obtain loans in the future.]

Explain that credit scores are used in many different ways. They are often used by organizations to determine whether an individual can lease an apartment, get a job, qualify for insurance and receive loans or credit cards. Ask students if they would be more likely to lend their savings to a classmate with a score of 400, which represents higher risk, or a score of 700, which represents lower risk? [700, because you are more likely to get your money back.]

Explain that credit scores also influence the interest rate an individual can obtain on a loan or if they can obtain a loan. Show Slide 6 and explain that an interest rate is the price paid for using someone else's money, expressed as a percentage of the amount borrowed. Explain that principal is the original amount of money invested or lent. Explain to students that adults often borrow money for major purchases, such as cars, boats, education and houses, because it would take too long to save for these purchases, and they would be unable to enjoy the benefits of them for a long period of time.

Explain to students that before analyzing how credit scores impact interest rates, they are going to analyze the impact of the interest rate on the total cost of a new car.

Display Slide 6 and ask students to solve this problem:
 Price of car/Loan principal: $15,500
 Interest rate: 0%
 Loan term: 5 years (60 months)
 What is the total cost of the car? [$15,500.]

What is the monthly payment? [Guide students to divide the principal by the number of months: $15,500/60 = $258.33.]

Show Slide 7 and explain that simple interest is interest paid only on the principal of a loan; that is the initial amount borrowed. In our example, the principal or initial amount borrowed is $15,500. To calculate simple interest for one year, multiply the principal by the interest rate expressed as a decimal. For a specific number of years, multiply the simple interest calculated for one year times the number of years of the loan. Add the total amount of interest to the principal to get the total cost of the car. Show Slide 8 and ask students:

What is the total cost of the car? [$15,500 + $1550 = $17,050.]

What is the monthly payment? [$17,050/60 = $284.16.]
Ask the students what the difference is between the total cost of the car with the two loan options — 0% interest and 2% simple interest. [$1550.] What is the difference in the monthly payment? [$284.16 – $258.33 = $25.83] How does paying interest affect the total cost of a car? [Paying interest makes it more expensive.]

What is the total cost of the car? [$15,500 + $1550 = $17,050.]

Show Slide 9 and explain that compound interest is interest paid on the principal of a loan (initial amount borrowed) and interest paid on the interest owed. Use the same scenario – a car that costs $15,500 but in this case the loan is for 2% compounded annually. Demonstrate the following for the first year of the loan with compound interest:
$15,500 X (1.02) = $15,810

Show Slide 10 and explain that in year two, 2% interest would be charged on $15,810 (the cost of the car plus the interest from year one). Explain that this would continue for each year of the loan. Ask students to calculate the amount owed at the end of two years, three years, four years and five years.
 at the end of two years [$16,126.20].
 at the end of three years [$16,448.72].
 at the end of four years [$16777.69].

at the end of five years [$17,133.25].

Refer students to slide 10 and guide them to derive the equation T = $15,500 x (1 + 0.02)^{n} where T is the total cost (assuming no payments until the end) and n is the number of years. [The general compound interest formula is Total Cost = Principal x (1 + interest rate in decimal form)^{number of years.}]

Show Slide 11 and ask students to calculate the total cost of the car [$17,113.25], again, assuming no payment has been made. Ask them to determine the monthly payment [$285.22].

Distribute a copy of Activity 1, the Exit Slip, to each student.
End Day One Here
Note to teacher: before continuing, use the credit scores to assign groups for Step 30. Make sure each group has students with a variety of different credit scores/interest rates.
Day Two

Begin by reviewing questions from the exit slip to check for understanding.
 Calculate the total cost of the $15,500 vehicle if the borrower obtains a compound interest rate of 5% (compounded annually) for 5 years (60 months). [$17,550.25.]
 Predict how higher interest rates, in general, will impact the cost of major purchases for consumers. [Higher interest rates will make items more expensive.]

Predict how your simulated credit score will impact the interest rate you are offered. [Answers will vary.]

Explain to students that when borrowers obtain loans for major purchases, like houses or cars, the lenders use a formula similar to the compound interest formula derived on Day One, although it is not exactly the same. This formula is called the amortization formula. Define amortization as the distribution of a payment into multiple installments as determined by an amortization schedule. Unlike other repayment models, each monthly payment includes both principal and interest. Explain that in class, they will use but not derive this formula. Show Slide 12 and provide each student a copy of Activity 2. Explain each of the variables in the amortization formula:
 A = monthly payments, which is the amount the borrower must pay each month over the term of the loan. The payment includes both principal and interest.
 i = monthly interest rate, which is the annual interest rate in decimal form/12 (Note that in this formula, interest is compounded monthly rather than annually. As a result the interest rate is divided by 12.)
 P= principal, which is the sum of money borrowed.

n = total number of payments, which is the term of the loan, expressed in months rather than years.

Distribute a calculator to each student and walk students through an example using the amortization formula (the formula, including the numbers, is on Activity 2). Use an interest rate of 2%, a principal of $15,500 and a 5 year (60 month) loan term. Ask the students:
 What is the total cost of the car? [Monthly payment X 60; $16,300.80.]

What is the additional cost of the car beyond the principal (initial car price)? [$800.80]

Tell students to complete question number 2 on Handout 2 (The Amortization Formula and the Price of Your Car) independently. [Monthly payment $478.98. Total cost of the car $34,486.56.]

Tell students to imagine that they are preparing to buy a new car with a price of $20,000. Explain that they will use the Earning Credit application (councilforeconed.org.earningcredit) to determine what interest rate a lender is likely to give them based on their credit score.

Direct students to log in to councilforeconed.org/earningcredit http://earningcredit.herokuapp.com/ again to find their own personal auto loan interest rate. Instruct students to enter the access code they received for the PreSurvey in the box under Returning Students (Note to teacher: have the spreadsheet of credit scores available in case students have forgotten their credit scores. This is available on the Teacher Dashboard.)

Tell students to record the best interest rate they are eligible for according to the table provided in the Earning Credit Application.
 Explain to students that for Question 3 on Activity 2 (The Amortization Formula and the Price of Your Car), they should assume they are buying a car with a price of $20,000. Direct students to calculate the monthly payment and the total cost of the loan using their interest rate, the price of $20,000, and a loan period of five years (60 months). [Answers will vary based on interest rates; see table below.]
Credit score 
Interest rate 
Monthly payment 
Total cost 
720850 
2.5% 
$354.95 
$21,297 
690719 
4.5% 
$372.86 
$22,371.60 
660689 
6.5% 
$391.32 
$23,479.20 
630659 
8.5% 
$410.33 
$24,619.80 
600629 
10.5% 
$429.88 
$25,792.80 
570599 
12.5% 
$449.96 
$26,997.60 
540569 
14.5% 
$470.57 
$28,234.20 
510539 
16.5% 
$491.69 
$29,501.40 
480509 
18.5% 
$513.32 
$30,799.20 
300479 
20.0% 
$529.88 
$31,792.80 

Arrange students in groups with a variety of different credit scores/interest rates. Show Slide 143 to explain expectations for group behavior. Show Slide 14 with discussion questions. Within each group, students should discuss:
 What was your credit score? [Answers will vary.]
 What was your interest rate? [Answers will vary.]
 How are your interest rate differences related to your credit score differences? [Lower credit score results in higher interest rates.]
 How did these differences impact the total cost of the car for individuals in your group? [Lower credit score results in higher total cost of the car.]
 What behaviors caused some students to have lower credit scores? [Missed assignments, low test scores, borrowing money.]
 What behaviors caused some students to have higher credit scores? [No missed assignments, high test scores, not borrowing money.]
 What could individuals with low simulated credit scores do to improve these credit scores? [Turn things in on time, perform more consistently on tests, not borrow money from parents or friends.]
 Now think about the categories used to calculate an actual credit score. What kinds of behaviors would result in a low score, representing a high risk? [Late/missed payments, too much debt, no credit history, too many requests for credit.]

What kinds of things can each individual do in the future to ensure that his or her real credit score is high? [Make payments on time, not borrow too much money, not have too many loans].

Explain that students will have an opportunity to obtain a new credit score and interest rate, based on their predictions about their own future behavior. Direct students to login to technology.councilforeconed.org/earningcredit/ and take the Post Survey. This time, the site will provide both the credit score and interest rate simultaneously.
 Optional Extension Activity (depending on time). Allow students to use Edmunds.com to select a car they would want, and complete Question 4 on Handout 2 (The Amortization Formula and the Price of Your Car) using their new interest rate and the price of their selected car. [The teacher may wish to use an online calculator such as chase.com/autoloans/paymentcalculator to check their work.]
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