Banking, Interest, and Credit Personal Finance Economics

Functions of Money Medium of Exchange Measure (Standard) of Value MAIN requirement: Accepted as payment Measure (Standard) of Value We can compare prices of goods/services Store of Value We can save it

Financial Institutions Banks: Corporation that offers customers services to earn profits for shareholders Checking deposit accounts Savings deposit accounts Credit card (sometimes) Loans: Home Mortgages, Auto Loans, Personal Loans, Business Loans Investment services Credit unions: Nonprofit membership based organization that offers similar services as bank Savings and Loans (“thrifts”): Similar to credit unions

Consumer finance companies, Title pawn, Payday lenders Financial institutions that provide loans to borrowers who cannot qualify for bank loan (bad credit history) Riskier loans Higher interest rates 18-30% interest

Other “financial institutions”

Deposits and Loans Deposit: Loan: Interest spread: Your money you put into a bank The bank pays you interest on your money FDIC: Insures your bank account up to $250,000 Loan: You borrow someone else’s money from a bank You pay the bank interest for the loan Interest spread: Interest rates on loans is ALWAYS greater than interest rates on deposits (why?)

Credit history Number of open credit accounts Total amount owed How many credit cards you have Total amount owed Bills paid on time or late Bankruptcies, liens, collections in past BETTER CREDIT HISTORY HIGHER CREDIT SCORE MORE CREDIT WORTHY LOWER INTEREST RATES http://credit.org/blog/what-is-a-good-credit-score-infographic/

Credit Scores FICO credit score: a 3 digit number based on your credit history 90% of lenders use credit scores to determine: Whether or not to loan you money What interest rate you will pay for a loan from them FACTORS AFFECTING YOUR CREDIT SCORE: The amount of money you owe to any lenders The number of credit cards and credit accounts you have open Your history of paying bills on time

Interest Rates by Loans Home Mortgage (4.5% APR) New Car (5.44% APR) Student (7% APR) Credit card (16.5%, compounded monthly) Consumer finance loan (30%) Payday loans (up to 200%)

Interest Percentage of money paid for using someone else’s money PRICE OF BORROWED/LOANED MONEY! Types of Interest Simple interest: interest paid only on the principal Compound interest: interest paid on principal AND accumulated interest

Simple vs. Compound Interest SIMPLE INTEREST You borrow $1000 Principal= $1000 Interest = 10% year Time= 2 years A= P x I x T 1000 X .10 X 2 = $200 Interest owed = $200 Total paid = $1,200 COMPOUND INTEREST You borrow $1000 Principal = $1000 Interest = 10% compounded annually Time = 2 years $1000 X .10 X 1 = $100 + $1100 X .10 X 1 = $110 Interest owed = $210 Total paid = $1,210

More on interest rates Annual percentage rate (APR) Yearly cost to you over the life of a loan Includes interest and all fees “Apples to apples” comparison of loans Longer term loans often have higher rates More risk for lender Risks? Failure to repay, inflation Loans with no collateral higher rates “unsecured loans”

Money Market Graph: Controlled by the Federal Reserve

Compound Interest Formula P = principal amount (the initial amount you borrow or deposit) r  = annual rate of interest (as a decimal) t  = number of years the amount is deposited or borrowed for. A = amount of money accumulated after n years, including interest. n  =  number of times the interest is compounded per year  RULE OF 72: 72/Interest Rate = Number of years for investment to double https://www.youtube.com/watch?v=HN2K-dkONb4