Financial Literacy: Credit Scores and Borrowing Responsibly
Understanding credit scores, credit reports, and smart borrowing choices
Financial Literacy: Credit Scores and Borrowing Responsibly
Understanding credit scores, credit reports, and smart borrowing choices
Financial Literacy - Grade 9-12
- 1
Explain what a credit score is and name two ways a lender might use it when deciding whether to approve a loan.
A credit score is a number that estimates how likely a person is to repay borrowed money on time. A lender may use it to decide whether to approve a loan and what interest rate to charge. - 2
A student has paid every bill on time for two years but recently missed one credit card payment by 45 days. Explain how this late payment could affect the student's credit score.
Think about what a lender wants to know about a borrower's past behavior.
The late payment could lower the student's credit score because payment history is one of the most important credit score factors. A payment that is 45 days late may be reported to the credit bureaus and can make the borrower look riskier to lenders. - 3
Maya has a credit card with a $1,000 limit. Her current balance is $300. Calculate her credit utilization rate and explain whether it is generally considered low or high.
Credit utilization equals current balance divided by total credit limit.
Maya's credit utilization rate is 30% because $300 divided by $1,000 equals 0.30. This is generally considered a reasonable level, but keeping utilization below 30% or even lower can be better for a credit score. - 4
Two borrowers apply for the same auto loan. Borrower A has a credit score of 780, and Borrower B has a credit score of 610. If all other factors are the same, which borrower is more likely to receive a lower interest rate, and why?
Borrower A is more likely to receive a lower interest rate because a score of 780 usually shows a lower risk of missed payments. Borrower B's score of 610 may cause the lender to charge a higher rate to compensate for greater risk. - 5
A bank offers Jordan a $2,000 personal loan for one year at 10% simple annual interest. A finance company offers the same loan at 18% simple annual interest. Calculate the interest on each loan and explain which option costs less.
For simple interest, use interest equals principal times rate times time.
The bank loan interest is $200 because $2,000 times 10% equals $200. The finance company loan interest is $360 because $2,000 times 18% equals $360. The bank loan costs less because it charges $160 less in interest. - 6
Lena earns $1,600 per month after taxes. Her monthly expenses are $1,200 before any new debt payment. She wants to take on a loan payment of $350 per month. Explain whether this seems responsible based on her monthly cash flow.
Subtract expenses and the new loan payment from monthly take-home pay.
This does not seem responsible because Lena would have only $50 left each month after paying $1,200 in expenses and a $350 loan payment. That leaves very little room for savings, emergencies, or unexpected costs. - 7
A credit card statement shows a balance of $250. Explain the difference between paying the full balance by the due date and making only the minimum payment.
Minimum payments can prevent late fees, but they do not erase the full debt.
Paying the full balance by the due date usually avoids interest charges on new purchases and keeps the debt from growing. Making only the minimum payment keeps the account current, but the remaining balance can be charged interest and may take much longer to pay off. - 8
Classify each action as a hard inquiry or a soft inquiry: checking your own credit score, applying for a new credit card, getting preapproved offers in the mail, and applying for an auto loan.
A hard inquiry usually happens when you apply for new credit.
Checking your own credit score is a soft inquiry. Applying for a new credit card is a hard inquiry. Getting preapproved offers in the mail is usually a soft inquiry. Applying for an auto loan is a hard inquiry. - 9
A credit report lists an unpaid medical bill that belongs to someone with a similar name, not to you. Describe two responsible steps you should take.
You should dispute the error with the credit bureau that reported it and provide any documents that show the bill is not yours. You should also contact the medical provider or collection agency to ask them to correct their records. - 10
Your friend asks you to co-sign a loan because they do not qualify on their own. Explain one benefit and two risks of co-signing.
A benefit is that co-signing may help your friend get approved for a loan. Two risks are that you become legally responsible for the debt if your friend does not pay, and missed payments can damage your own credit score. - 11
Calculate the debt-to-income ratio for a borrower with $450 in monthly debt payments and $3,000 in gross monthly income. Explain what the result means.
Debt-to-income ratio equals monthly debt payments divided by gross monthly income.
The debt-to-income ratio is 15% because $450 divided by $3,000 equals 0.15. This means 15% of the borrower's gross monthly income goes toward debt payments. - 12
Explain how a secured credit card can help someone with no credit history begin building credit responsibly.
A secured credit card can help build credit because the borrower makes a cash deposit that reduces the lender's risk, then uses the card and makes payments on time. If the card issuer reports to the credit bureaus, responsible use can create a positive credit history. - 13
Compare two one-year loan offers for $500 using simple interest estimates. Offer A has a 12% APR and no fee. Offer B has an 8% APR and a $100 origination fee. Which offer has the lower total cost, and why?
Remember to include both interest and fees when comparing loan costs.
Offer A has an estimated cost of $60 because $500 times 12% equals $60. Offer B has an estimated interest cost of $40 plus a $100 fee, for a total of $140. Offer A has the lower total cost because $60 is less than $140. - 14
List three habits that can help improve or maintain a strong credit score over time.
Three helpful habits are paying bills on time, keeping credit card balances low compared with credit limits, and applying for new credit only when needed. These habits show lenders that the borrower manages debt responsibly. - 15
A payday loan offers $300 for two weeks with a $45 fee. Calculate the fee as a percent of the amount borrowed, then explain why this type of borrowing can be risky.
Divide the fee by the borrowed amount, then convert the decimal to a percent.
The fee is 15% of the amount borrowed because $45 divided by $300 equals 0.15. This borrowing can be risky because paying a high fee for only two weeks is very expensive, and borrowers may have to take out another loan if they cannot repay it on time.