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As you’ll recall, way back in Lesson 1, we talked about the idea that education is designed to qualify a person to be employed — to enter the labor pool and earn an income. But income isn’t wealth. It’s what you do with your income, how you manage your money, that converts your income to wealth. It’s interesting to me our education seems to stop short. We teach our students skills to be employable (or at least that is the objective), but we don’t teach the skills to be financially secure. I think this must be because our education is really still based on a 19th century model, but the need, the absolutely essential importance of building wealth and understanding the complexities of building wealth are 21st century issues.
You’ll recall in unit 1 we compared wealth and income. Wealth includes things like investments and a healthy retirement fund. While income ends when a job ends, wealth provides long-term financial security. I want students to start wrapping their heads around the idea that they are preparing for 2 jobs: a career that earns them an income, and money management skills that help them build wealth because that is the other part of the financial security equation.
This lesson begins on Page 114 of the Instructor’s Guide so let’s turn to that now. The Supplemental Resource for this lesson is SimpleTuition.com. We don’t cover a lot of student loans in this course mainly because so many high schools and college counselors already do this. But SimpleTuition is a good website that has pretty much all the information a prospective college student or their parent could need about student aid and it’s a really easy site to navigate.
Let’s move to Page 116: Gaining Attention which poses the conundrum. You can expand on this by asking students if they’ve ever borrowed money maybe from a friend or a parent and what their experience was being a borrower. Was it worth going into debt to get the thing they wanted? Was it difcult or did it take a long time to repay the money they borrowed?
The Presentation of Content begins with a historical summary of credit. We delve a lot deeper into this in The 21st Century Student’s Guide to Financial Literacy: Going Global. Credit and the history and impact of credit is really interesting. But students should know that credit has been around a long, long time. People have always been borrowers and lenders. Credit – which is the ability to borrow money and repay it later — is a very valuable tool that enables money (capital) to flow from those who have it to those who need it. Credit has advanced civilization. It is important that students come away from this lesson with a sense of the historical value and importance of credit. Sometimes we only focus on the downside of that conundrum, which is debt, but there are many important positive aspects to credit.
Since this is a course on personal finance, our focus in this lesson is not on the type credit that is used to build big companies or fund innovation. Our focus is on the type of credit that individuals (regular people) use. So the first thing we do is compare Consumer and Non-consumer credit. You can read the diference between those on Page 116. But you know, students have probably never really thought about credit and have probably thought even less about the diferences between consumer and non-consumer credit. But a simple explanation is that while these are both loans made to individuals, it’s what the borrowed money is used for that makes the diference.
Consumer credit gets kind of a bad rap because most of consumer credit in the U.S. is made up of credit card debt. We have an entire later lesson devoted to credit cards so we won’t debate the pros and cons of credit card debt now. Students should, however, understand that consumer credit has a important role in our economy. It all has to do with the fact that it creates what is called “purchasing power” for consumers — for everyday, ordinary people. The italicized paragraph on Page 117 provides some discussion points that illustrate for students why the purchasing power that consumer credit provides is so important.
Let’s move on to Roman Numeral number III on Page 117. Where Does Credit Come From? Who or what provides consumer credit? What kinds of institutions make loans to people? That’s pretty easy to understand – banks, finance companies, payday lenders, and now, crowdlenders. Banks are the leaders in consumer credit but you can see that other institutions are also engaged in that business. Your students may be most familiar with crowdlending because it originates online and your students are all about the internet. Note that crowdlending is diferent than crowdfunding. We explore crowdfunding in our Going Global program because it’s more a source of start-up capital. As an aside, if your students are interested in seeing what kinds of start-up projects people are working on, it’s really fun to explore some of the crowdfunding sites like Indigogo, Kickstarter or Rocket Hub.
Let’s move over to Page 118, Roman Numeral 4: The Dangers of Consumer Credit. I don’t want to go all negative on consumer credit because it’s just a really valuable and important source of money. It provides purchasing power and fuels the economy, and moves innovation forward because it creates demand for products and improvement of those products. But we have sort of a lovehate relationship with consumer credit. Because in spite of all its benefits, there is a downside to consumer credit. It can be abused. People overspend. They get into to much consumer debt when credit is easy to get. In fact, much of America is seriously in debt due to abuse in consumer credit, mainly in the form of credit cards. So you can read about that in Section 4.
Also, your students must understand that credit is not free. It costs a lot. We’ll look more closely at the cost of credit in a later lesson on credit cards but students should understand that when you borrow money, you have to pay back all of what you borrowed plus a fee for the privilege of using that money. Many people think that interest, which is a percentage of the loan amount, is all you pay when you borrow. That could be true, but more often that not, a loan includes other costs such as fees. The true cost of credit is revealed not by the interest rate but by the Annual Percentage Rate — the APR. When shopping for a loan or credit, check the APR. The chart on Page 118 will help you demonstrate for students the diferences between the interest rate and the annual percentage rate. Spend some time explaining to students that loans and credit are products. Diferent lenders provide diferent loan products so when in the market for a loan, shop around and negotiate.
Let’s move on to Page 119: Using Debt to Build Wealth. It may seem incongruous or counterintuitive, but some types of debt are considered necessary for building wealth. Economists like to express the diferences at bad debt vs. good debt. Bad debt is the kind of consumer debt you get into when you accumulate credit card and other consumer debts. In other words, the stuf you bought with the money you borrowed is consumed so it does not have the potential of increasing that value over time. Good debt is non-consumer type debt taken on to build wealth. In Section 5, we’ll look at three common types of debt that are considered good debt because they increase the borrower’s potential of building wealth. Those are student loans, car loans, and home loans and you can read about each of those. Each of these have their own unique problems such as student debt levels are too high. But overall, this use of credit is considered good debt because it enhances the ability to build wealth and financial security.
Let’s look at Page 120 Credit Reports, Credit Scores and DTI Ratios. In this section, students learn, obviously, about credit reports, credit scores, and debt to income ratios. One day, they will apply for a loan that is not a student loan. It could be a car loan, or it could be something like a cellphone contract. The lender will assess if they are a credits risk – that is how likely are they to live up to their financial commitment and repay the loan. That is where credit reports come in. It’s not hard to understand credit reports and credit scores. They are just often overlooked or avoided by consumers. It’s important to know a bit about credit reports and credit scores because it enables you to play a better ofensive game with lenders and head of problems before they happen. So students should know how the credit game is played. There’s a ton of information on the FICO website. The law requires credit reporting companies to be very transparent about what they do and how they do it so that site is a good place for students to learn about credit and credit reports.
In a lesson activity, students will explore credit reports and credit scores. Your students are not in the credit reporting system yet but when they have a student loan, they will be. Encourage your students that once they’re in the credit reporting system, they should check their credit report a couple of times a year. It’s free.
A word about this lesson: I wish we had more time to go into depth on these issues but there’s just so much material in this course, it wasn’t possible — or the books would have been 500 pages. The goal here is to introduce students to these concepts so that as they get older and these things start playing a more and more important role in their financial lives, they will know what they are and understand the importance of and basics of developing and maintaining good borrowing habits.
On Pages 120 and 121, there is some information about post-college graduation student loan maintenance. It’s not all that hard to maintain good credit with a student loan. The payments are usually low and there are opportunities to suspend or reduce payments in times of financial stress. The point to make here with students is don’t wait until you’re in the middle of a financial disaster with your student loan. That is, having delinquencies or defaulting on your student loan which tanks your credit score. You will know when things are going sideways so be proactive. Call the lender and make arrangements to suspend or reduce your payments until you are more financially stable. A student loan is a first and very important step on the road to building credit so make it work for you and not against you.
On Page 120, there’s also a section on debt to income ratio or DTIs. DTIs are not included on credit reports but banks will look at DTIs when applying for a loan. Students should understand this and know that if they have dreams of owning a home one day, they should really try to keep their debt to income ratio in mind and that means keeping a lid on the amount of consumer credit they use, and how often the whip out that credit card!
On Page 121: The Big Picture Read Aloud restates the key points of this lesson.
On Page 122, Let’s Practice Activity A is an exploration of the FICO website. Students will discover what’s included in the credit report, they’ll learn about the Fair Debt Collection practices, and review FICO’s own directions, right from the horse’s mouth, how to garden your credit, meaning how to improve your credit score.
Activity B is a FAFSA activity. Undoubtedly, students will come across FAFSA information throughout high school. But the point of this lesson is a little bit diferent. It introduces them to the FAFSA form with the objective of students appreciating that it is a project that a) will involve their parents too, and b) can take an extraordinarily long time to complete especially if they are first in their family to go to college. They should know their FAFSA deadlines and start gathering information for completing the FAFSA, and get parents on board well before applying to college.
Our Debate-Persuade Activity is always a hot economic, social, and political topic – Free College. Should a university education be free in America? What are the arguments for and against this proposition?
The next lesson’s, Ponder and Predict, asks students to consider how time is a powerful tool for building wealth. Why is that? What does time have to do with building wealth?
And finally, our Blog Q asks students to fess up about their buying habits. Are they impulse buyers? Have they ever bought something on impulse and later regretted it? Haven’t we all?
So that wraps up this podcast. Thank you, Teachers, for joining me and I’ll see you next time when we explore Lesson 8: Supersize Your Savings.