1. Banking, Interest, and Credit
Personal Finance Economics

2. 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

3. 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

4. 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

5. Other “financial institutions”

6. 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?)

7. 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

8. 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

10. 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%)

11. 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

12. 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

13. 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”

15. Money Market Graph: Controlled by the Federal Reserve

16. 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