Credit Cards are a risky business these days, especially for students and those holding multiple cards. Interest rates on credit card balances have always been high relative to other rates, for several reasons. Despite this, there is still a demand for the “plastic money” that many people see as convenient and ideal with the increasingly technological world economy. This lesson explores many issues surrounding credit cards- from what to look for when selecting a card to what the government is doing to aid consumers.
Credit Cards are a risky business these days, especially for students or those holding multiple cards. Interest rates on credit card balances have always been high relative to other rates, for several reasons. Despite this, there is still a demand for the “plastic money” that many people see as convenient and ideal for use in our increasingly technological world economy. This lesson explores many issues surrounding credit cards- from what to look for when selecting a card to what the government is doing to aid consumers.
- Demonstrate an understanding of interest rates.
- Identify and explain the criteria to be considered when choosing a credit card.
- Describe the extra (hidden) fees and payments that go with using a credit card.
- Identify the ways in which credit card identity theft occurs.
- Define the Red Flag Rules and explain their costs and benefits.
Deter. Detect. Defend. Avoid ID Theft: Read about identity theft and what one can do about it. This site is provided by the Federal Trade Commission.
Red Flag Rules: This site provides an overview of the Red Flag Rules and explains some of the issues that surround them.
- Don’t Jump at that Credit-Card Offer: Gerri Willis (CNN personal finance editor) offers a brief article explaining the difference between APR and “effective APR” and how fees on cards can add up quickly.
- Q&A Credit Card Reform: The National Public Radio simulates a “Question and Answer” session on the Credit Cardholders’ Bill of Rights Act of 2009. https://www.npr.org/templates/story/story.php?storyId=104349764https://www.npr.org/templates/story/story.php?storyId=104349764
- Checklist for Comparing Credit Cards: This website offers a checklist for comparing the different features of credit cards.
- What the Credit Card Bill of Rights Means for Consumers: This bullet list provides an outline of what the Credit Cardholders’ Bill of Rights Act of 2009 will do for consumers.
- Teens: Are You Ready for a Credit Card?: This link provides an assessment quiz for teachers to use in evaluating how much their students know about credit cards.
- Dallas Federal Reserve’s Credit Card Repayment Calculator: The Dallas Federal Reserve offers a “Credit Card Repayment Calculator” consumers may use to estimate minimum monthly payments and the time frame for paying off the balance owed on a credit card.
Note to the teacher: Here is some background information on credit cards. (source: The Great Economics Mysteries Book: A Guide to Teaching Economic Reasoning, by Mark C. Schug and Richard D. Western). Please read this excerpt to the students or present it to them in some form:
“Credit cards are convenient for consumers. Cards are easy to get. Tests for credit-worthiness are simple to pass. Cards are easy to use.
Credit card risks are high. Levels of theft and fraud are high. Credit cards are often used for purchases that are consumed or easily hidden, not for cars or houses that can easily be repossessed, when people default on their loans.
Credit card providers understand the risks associated with widely available credit and charge higher interest rates as compensation for taking these risks. The higher interest rates are incentives that encourage providers to continue to offer credit card loans.
What would happen if government imposed limits to the amount of interest these providers could charge? Credit card providers would soon impose higher tests for credit and make credit cards available only to low-risk, wealthier people.”
Introduce the topic of selecting a credit card. Ask: How should a consumer select the best credit card for his or her financial situation? Discuss their responses briefly.
Have students read the Checklist for Comparing Credit Cards. This checklist provides a useful summary of the features of credit cards, including some fees and and conditions that new card holders do not always consider.
Next pose questions about issues a consumer may face after he or she has obtained a credit card.
So, you finally have your new credit card. Now all you have to worry about is how much you spend and making your minimum monthly payments, right? Discuss the students’ responses briefly. In the discussion emphasize the point that there are several additional issues that a card holder must be aware of and monitor.
Explain some of the additional issues. For example, credit card holders often need to close their accounts earlier than they could have imagined, for several reasons. Sometimes they open credit card accounts even though they no income, little income or inconsistent income. In these cases, they may find it difficult to make the required payments. Then late fees will begin to pile up, perhaps creating an overwhelming burden.
For this reason, many high school or college students open co-accounts in which a parent or legal guardian is designated as the primary account holder.
Even then, however, there may be serious difficulties. Interest rates may go up unexpectedly, for example. And card holders my receive offers of additional cards from other credit card companies- offers tempting them to take on more obligations than they can handle. Also, card holders may receive their statements of outstanding balances with due dates that allow only a short time for payment, making it difficult to pay one time. This problem can prompt some card holders to pay over the Internet or by telephone. Some companies charge for payments made via Internet or by telephone, which adds to the card holders obligations.
While these are just a few examples of additional payments and conditions that might affect card holders, they underscore the point that people do not always know what they are getting themselves into.
To pursue this point, have the students read “http://archive.boston.com/business/personalfinance/managingyourmoney/archives/2009/05/what_the_credit.html“. This site provides information about the Credit Cardholders’ Bill of Rights Act of 2009. Then have the students look at “https://money.cnn.com/2009/05/20/pf/saving/credit_cards_willis/?postversion=2009052012” to read about things people should consider when they receive a new credit card offer.
With the class, discuss the Credit Cardholders’ Bill of Rights to clarify what this act implies for the economy. After the discussion, ask the students to define “effective APR” and review the “Tony” case, to get a better understanding of the rates and fees that apply for people opening a new credit card account.
Next, have the students read “https://www.consumer.ftc.gov/features/feature-0014-identity-theft” about credit card identity theft- what it is and how it occurs. In a brief discussion, either ask these following questions or have the students answer them on the provided note-taker and print them out. View Interactive Activity
1. What are the ways in which credit card account information is fraudulently obtained? [People can steal your card, copy the details off your credit card, or steal your Personal Identification Number (PIN)]
2.What risks do creditors take when issuing unsecured credit cards? [Risk of fraud, theft, and default.]
3. What incentive exists to compensate creditors for taking the risk of extending credit? [Interest payments. Generally, in the financial services market, the higher the risk, the higher the rate of interest.]
4. What would happen if government imposed limits to the amount of interest these providers could charge? [The amount of credit supplied would decline, because the incentive to issue loans would be decreased by the limits on interest rates. There would be a shortage of credit for higher risk borrowers.]
What is being done to prevent identity theft? One answer has to do with something called the “Red Flag Rules”. These rules stem from a 2003 law enacted by Congress in an effort to help people “detect, prevent and mitigate identity theft in connection with the opening of certain accounts or existing accounts,” according to a Federal Trade Commission report. Have the students read this introductory article “Red Flag Rules to Stem ID Theft Delayed” and answer the questions below. Students can enter their name, class period and print off their answers on the last page. View Interactive Activity
1. What are the Red Flag Rules? [Red flag rules “push financial institutions to make sure that people are who they say they are — authenticating identities…” They also require actions intended to “detect, prevent and mitigate identity theft in connection with the opening of certain accounts or existing accounts”]
2. Whom do the Red Flag Rules apply to? Financial institutions and creditors that “offer or maintain covered accounts” including (but not limited to) banks, credit unions, auto dealers, mortgage brokers, utility companies and telecommunications companies]
3. Who opposes the Red Flag Rules? Why? [“Smaller dealers with limited financial resources” and institutions that have the “financial and bureaucratic burden of being forced to comply with the rules.” Some will have to hire a third party to ensure that they comply with all rules.]
4. What are the benefits of the Red Flag Rules? [The main benefit is that they will “detect, prevent and mitigate identity theft in connection with the opening of certain accounts or existing accounts.” They may help to protect bank’s customers; since they “will involve some transparency of procedures.” Given the rules, employees will be able to spot identity fraud easier, and there will be a “balance between the consumer’s best interest and an organization’s need to keep its defenses opaque to thieves.”]
5. What are the costs of the Red Flag Rules? [They will require a significant amount of time, forcing managers and service providers to pay attention to them; smaller dealers may not be able to afford them, causing them to hire a third party; they have been described as “excessive and overly burdensome”; they require “financial institutions and creditors” to “update their programs periodically”; etc.]
Credit cards can be convenient and beneficial but many people do not understand the issues that go with using credit cards. Credit card providers do understand the risks associated with credit; they charge higher interest rates for taking these risks. Nonetheless, consumers continue to use credit cards, and the higher interest rates create incentives that encourage providers to continue to offer credit card loans. Both sides clearly value the benefits over the costs in these contractual agreement. Consumers must compare many different cards to find those that are best for them; they must also deal with the extra fees and payments that go along with using the cards they choose. Many card holders close their accounts when they find themselves unable to pay off their balances. Those who continue to hold an account must be aware of other issues such as identity fraud. Red Flag Rules are being implemented in order to identify and curtail suspicious activity associated with identity fraud.
First, have the students visit the https://www.dallasfed.org/educate/calculators/open-calc.aspx to gain an understanding of how long it can take to pay off a credit card balance. Ask the students to enter a random total balance ( somewhere between $500- and $2,000) and the highest annual percentage rate (APR) (between 7%- and 25%). The site will provide an estimated initial payment, the amount of time needed to pay off the balance, and the amount of interest the card holder would have to pay in that amount of time. Have the students click on the question marks to learn how these numbers are generated. After they have done this, have them scroll down to the bottom and enter the number of years in which they want to have the card paid off. Once again, the site will provide information about how the numbers are generated. Do the same for a hypothetical amount they would be able to pay each month on the right. Discuss some of the different scenarios the students encountered. This link is a great “eye opener” for students who don’t fully understand the reality of balances, minimum payments, and interest charges facing people who use credit cards.
Next, have the students visit “Teens: Are You Ready for a Credit Card? ” to take a short quiz that will reveal how much they really know about credit cards. (Note: This quiz can be used as an informal assessment.)
Finally, direct the students to the https://www.npr.org/templates/story/story.php?storyId=104349764 to see what President Obama and others have planned in order to reform the credit card industry, and to see how such reforms might affect consumers. Discuss this Q&A as a class.