## Lender or Borrower Be?

### Thomas Lucey

#### Description

Students compare the costs and benefits of interest involved with borrowing and depositing at banks.

#### Objectives

The student understands a variety of factors to consider when making wise consumer decisions (for example, cost, performance, reliability).

The student knows the various kinds of specialized institutions that exist in market economies (for example, corporations, labor unions, banks, stock markets).

#### Materials

-Pencil and paper for students.
-Calculators for students (optional)

#### Preparations

1. Ensure students have paper and pencil to work the problems.(see procedures)
2. Ensure seats are arranged to students may easily be broken up into pairs.
3. Download and printout the answer key for review of any extended problems. (see extensions and associated file)
4. Transfer problems in procedures section to a transparency or handout for students. (if desired)
5. Calculate the answers to the problems in the procedures section before beginning the lesson.

#### Procedures

1. Discuss with students: A bank is a business that buys and sells money. It buys money from people and calls the money deposits. It sells the money and calls the money loans. The record of each deposit or loan is called an account. The bank must pay back your deposits when you ask,
and you must pay back your loans when your bank asks. Interest is the money paid to and by the bank for the use of the money. Credit Unions and Savings and Loans are very similar to banks. They provide services at a lower cost, but may not have all of the services a bank can provide. PEOPLE EITHER EARN OR PAY INTEREST DEPENDING ON WHETHER THEY SAVE OR BORROW MONEY. In today’s lesson you will either be a depositor or borrower at the bank. Through this exercise, you will see the advantages and disadvantages to each role.

2. Divide the students into pairs.

3. Tell the pairs that one member will pretend to be a borrower, the other will be the bank.

4. Inform the pairs that the borrower will decide how much they want to borrow. The amount borrowed will cost 8% interest for use of the money for a year. Ask each group what the dollar amount of interest cost will be. (Hint: Amount Borrowed x .08 = Interest Cost). Students should be informed that integers and decimals may be converted into a fraction by putting them over a demoninator of -1-. For example, 5 is the same as the fraction 5/1. You should also review the order of operations with students, solving content within parentheses first, then working multiplication.

5. Ask the borrows to determine if interest were compounded each quarter on the loan, how much interest would they pay in interest?
(Hint: *Quarter 1 interest = Amount borrowed x (.08 x 90/360)
**Quarter 2 interest = (Amount borrowed + Quarter 1 interest) x (.08 x 90/360)
***Quarter 3 interest =(Amount borrowed + Quarter 1 interest + Quarter 2 interest x (.08 x 90/360))

6. Ask the students what would be the best manner of compounding for banks. What would be the best way for the borrowers? What if interest
were compounded monthly?

7. Instruct the students to repeat Steps 3-5. In this case, the former banker is a depositor, the borrower is the banker. The amount borrowed is now deposited. The interest rate is 3%.

8. Discuss with the whole class what they think
about differences in loan and deposit rates at banks.

NOTE: This lesson also applies to the following Tennessee standards:
Social Studies
Curriculum Standards
Approved by the Tennessee State Board of Education
August 31, 2001
Economics

Content Standard: 2.0

Globalization of the economy, the explosion of population growth, technological changes and international competition compel students to understand, both personally and globally, production, distribution, and consumption of goods and services. Students will examine and analyze economic concepts such as basic needs versus wants, using versus saving money, and policy-making versus decision-making.

#### Assessments

1. Formatively assess student ability to accurately complete the problems from the procedures
section by collecting their work.
2. Instruct the students to write a composition about how they will operate “The Bank of Me.- In this composition, they should explain how they manage their money to develop financially, knowing how banks set deposit and loan rates.

Assessment Checklist:

---- Mentions differences in loan and deposit rates and how they are determined.
---- Mentions an understanding of shopping for lower loan rates or higher deposit rates.
---- Mentions an understanding of differences in interest from compounding methods.

#### Extensions

Extending Activities:

Many banks have policies which allow fewer people to borrow from them than other banks. Have your students write a theme discussing why this is.

Have the students go to the FDIC website (see Weblinks) and look up the Statement of Policy on Basic Financial Services. Are the basic services different than what the class expects? Why?

Have the students research credit card rates and deposit rates at local banks and financial institutions. What are they? Can your students get financially ahead if they use credit cards while saving in deposit accounts? Why or why not?

For a long-term project, contact a local bank and ask them about establishing a REAL school bank, managed by students. What considerations must be made about making loans, paying deposits and selecting bank personnel?

Support Problems (see Assoc File for answer key)

1: You have a \$1,000 Certificate at the Bank which is earning 6½%. You decide to borrow \$1,000 from the bank so that you do not have to use the deposited money and you are charged 7% for the loan. Imagine you do not get a tax break for the loan and that you are in the 15% federal tax bracket. What is it costing you to borrow rather than to use the Certificate Funds?

2: You have \$1,000 to deposit at the bank for three years. You have three options for doing so:

Option 1 is a Certificate of Deposit which pays 6½% and matures in 18 months. It will
automatically renew for another 10 months at 6¾%.

Option 2 is a Certificate of Deposit which pays 65/8% for 36 months.

Option 3 is a Certificate of Deposit which pays 6% and increases its rate ½% each year.

If interest is paid annually, which choice is the best alternative?

3: You wish to borrow \$1,250. The bank offers an unsecured loan, (no collateral), which will allow you to borrow for 12 months at 13%. If you pay this loan back in 6 months, you pay the interest for 6 months plus a \$35 prepayment fee. What rate would you be actually paying if you pay the loan off early? What if the fee is \$30 and you borrowed \$1,200?

4: You want to borrow \$500 at 10% interest for a year. The bank requires you to purchase credit insurance which will cost you \$10. What rate are you actually paying for the loan?