Fin Lit 10 Study Guide

1. Banking & Financial Institutions

Types of Financial Institutions

• Commercial Banks: For-profit institutions owned by shareholders. Offer full-service banking (checking, savings, loans, mortgages) to individuals and businesses. Focus on profit generation, which often translates to higher fees and lower savings yields.

• Credit Unions: Non-profit financial cooperatives owned and controlled by their member-owners. Membership is typically defined by location, employer, or association. Because profits are returned to members, they generally offer lower interest rates on loans, higher yields on savings accounts, and fewer fees.

• Online / Neobanks: Digital-only institutions operating without physical branch locations. Reduced overhead costs allow them to offer minimal or zero account fees alongside competitive High-Yield Savings Accounts (HYSAs).

• Alternate Lenders: Non-bank financial services including payday lenders, title loan companies, check cashers, and peer-to-peer (P2P) platforms. While highly accessible to individuals with poor or limited credit, they charge extremely high finance charges and annual rates that can exceed $400\%$.

Account Types & Features

• Checking Accounts: Primary transactional accounts designed for daily liquidity, bill payments, and debit card transactions. Generally offer little to no interest.

• Savings Accounts: Deposit accounts designed for short-term savings and emergency reserves, earning modest interest.

• Money Market Accounts (MMAs): Hybrid accounts offering higher interest rates alongside limited check-writing and debit features, often requiring higher minimum balances.

• Certificates of Deposit (CDs): Timed deposit accounts where funds are locked for a fixed duration (e.g., $6$ months to $5$ years) in exchange for a fixed interest rate. Early withdrawal incurs financial penalties.

Choosing a Bank & Deposit Protection

• Fee Structures: Watch for monthly maintenance fees (often waivable with direct deposit or minimum daily balance), out-of-network ATM fees, overdraft fees (charged when transactions exceed available balance), and non-sufficient funds (NSF) fees.

• Deposit Insurance Coverage:

  • FDIC (Federal Deposit Insurance Corporation): Insures commercial bank deposits up to $250,000$ per depositor, per insured bank, for each account ownership category.

  • NCUA (National Credit Union Administration): Provides identical insurance coverage up to $250,000$ for deposits held in qualifying credit unions.

2. Interest & Money Math

Fundamental Terms

• Principal ($P$): The initial sum of money borrowed or invested.

• Annual Percentage Rate (APR): The annualized cost of credit expressed as a percentage, incorporating both the base interest rate and mandatory lender fees.

• Annual Percentage Yield (APY): The actual annual rate of return earned on an investment or savings account, accounting for the effect of compounding interest over time.

Simple Interest

Interest earned or charged solely on the initial principal balance throughout the period. $\text{Interest} = P \times r \times t$

• $P$ = Principal balance

• $r$ = Annual interest rate (expressed as a decimal)

• $t$ = Time in years

Compound Interest

Interest calculated on both the initial principal and the accumulated interest from previous periods ("interest on interest"). $A = P \left(1 + \frac{r}{n}\right)^{n t}$

• $A$ = Final accrued amount (principal + interest)

• $P$ = Principal sum

• $r$ = Nominal annual interest rate (decimal)

• $n$ = Compounding frequency per year (e.g., daily $n = 365$, monthly $n = 12$, annually $n = 1$)

• $t$ = Time elapsed in years

The Rule of 72

A financial shortcut used to estimate the time required for an investment to double at a given fixed annual compound interest rate: $\text{Years to Double} \approx \frac{72}{r}$ (Where $r$ is the annual interest rate expressed as a percentage, e.g., $6\%$ rate uses $r = 6$ to yield $12$ years).

3. Building Credit & Credit Scores

Credit Reporting Agencies

Three major national credit bureaus compile individual financial behaviors into credit reports: Experian, Equifax, and TransUnion.

FICO Credit Score Breakdown (Range: $300$ to $850$)

1. Payment History ($35\%$): The most critical factor. Measures consistent, on-time payment behavior. Late payments ($30+$ days past due), defaults, and bankruptcies significantly lower scores.

2. Credit Utilization Rate ($30\%$): The ratio of total revolving credit balance relative to total available credit limit.    $\text{Credit Utilization} = \frac{\text{Total Revolving Balances}}{\text{Total Credit Limits}} \times 100$

   • Recommended threshold: Maintain overall and per-card utilization below $30\%$, with optimal scoring achieved under $10\%$.

3. Length of Credit History ($15\%$): Evaluates the average age of all open accounts, as well as the age of the oldest account.

4. Types of Credit / Credit Mix ($10\%$): Demonstrates the ability to manage a combination of revolving credit (credit cards) and installment loans (auto, mortgage, student loans).

5. New Credit & Inquiries ($10\%$): Measures recent applications for credit.

   • Hard Inquiries: Occur when lenders review credit for lending decisions; slightly lowers score temporarily.

   • Soft Inquiries: Occur during background checks or personal credit reviews; does not affect credit scores.

Strategies for Building Credit from Zero

• Secured Credit Card: Requires a refundable security deposit that typically acts as the credit limit.

• Authorized User Status: Being added to an established credit card account of a family member with good payment history.

• Credit-Builder Loans: Loan proceeds are held in a locked savings account while the borrower makes fixed monthly payments reported to credit bureaus.

4. Loans, Debt & BNPL Plans

Loan Structures & Categories

• Secured Loans: Backed by physical collateral (e.g., mortgages secured by real estate, auto loans secured by vehicle). Failure to repay results in collateral repossession or foreclosure.

• Unsecured Loans: No collateral attached (e.g., credit cards, student loans, personal loans). Poses higher risk to lenders, resulting in higher interest rates.

• Fixed vs. Variable Interest Rates:

  • Fixed Rate: Interest rate remains constant throughout the loan term, ensuring predictable monthly payments.

  • Variable Rate: Interest rate fluctuates based on underlying market benchmarks (e.g., Prime Rate), causing payment amounts to change over time.

• Revolving vs. Installment Credit:

  • Revolving Credit: Open line of credit with variable monthly payments and repeatable borrowing up to a credit limit (e.g., credit card, HELOC).

  • Installment Credit: One-time lump sum loan repaid in fixed, recurring payments over a predetermined timeframe (e.g., $48$-month car loan).

Debt Payoff Strategies

• Debt Avalanche Method: Focuses extra payments toward the debt with the highest interest rate while paying minimums on others. Minimizes total interest paid over time.

• Debt Snowball Method: Focuses extra payments toward the smallest balance debt first. Provides quick psychological wins to build momentum.

Buy Now, Pay Later (BNPL) Plans

BNPL services (e.g., Klarna, Afterpay, Affirm) split purchases into fixed installments (frequently $4$ equal interest-free payments across $6$ weeks).

Features & Considerations

• Pros:

  • $0\%$ interest rate if payments are completed on schedule.

  • Minimal or no credit checks required at checkout.

  • Convenient integration into digital checkout platforms.

• Cons:

  • High late fees and potential default consequences.

  • Encourages overspending and impulse buying by obscuring immediate total costs.

  • Lacks traditional credit card consumer protections (e.g., robust chargeback rights).

  • Historically did not report positive payment activity to credit bureaus, though negative defaults may be reported.

Summary