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Have you ever wondered why people have credit cards? Or how people can afford to buy a house? This lesson will teach you about the basics of loans and what it means to borrow money.
Catch-Up and Review
Here are a topics that should be understood before getting started with this lesson.
Savings & spending basics:
- What is a personal financial goal?
- How can you make a personal budget?
- What is planned spending vs. necessary spending?
Understanding responsibility and consequences:
- What happens when rules are not followed? (loan repayment fees, penalties, etc.)
Basic percentage and multiplication:
- How will interest increase the total cost of a loan? (e.g., 5% of $100)
Needs vs. wants:
- Is something worth the cost of paying interest?
- When is borrowing useful or necessary and when is it risky?
Discussion
What Is a Loan?
A loan is money that you borrow and have to pay back later, usually with extra money added on called interest. When you take out a loan, there are two main parties involved:
- Lender — a person or business (like a bank) that gives the money that is being borrowed
- Borrower — a person that takes a loan and promises to pay it back
Discussion
Why Do People Take Out Loans?
Sometimes people need money for things that are important but are too expensive to pay for all at once. They might want to buy a car, fix a broken appliance, go to college, or cover any other big expense.
Pop Quiz
Lender or Borrower?
Discussion
Paying Off a Loan
When you take out a loan, you borrow a certain amount of money which is called the principal of the loan. This is the original amount you borrow, not including anything extra. The most common type of extra money you have to pay is called interest. Interest is like a fee for using someone else's money. Interest is usually a percentage of the principal.
Example
Jalen's New Ride
Jalen wants to buy a used bike for $60.
He doesn't have the money right now, so his older sister says that she will lend it to him but she will also charge him 10% interest on the loan. He agrees to pay her back in 3 equal payments.
a What is the total amount of interest being paid?
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b How much will Jalen pay his sister in total?
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c If Jalen pays in 3 equal payments, how much does he pay each time?
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d How much of each payment goes toward the interest?
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e How much of each payment goes toward the principal?
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Hint
a Move the decimal one place to the left to find 10% of a number.
b Add the principal and the interest together.
c Divide the total amount he will pay by 3.
d The total interest is spread out equally across all the payments.
e Subtract the interest portion from each payment to find how much of each repayment goes towards the actual loan.
Solution
a Jalen wants to buy a used bike for $60. His sister lends him the money with 10% interest. To find the interest, we need to calculate 10% of the loan amount.
10% of $60⇓10%⋅$60
Let's perform the calculations.
The total interest Jalen will pay is $6.
b To find the total amount Jalen will pay back, we add the principal of the loan and the interest he will pay.
$60+$6=$66
Jalen will pay back a total of $66 to his sister.
c To find the amount of each of the three equal payments, we divide the total amount by 3.
3$66=$22
Jalen will pay $22 each time.
d We know the total interest is $6 and that Jalen will repay his loan in 3 payments. To find out how much of each payment goes toward the interest, we can divide the interest by 3.
3$6=$2
For each $22 payment Jalen gives his sister, $2 goes toward the interest.
e The principal is the original loan amount, $60. We know Jalen pays $22 each time, $2 of which goes toward the interest. To find out how much goes toward the principal, we subtract the interest from the total payment.
$22−$2=$20
For each $22 payment Jalen gives his sister, $20 goes toward the principal.
Example
The Price of Fun
Ava wants to buy a new video game that costs $30. Her aunt offers to lend her the money but Ava has to pay her back $40 total, in four equal weekly payments.
a How much total interest is Ava paying?
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b How much interest is Ava paying each week?
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c What percentage of the loan is Ava paying in interest? Round your answer to the nearest whole percentage.
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Hint
a Subtract the price of the game from the total amount Ava will pay back.
b Divide the interest by the number of payments Ava makes.
c To find a percent, divide the interest amount by the original loan and multiply by 100.
Solution
a Ava wants to buy a new video game that costs $30. Her aunt is lending her the money, but she has to pay back $40 in total. To find the total interest she will pay, we need to subtract the amount Ava borrowed from the total amount she has to pay back.
$40−$30=$10
Ava is paying $10 in interest.
b Ava has to pay a total interest of $10 over four weeks. To find out how much interest she is paying each week, we can divide the total amount of interest by 4.
4$10=$2.50
Ava will pay her aunt $2.50 each week for four weeks.
c We can find the percent of the loan that is interest by dividing the total amount of interest by the cost of the video game and then multiplying by 100.
$30$10⋅100
CalcQuot
Calculate quotient
0.3⋅100
Multiply
Multiply
33.3%
RoundInt
Round to nearest integer
33%
Discussion
Credit Score
A credit score is a number that shows how likely someone is to pay back a loan. Credit scores are usually between 300 and 850. A higher score means that you are considered more trustworthy to lenders.
Credit score charts often show wedges of equal size to make them easy to read. However, even though they look the same, the ranges they represent may not be equal. This can be misleading, so make sure that you are always reading the numbers carefully!
How can debt help you build your credit score?
When you borrow money and pay it back on time, you build a good credit score. This shows lenders that you are responsible and can manage your money well. Having a good credit score is like building a good reputation with lenders, which can help you get better loan and credit card deals in the future. Here are some more things that can help or hurt your credit score.
| Actions That Affect Your Credit Score | |
|---|---|
| Help | Hurt |
| Pay bills on time | Miss a payment |
| Keep credit card balances low | Max out credit cards |
| Use credit responsibly | Owe more than you can pay back |
| Keep accounts open for a long time | Frequently open and close credit accounts |
Explore
Would It Help, Hurt, or Not Affect Your Credit Score?
Certain actions can boost your credit score, while others can bring it down. Some actions will not change it at all. Look at each situation below and sort it into the most appropriate group.
Closure
The Hidden Cost of Forgetting to Pay
When you default on a loan, it means you stopped paying it back like you promised. That might not seem like a big deal now, but it can lead to real problems later!
What Happens When You Default
- You still owe the money — and now maybe even more because of late fees.
- Your credit score drops, making it harder to borrow money again in the future.
- The lender might take back what you bought or send collection agencies after you!
How to Prevent Defaulting
There are many ways that you can prevent yourself from defaulting on a loan.
- Only borrow what you know you can pay back.
- Understand interest before you say yes to a loan. Even low interest can add up if you are not careful!
- Make a budget so you know where your money is going.
- Always communicate with the lender if you are struggling — they might be able to help you out.
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