Banking, credit and debt

Key topic

It is very important for athletes to develop an understanding about how banks work so that they can manage their banking to their best interest and this is what we are trying to do in this lesson.  Properly managed bank accounts can reduce expenses and protect the athletes’ personal information.  Making purchases on credit is a major part of everyday life to the point that it is being frequently abused and may be transformed into excessive debt which is not manageable.  By understanding ‘good’ and ‘bad’ debt athletes will be able to utilize debt when and where it best suits their overall financial plan.  In this lesson we aim to present the basic banking operations that most closely relate to the athlete’s needs and discuss the different banking risks associated with credit, debt, and credit history.  Moreover, this lesson discusses the risks of loans and being in debt, as well as presents ways of keeping debt under control.

Learning objectives

• Understand the basic banking operations.
• Discover the risks associated with bad loans and collaterals.
• Opening and maintaining the right bank accounts is a very important aspect of good money management. Your bank accounts are the center of your financial planning.
• There are different types of bank accounts which will help you get your finances in order.
• A debit card works like a plastic check. A credit card is a credit facility from a bank: Knowing the differences between credit and debit cards will help you use them appropriately.
• Credit is an arrangement that defers payment for borrowed money or a purchased item until later. Your credit history represents your financial reputation and it is very important to build a positive record with lenders.
• Any debt, as a whole, is not good. However, some types of debt are considered good because of the investment value they hold.
• Your personal circumstances and credit score are correlated with loan qualification and loan repayment ability.
• Defaulting on a loan will create a multitude of problems both in the present and the future.

Introduction

A bank is a financial institution that handles money, including keeping it for saving or commercial purposes, and exchanging, investing and supplying it for loans. Banks offer safe, secure, convenient services so you can save money and build a better financial future. Debt, credit and banking are ultimately related to each other in many ways. It is important to learn to distinguish between the three but also learn about their interplay.

Let’s begin with a short clip about some of the topics we will cover today:

Banking explained- Money and Credit

Why do we use banks?

There are a number of reasons why you should put your money in a bank:

• Safety: Storing your money in a bank is much safer than holding cash.
• Earning Capacity: The bank pays you interest every month just for depositing your money, therefore your money creates more money!
• Convenience: You can have your paycheck electronically deposited into your checking account and you can make electronic payments for pretty much everything without having to physically go to the bank.
• Organization: Bank accounts help you track spending, manage savings, and stay on target with your budget.
• Alignment of Incentives: It is in the best interest of both of you and your bank to be financially successful.  If your personal finances are doing well, then you will save more (more money for them), spend more (greater line of credit) and utilize more of the bank’s services.

There are however also disadvantages in banks:

• Despite the fact that your money is safer, it still loses value due to inflation because it is still “inactive”. Let’s take a step back and talk about inflation for a bit. You might have heard politicians, journalists and economists talk about inflation or the rate of inflation. Inflation is a rather simple concept: it is the rise in the prices of goods and services. Inflation usually occurs in two cases. When there is marked decline in supply or a sharp rise in demand of let’s say bead. Let’s assume that in country X the population is 100 people and we have 100 loaves of bread costing $1 each. If suddenly 50 people are born then there will not be enough bread for everyone and therefore prices will rise due to this shortage. The same will also occur if 50 loaves of bread are destroyed and we will only have 50 loaves left for 100 people. If let’s say, the price goes from $1 to $2, then you who has 50$ to spend have to spend more on bread. Instead of being able to purchase 100 loaves with your money you are now able to only buy 50. Therefore, your money has lost some of its purchasing power; its strength. Now this concept applies to all goods and services.
• Banking systems are country-specific. There are countries with solid and efficient banking systems but there are also countries with unstable banking systems.
• There is always the possibility of a bank-run during times of recession. Such events occurred in the US during the Great Depression and in both the US and Europe during the Great Recession.
• Depending on whether you have a savings account or a current account, then you are vulnerable to fluctuations in interest rates. Also, interest rates in most countries are rather low at the moment. Let’s briefly explain interest rates as well because they will be useful for the rest of the class. Interest rates apply to both lenders and borrowers. If you get a loan of $100,000 and you are also charged a 10% interest rates, it means that if you repay your loan in a year’s time, you will have to give back to the bank $110,000. Now, if you place your money in the bank and the annual interest rate is 10% (which will never be that high), then at the end of the year those $100,000 will become $110,000.

All in all, the benefits of saving/placing your money in banks outweigh the costs. You should definitely use banks to a certain extent.  It is always good and handy to have liquid assets but you should avoid leaving all your money in the bank, because they continually lose value.

Remember that how you manage your money today determines whether you achieve financial freedom tomorrow.  Your checking account will help you organize and keep track of your finances whereas through your savings account, you can take advantage of the power of compounding interest.  As previously discussed, compounding interest is defined as the process by which the value of an investment increases exponentially because it earns interest both on the principal and the prior interest payments.

How do banks work?

As a business model, the banking concept is pretty simple: banks use your money to make loans to other accountholders. This serves the interests of all parties involved. You earn money through interest when you save money with the bank, like already discussed. When other people borrow money to serve their needs, they are charged with an interest that is higher than the interest on deposits and the bank makes money off of the interest (from the difference between the saving and lending rates) and its ability to use other people’s money.  For example, you deposit your money in a savings account and earn 2.25% interest and the bank then lends your money to other customers at an interest rate of 4%. The bank makes a profit from the difference between the saving and lending rates.

In order to decide which bank is right for you and your money, first you need to consider your expectations and purpose for opening an account. Is it for business, for pleasure, for savings, salary-depositing, eventual loans, or something else?

You should choose a bank that offers online banking because in today’s economy it is a feature you can’t do without. With online banking, you can do transactions and check balances from wherever you are.

You should also look at banking costs.  Banks have to be competitive, so it pays to compare fees for opening and running an account. There are often fees for both checking and savings accounts. The bank also may charge separate fees for such things as receiving statements in the mail; online banking; and multiple checkbooks. Make sure to ask and compare all potential fees before settling on a particular bank.

It is also important to use a bank that’s convenient to where you work or live and it is equally important, to check out the convenience of ATM locations.

Remember that you want to build a long-term relationship with the bank you choose. You’ll find that, the longer you remain a good customer, the more benefits you’ll receive. Then the next time you need a car loan, investment account, business loan, or home loan you may get better terms because of that positive relationship.

In summary, opening and automating your accounts is the first step toward building a financial foundation. Find a bank with which you can grow over time. Look for one that offers the services you need now, as well as those you may need in the future. Be a good customer and grow with your bank. As that relationship grows, so will the benefits you receive.

Checking and savings accounts

There are several different types of accounts you can open at a bank. At the minimum, you should have a checking account and a savings account.

• A checking account is where most of your transactions will take place. A checking account is your banking hub and will handle most of your financial ins and outs.  Usually checking accounts do not pay any interest.
• A savings account pays interest on the money you have on deposit. You may use savings accounts for your emergency fund, your short-term fun fund and your long-term investment fund. This is the account where you will be given an interest rate and receive an annual amount based on that interest rate

Once you have chosen the bank that best suits your needs, immediately open both a checking and a savings account. This is the first step to getting your finances in order.  Savings and checking accounts can be linked so you can transfer money between accounts with ease. Ideally, you should set up your accounts to automatically transfer a fixed portion of your money each month from checking to savings. That way saving money becomes easy and automatic. Plus, all your accounts can be monitored smoothly.  It’s important to have a good understanding of your account balances, so you know how much money you have available to spend at any time.

Debit cards vs credit cards

A debit card works like a plastic check. Just like when a check clears, using your debit card deducts money automatically from your checking account. The money is automatically withdrawn at the time of the transaction—unlike a credit card, where the charge is placed on a bill that you’re asked to pay later.  The characteristics of a debit card are:

• Debit cards are linked to a bank account.
• When you use a debit card, the amount of the purchase is automatically deducted from your bank account.
• When you use a debit card you cannot make a purchase for more than the balance in your bank account. (If you have US$400 in your account and want to make a US$500 purchase, you will be unable to do that with a debit card.)
• A debit card is an alternative to carrying cash.

Using a credit card is basically the same as a loan. The credit card company lends you money and charges you fees and interest for borrowing money from them. The interest rate is usually determined from your credit history, which in essence is your past record of paying bills and handling credit. The characteristics of a credit card are:

• A credit card is a loan from a bank or company.
• The lender pays for the purchase at the time of the purchase and you must pay the lender back over time.
• The lender of your credit card, charges you interest each month until the bill is paid in full.
• When you use a credit card, if you do not pay off the card in full each month you end up paying more than the amount for which you purchased the item because of interest and fees.
• Many credit cards offer bonuses like gifts and airline miles with each purchase. Educated credit card users who pay their bills in full each month can reduce the cost of other purchases.
• Generally, credit cards offer greater protection in case of theft.

Credit cards are convenient; most businesses accept them and they’re easier to carry than cash. Credit cards can be a handy tool for your purchases as long as you pay the bills in full each month and avoid paying sizable interest fees.  However, when faced with an emotional or impulse purchase, pulling out the plastic can be far too easy to do. If money is tight, it’s easy to talk yourself into thinking “charging it” is no big deal. But if you don’t take spending seriously, receiving that credit card bill can be a painful experience.

The best way to manage a credit card is to be the company’s worst customer. Credit card companies make their money when customers carry a balance from month to month. Plan and budget for your purchases properly so you can pay your credit card bills in full each month.  You may think it’s okay to pay just the minimum payment the credit card company calculates for you. That’s a common misunderstanding.  In fact, the minimum payment just represents the minimum amount that will keep your account active. It’s not enough to actually retire the debt in a reasonable time.

Carrying a small debt for two, maybe three months is not ideal, but it is no big deal either.  If you start carrying balances longer than three months, that can be a good indicator that you’re developing a debt management problem.  If you can’t handle credit card debt, you need to literally “cut it out”— cut your plastic cards into pieces before you get into real trouble!  If you understand the dangers of using credit cards, you can learn how to use them to your advantage. For instance, traveling with a credit card is much safer than carrying a pocketful of cash. Credit cards allow you to rent cars easily and, in an emergency, a credit card can be a lifesaver.

Real Life Example (3-minute discussion) Mike Tyson is undoubtedly one of the greatest boxers of all time. During his peak his net worth was between $300-400 million. By the early 2000s he was $60 million in debt. The reasons were the usual ones: excessive parties, drugs, alcohol, outlandish purchases and gifts. In an interview, Tyson revealed that he never managed to pay back his debt. However, bizarrely, his creditors kept cutting down his debt to the point that he only had to pay back $2 million which he did. Tyson has made a few appearances in Hollywood and Broadway and today runs his own marijuana farm and podcast Hotboxin’ with Mike Tyson. Tyson’s good fortune is not the rule but the exception.

You should be aware that as you build your credit status, credit card offers will begin flooding your mailbox. Credit card offers vary a lot, so read them carefully.  Just because they send you a “pre- approved” application with a huge credit limit doesn’t mean you should apply.

Action Steps – Exercise 1 (5 minutes)

Tell athletes that they have a bank account with a debit card linked to that account.  Their account has a balance of $400.  Tell them that they also have a credit card with a $2,000 limit to use for purchases, with a 28% interest rate each month.

Given the above budget, have the athletes select what they want to purchase from the below choices and state how they will pay for their choices:

• Dinner for two                $450
• Brand new outfit            $900
• Clubbing with friends   $600
• Day trip with friends     $600
• Lunch with friends        $180

Ask 4 or 5 athletes to disclose their choices and the rationale for their choices.  Have a discussion about whether they would consider purchasing something with credit and when it is appropriate to use credit for purchases.

Credit and credit history

Credit is an arrangement that defers payment for borrowed money or a purchased item until later. In other words, you get money or stuff now, and you agree to pay it back later. When you buy or borrow on credit, you generally end up paying back more than the original amount in interest. How much interest you pay depends on your credit history (your record of paying bills and handling credit in the past). The percentage of the debt that you’re charged on top of the original amount is called interest and it is determined by the interest rate.  Learning how credit works is the key to building an outstanding credit history.

Credit refers to your ability to borrow money to pay for something. Such borrowed money also includes credit cards. Credit is used to buy cars, houses, and major appliances. Simply defined, good credit means you keep all your financial agreements in good faith; you honor your commitments and pay all your bills on time.

Your credit score is similar to a report card in school; it will open doors if it’s high and close them if it’s low.  If you don’t pay your bills on time, carry a high debt load, and have bills that you stopped paying, you probably will have a bad credit score.

Your credit history, or credit report, is a detailed account of all the information about your credit situation: how much you owe, how you pay your bills, and whether your payments have ever been delinquent. Credit bureaus track and analyze this information to calculate your credit score. Credit scores are expressed in numbers between 300 and 850; the higher your score, the better your credit. A good credit score helps you obtain loans, rent apartments, get jobs, and qualify for lower interest rates and therefore lower payments.

Action Steps – Exercise 2 (10 minutes)

Athletes should form small groups of four.  Each group has $400 in cash and $1,000 in credit.  Have athletes look at the items in the grid and determine the best method for purchasing the items.  Choices are: save money over time; buy now with cash, or buy now with credit.  Athletes should be able to justify their reasoning.

What is the best payment option?

Item	Cost	Save money over time	Buy now in cash	Buy now with credit
New computer	$800
New clothes for summer	$1,000
Birthday present for a friend	$300
Brakes for your car	$300
New TV	$2,000

Once the activity is complete, discuss the athletes’ choices.

• Ask each group to disclose their decisions on the three options above and to provide their reasoning for why it is the best option.
• Challenge their reasoning to determine if there are equally viable options.
• Encourage athletes to reflect upon their answers and add suggestions.
• Remind them that they want to carefully build their credit over time, so using credit for purchases on some level is okay.

Loans, risk and collateral

A loan is a sum of money that you borrow now and which you can repay in the future with interest.  A lender is a person or organization that lends money.  Sometimes the lender may ask you for collateral, so that they minimize risk. In the world of financial management, risk refers to the possibility of financial loss.  Collateral is something you pledge as security for a loan. If you do not repay the loan, the lender keeps your collateral. Lenders estimate the value of your collateral to reduce their risk. There are high-risk loans, and there are low-risk loans.

Lenders look at the overall picture to determine whether you qualify for a loan.  They want to see that you are not high-risk.  A high-risk applicant is one whose financial situation indicates that they would have trouble repaying a loan.

Credit is the first thing a potential lender will look at to qualify a loan applicant. If you maintain an excellent credit status, then qualifying for a loan will be much easier.  Also, the debt-to-income ratio shows lenders you are able to afford monthly loan payments given your income.

Stability is one of the factors at which lenders look when a person applies for a loan. If a person moves a lot, or has had a lot of different types of jobs within a short time, he or she appears to be unstable and instability is a high risk to lenders.

Tips on keeping your debt under control

In today’s world, debt has become a necessity in various stages of our lives. Every person, at some point in their life wants to acquire something expensive, such as a car or a house. To finance these purchases, you need to take out a loan in most cases.

As an athlete, you have learned to have full control of your physical condition and your health. The same attitude and discipline should be applied to your financial life, especially to the management of your debt. If you dream of a successful financial future, you have to be able to manage your debt despite its size.

If your debt is small, you have to be sure it doesn’t get out of control by keeping up with your instalments. On the other hand, if you have a large debt, your efforts towards paying that debt should be more rigorous. The following are four small but important tips for keeping your debt under control.

TIP #1 – Be Fully Aware – “The Debt List”

Knowing to whom and how much you owe is by far the most important part in the process. In order to have the situation under control create a “debt list” with your debts which will include:

• the creditor
• the due date
• the total amount of the debt
• the monthly instalments
• the interest rate the loan carries

By making this list and considering all of your debts, you will be able to see the bigger picture and be fully aware of your complete debt position. You should make sure that you update your debt list regularly and keep tab of decreasing debt. Watching your debt go down will make you feel good and will give you the right perspective to continue paying your installments as planned.

TIP #2 – Be Consistent

Being prompt with your monthly instalments, keeps the situation under control and yourself in check. On the other hand, late payments make the situation a bit chaotic and more difficult to handle. It becomes harder to repay the debt due to the fact that it accumulates plus you are charged with overdue interest and other default charges.

What can you do? If you don’t want to create a standing order agreement with your banking institution, you can use a calendar system on your phone or computer, record the instalment due dates there and set an alert to remind you in advance when your payment is due. It is important if you miss an instalment, not to wait until the next due date, but to proceed with the payment prior to the due date of the next installment.

TIP #3 – At Least, Pay the Minimum

In case of credit card debt, if you cannot afford to pay any additional amount further to the minimum, make sure you will at least proceed with your minimum payment. This will not really help you in making actual progress towards repayment of your debt but it will keep your account stable and your debt will not grow further. It is noteworthy to mention that when you fail to make your monthly payments, it becomes harder to catch up and sooner or later your loan could be in default.

TIP #4 – Prioritize

Last but not least, you should prioritize your debts.  In other words, decide which debt is best to settle first. For instance, credit cards have higher interest rates than other loans. Therefore, the best you can do is to prioritize the repayment of any credit card debt you may have. Another option is to repay the debt with the lowest balance first. In order to avoid any extra costs, use your list to rank and prioritize your debts in the best possible way to improve your financial position.

Keeping your debt under control is not impossible. All it needs is some careful planning and lots of discipline. You have to be careful and realize that defaulting on a debt will create a multitude of financial problems, both in the present and the future. Always make sure that you follow these tips when borrowing money and make sure that you get some credible financial planning advice before proceeding with any major financial decisions.

What happens if you are already in debt?

If you’re already in credit card debt, it’s not the end of the world.  You just need to get organized and commit, in order to get out of the hole. The key to getting out of credit card debt is to prioritize the payments on the cards that have higher interest rates because they eat away more of your money. Once you have the rates each credit card company charges you, organize a payment structure.

Pay the minimum payment on all credit cards except for the one with the highest interest rate where you should be paying much more in order to get the debt down as fast as possible.  Once that card is paid off, take the card with the next-highest rate and pay that one down. Following this payment structure will save you a lot in interest. Keep up that plan until all the cards are paid off.

Real Life Example (3-minute discussion) Olympic gold medal figure skater, breast cancer survivor and television personality Dorothy Hamill, at the height of her career in the 1980s, was reportedly raking in $1 million a year to skate in prime-time TV specials.  However, after years of excessive spending, she had to file for bankruptcy in 1996 and faulted her husband for bad advice. To help pay off her debt Hamill toured the professional ice-skating circuit for several years, returned to television and published her autobiography which made the New York Times bestseller list. After she survived breast cancer, she partnered with vitamin brand Nature’s Bounty to promote health and wellness. What does the case of Hamill teach us?

Lending money to friends and family

It is a good thing to help out friends and family occasionally, not systematically. Asking for money is a decision that most people don’t take lightly. On the other hand, the freeloaders, those who habitually ask for money do so without blinking an eye. You need to distinguish between the two and only help out those who fall within the first description.

Money shouldn’t—but often does—come between friends and family. As a general rule, you should only lend money to loved ones if you do not expect it back.  Many times, when friends need money, it is due to poor money management. Of course, emergencies do occur and you may want to treat emergency situations differently. But if your friends are already unable to pay their bills, there’s a good chance they won’t be able to pay you either.

By the phrase “expecting back”, we do not mean that you should only give money to completely unreliable and untrustworthy friends and family, not by a long shot. What we mean is that you should only give out money that are not vital to your own needs and that in the event that you don’t get it back, you will still be able to make it through without them. In addition, when lending money, always have in the back of your mind that you might never see it back.

There is ‘good’ debt and ‘bad’ debt

It is nearly inevitable that you will take out some form of debt over the course of your lifetime. To build positive credit history, it is important to strive to obtain debt that is good, rather than bad.

• Any debt, as a whole, is not good. However, some types of debt are considered good because of the investment value they
• Any type of debt — good or bad — increases your
• Acquiring debt on investments may help you get a higher return on your investment—meaning that you are able to make more money but also carry greater risk at the same time.

Good debt is the kind we use to buy assets—things like real estate, stocks, and businesses. The goal of good debt is to purchase items that we believe will eventually appreciate in value, so we increase our wealth over time. Bad debt is loans we use to purchase depreciable or consumable items such as travel tickets to go on vacation, clothes, toys, etc. Good or bad, we should treat all debt with a degree of respect. Even loans used to purchase good investments can lead to financial problems if we don’t handle them properly.

What types of debt are considered ‘Good debt’?

Investment Loans:  For investment fanatics with high-level knowledge and a trusted team of advisors, investment loans may help gain leverage to earn higher return on investment.

Loans for Income-Producing Real Estate:  This, may be considered good debt because it produces revenue when the real estate is rented out and the resulting revenue can be used to repay the loan.  Therefore, you have the chance to repay the loan fully and be left with a money producing asset as well.  It is also possible that the real estate may increase in value and thus when sold, it may bring in profit (re-sold at a higher price).

Business Loans:  For entrepreneurs looking to expand and grow their businesses, taking on a business loan may help them do that. Such loans are provided by financial and non-financial institutions. You can look for one from a bank, but there are also several government bodies and institutions providing them, the European Union being a prime example.

Education Loans:  Athlete student loans and other investments that finance one’s education can be good debt, depending on how well you plan. Since individuals with degrees tend to make more over a lifetime, typically around US$500,000 (depending on location) more than those without higher education, this investment can be considered a good debt.

Home Loans for a property you live in:  This may be considered good or bad debt, depending on your investment strategy. Purchasing a home may be a good investment because instead of paying rent, your payment goes towards the mortgage and the house will end up being yours after you have repaid the loan.  However, it all depends on the location of the house, the type of mortgage and interest rate that you pay and the acquisition price of the house.  If you bought an expensive house when real estate was high, in a neighborhood with high real estate taxes, with little down payment and a high mortgage interest rate, while shortly after real estate prices are beginning to fall, then you are in for some real trouble!

What types of debt are considered ’Bad debt’?

Credit Card Debt:  Essentially, any type of credit card debt is considered bad debt. Credit cards carry high interest rates and finance charges. Retail stores, banks, and other companies offer credit cards to consumers. These cards usually come with incentives to spend, such as points which can be redeemed in future purchases or travel miles to be used in future trips.  A credit card can be good debt if you pay the money you borrow back in full each month; that helps increase your credit score and you incur no interest charges. Plus, you may accumulate bonus points to be used towards future purchases.

Personal/Consumer Loans or Bank overdrafts are cash loan facilities from a bank. These types of loans are an unwise investment. Like credit cards, they carry high interest rates and they usually cater for the acquisition of ‘toys’ plainly offering either relief from ‘pain’ or instant gratification.

Some bad debt may be unavoidable, but it is important to be in control of the situation and to have a reasonable strategy for its timely repayment.

Real Life Example (3-minute discussion) Floyd Mayweather is a very controversial figure. We have heard stories about him spending $50,000 at a nightclub once. He has been arrested a few times for abusing women. We have seen him waving stacks of money around. We have heard him boasting about tax evasion and his gambling problem is no secret. At some point, he also spent $16 million on a necklace for his fiancé. What does this extravagant gift tell us?

Action Steps – Exercise 3 (5 minutes)

Break athletes into small groups as the previous activity. Have them identify whether each type of debt is good or bad and why and then briefly discuss their answers as a class.

1. Shelly wants to go to college but her family has no money for her to use toward expenses. She doesn’t make enough money to pay for school and doesn’t qualify for grants. She wants to take out a $20,000 loan to pay for school.
2. Daniel wants to buy his girlfriend an engagement ring. There are some rings in his price range but he found a really nice one that he can finance and pay $200 per month.
3. George is short on cash until payday. His car broke down and will cost $750 to fix. He has been saving for about a year and has $1,000 in savings. He wants to use his credit card so he does not deplete his savings account.

Reiterate the importance of knowing the difference between good debt and bad debt.

What happens if you default on a loan?

You found yourself in a tight situation with respect to money. You decided to take out a loan and of course you knew that you were going to make everything in your power to pay back the loan. However, you’ve now fallen behind by a payment, maybe two. Perhaps it doesn’t even look possible that you will be able to make up for those payments anytime soon.  Whether you got that from a traditional lender like a bank or an alternative lender, if you default on that loan the outcome will most likely be the same.

Each lender has their own guidelines and timelines for deeming a loan to be in default. Bank X might take action after one missed payment while Bank Y might wait for a few months before acting. Lenders will start making contact with a person who has let a loan go into default. As time goes by the communication will become more firm, aggressive and demanding. A strict lender like Bank X, might contact the credit bureaus within 30 days of a missed payment, which will lead to the deterioration of the borrower’s credit score.

If we are talking about a secured loan that you had to commit some kind of collateral to get, that will mean that you will lose the collateral if you default. A simple example of that is a car loan. In the case of default on that loan then the car that you were loaned the funds to purchase will be repossessed and resold at an auction to recover the amount or at least part of the amount.  If the lender believes that the only way to recoup the loan and interest is to appropriate the collateral, they will.

In a case where no collateral was put up, then the loan is considered unsecured. If you fall behind on payments, the lender may start adding fees and driving up the interest rate. If, on the contrary, the lender’s criteria result in the debt to be in default the loan may be sent to a collection agency which will try to secure loan payment. If the collection agency is unsuccessful, then the agency will turn to the law and the courts in order to pursue other solutions such as garnishing your salary or putting a lien on your home and other assets, which means that you are prohibited from selling it, among other things!

As previously mentioned, after defaulting on a loan your credit score will drop significantly, which will make it harder for you to secure credit in the future. In case you find a lender who is willing to take a risk on you in spite of your credit score and credit history, the interest rate will probably be much higher than it would be for someone with better credit.

Action Steps – Exercise 4 (10 minutes):

Determine whether the following statements are True or False based on today’s lecture

1. One of the advantages of keeping your money in the bank is the fact that it is safe. In other words, having your money in the bank rather than hiding it under your mattress is much safer. ____
2. The simplified business model of banks is that it brings savers and borrowers together. ____
3. A checking account pays interest on the amount you deposit ____
4. When you use a debit card, the amount of the purchase is automatically deducted from your bank account ____
5. Credit history does not have any long-term implications on your borrowing capabilities. ____
6. If you borrow to buy a house then that is automatically considered a bad debt ____
7. Any kind of debt, be that good or bad, increases your risk ____
8. A loan can be summarized as a sum of money that you borrow now and which you can repay in the future with interest ____
9. In the case of car loans, if you miss any payments and, in any way default, the lender cannot repossess that vehicle and turn around and sell it to recover the amount of the loan ____
10. A collection agency is essentially a debt collecting body that your lender may turn to if they don’t manage to get the money from you. ____

Answer Sheet:

1. True
2. True
3. False- That would be a Savings account
4. True
5. False- It certainly can have
6. False- That is not necessarily the case, other factors are in play as well
7. True
8. True
9. False- That is something that the lender can do
10. True

Lesson wrap-up

We have covered a variety of topics today in relation to credit, debt and banking. The lesson was divided into roughly two clusters: banking on one hand, and credit and debt on the other. We started with banking and explained how and why we used banks before distinguishing between the two most important types of accounts: checking and savings. We then moved on by connecting banking with credit and debt through credit and debit cards. We then focused on credit and tried to answer such questions as: what is credit, what is credit history and how it affects you both in the short run as well as in the long run. Finally, we focused on the issue of debt by discussing good and bad debt, as well as what happens if you default on a loan.

At this point, we will wrap-up today’s lesson.  First, we will go over the learning objectives of this lesson and we want your feedback as to whether they have been achieved, and then we will address any questions you may have.  Please feel free to ask anything you’d like in relation to today’s lecture and we would love to hear how the concepts we discussed today relate to you and your greater life plan.