83999 Your Money, Your Future A practical money management guide for students and their families Table of Contents Prologue .......................................................................................................................................................3 Chapter 1: Basic Financial Issues ..........................................................................................................4 Activities ................................................................................................................................................8 Chapter 2: Creating and Managing a Budget .............................................................................. 12 Activities ............................................................................................................................................. 18 Chapter 3: Student Loans .................................................................................................................... 23 Activities ............................................................................................................................................. 27 Chapter 4: Establishing Credit ........................................................................................................... 32 Activities ............................................................................................................................................. 37 Chapter 5: Managing Debt ................................................................................................................. 41 Activities ............................................................................................................................................. 47 Chapter 6: Repaying Debt ................................................................................................................... 52 Activities ............................................................................................................................................. 59 Chapter 7: Saving and its Bene ts .................................................................................................... 63 Activities ............................................................................................................................................. 70 Your Money, Your Future 2 Prologue Your Money, Your Future (referred to as the “Guide” throughout) was created to assist potential student borrowers and their families in making decisions regarding money management. The Guide is intended for students who are considering attending or are already enrolled in a tertiary education institution (tertiary education includes university, technical and vocational training, and any other studies completed after secondary school). The Guide covers topics such as student loans, goal-setting, repaying debt, and aims to educate students – and their families – in ways that will make them better money managers and more responsible borrowers throughout their university careers and beyond. Many of the topics raised in the Guide will be completely new to you and some may not seem directly relevant to your current nancial situation. However, preparing to make smart nancial decisions early in your life will lead to fewer mistakes and more opportunities to be nancially successful in the future. Additionally, information covered in the Guide may be important for your parents, particularly in the scenario where you and your family would incur debt in the form of a student loan. Therefore, it is critical that you take time to share this information with your parents. They may be able to o er insight on the lessons they learned throughout the course of their lives and may also bene t from new concepts raised in the Guide. The most important thing to remember when working through the Guide is that there is not one right approach to managing your money. As discussed throughout the Guide, everyone has di erent goals and ambitions, and consequently, will save, borrow and earn money di erently. This Guide will teach you basic concepts and knowledge about nancial management. It is intended that this foundation will empower you to make the right nancial decisions now and in the future so that you can achieve your goals. For the purposes of illustration, the Dinar (a currency used in several countries) is referred to throughout the Guide. However, the content of this Guide is transferable across countries and their respective currencies. About IFC IFC, a member of the World Bank Group, is the largest global development institution focused on the private sector in developing countries. We create opportunity for people to escape poverty and improve their lives. We do so by providing nancing to help businesses employ more people and supply essential services, by mobilizing capital from others, and by delivering advisory services to ensure sustainable development. In a time of global economic uncertainty, our new investments climbed to a record $18 billion in scal 2010. For more information, visit www.ifc.org. Your Money, Your Future 3 Chapter 1: Basic Financial Issues Your Money, Your Future Chapter 1: Basic Financial Issues For many people, money concerns are at the top of the list of anxieties that preoccupy their daily thoughts. Why does dealing with money seem so problematic? It could be because very few people have had the opportunity to be educated in personal nancial matters. Lack of nancial education is especially common among young adults, who may be earning income, borrowing money or thinking about their nancial future for the rst time. Without proper nancial education, young adults make uninformed decisions that usually result in a pattern of poor nancial management. As personal nance This Guide will provide becomes more complex and people have access to credit at a younger age, it becomes apparent that you with an overview of learning how to manage money has evolved into a the most essential personal life skill – like reading or writing. nance topics, from goal setting to understanding This Guide will provide you with an overview of the most essential personal nance topics, from goal studentloans,tobudgeting setting to understanding student loans, to budgeting your money, to credit your money, to credit basics. This information is basics. presented as an educational tool to assist you and your family in making wise nancial decisions as you commence your university studies and throughout your lives. For many young adults, a student loan may be the rst signi cant loan for which they are responsible. Entering the world of nance will involve many such decisions; some of which may have implications for many years to come. However, knowledgeable consumers usually make more intelligent decisions than consumers who are less informed. After having read and studied this Guide, you will be equipped with the knowledge and skills to help you navigate the world of personal nance and hopefully avoid making costly money mistakes. For the purposes of illustration, the Dinar (a currency used in several countries) is referred to throughout the Guide. However, the content of this Guide is transferable across countries and their respective currencies. Please use the relevant currency for your country when using this Guide. Setting Goals Personal nance is about setting goals, making choices and following through. In the next few years, you will nd that managing your money will become an increasingly important part of your life. Even if you do not have much cash to work with now, it is well worth it to start learning all you can about how to manage your money. When you begin to earn an income, you will be aware of your options, what mistakes to avoid, and what steps to take to achieve the best possible outcome. Those who start planning early will be poised for nancial success. Your Money, Your Future Chapter 1: Basic Financial Issues 5 When it comes to setting goals, many people neglect to create nancial goals. They develop goals for other parts of their life such as major area of study while in university, desired profession, marriage plans, or summer vacation. But when it comes to money, they earn it and they spend it without a plan. Usually when they earn more money, they spend more as well. In this scenario, if they had a plan, they might elect to use their additional income to increase their savings or to pay down their debt obligations. The rst step in setting nancial goals is to decide what goals are important to you. No two people are identical in their goals and aspirations. You may wish to save money for a car, a mobile phone, clothes, a computer or the future purchase of a home. There is no right or wrong answer regarding which goals are the best for you. It is a personal decision to be made after much re ection on your current nancial situation and what you would like to accomplish in the future. Opportunity Cost Opportunity cost is the value of the next best choice that one gives up when making a decision. By de nition, any decision that is made causes other decisions that could have been made to be abandoned. If one drives north, they cannot drive south. In another instance, if a family decides to use 1,000 dinars to add an extra room onto their house, the opportunity cost is some other thing for which the 1,000 dinars could have been used. In choosing to add the extra room, the family might have forgone the opportunity to take a family vacation or replace an aging car with a newer one. Electing to continue your studies also involves an opportunity cost. If you decided NOT to pursue your education, what would you do instead? Would you get married, nd a job, or travel? In addition to short- term trade-o s, what would be the long-term trade-o if you decided to abandon the higher education goal? Would you be trapped in lower paying jobs and / or have fewer job opportunities? Data from many countries illustrate the positive link between higher education levels and unemployment. For example, in Chile, higher unemployment rates exist among those with only secondary or incomplete college education.1 Other research shows the impact between education level and salary/job quality. For example, in Brazil, on average the salary of a college graduate is worth almost three times the salary of a worker with a high school diploma.2 Furthermore, in Egypt among both males and females with a secondary education and above, the quality of their rst job was substantially greater than among those with less than a secondary education. This data con rms a correlation between a higher education and increased and better quality job opportunities.3 1 Source: OECD and World Bank. Tertiary Education in Chile, 2009 2 Source: Alberto Rodriguez. Knowledge and Innovation for Competitiveness in Brazil, 2008 3 Source: Ragui Assaad and May Gadallah. Pathways from School to Work for Egyptian Youth, 2009 Your Money, Your Future Chapter 1: Basic Financial Issues 6 Your decision to pursue and attain a higher degree is not one to be taken lightly. It is a choice that will be instrumental in the direction your life takes in the years to come. This decision should always precede the discussion about funding. If you decide that a university education is one of your life goals, you will then nd a way to pursue it – regardless of the nancial obstacles. Student loans provide one alternative way to make higher education more a ordable (See Chapter 3). Write Down Your Money Goals The best way to accomplish a money goal or objective is to write it down. The simple act of writing the goal on paper makes it more tangible and allows you to organize and prioritize. Once the goal is written down, the mind starts working on ways to make this goal a reality. Once you choose a general goal, you should write down the steps needed to achieve that goal. By breaking up the goal into manageable pieces, it will not seem so overwhelming. For example, you may decide to allocate an amount of money to be put toward your goal every month. If you consistently put the money away in your savings, you will have the money your goal requires by the end of the time period needed to reach your goal. If this monthly savings amount is too high for your budget, you may have to extend the time period needed to save the total amount. Almost any goal is possible if you are willing to adjust the monthly amount saved or the time period required to achieve your goal. The only other factor for success is having the will to succeed and making sure that your chosen goal is not an impossible one to achieve. Do not be afraid to ask questions. There Money Should Not Be a Taboo Subject are no wrong questions Do not be afraid to ask questions. There are no wrong questions when it comes to making when it comes to making an important nancial decision. an important nancial When it comes to money, the more it is discussed, the better it is decision. understood. Sometimes people are embarrassed to ask questions if they do not understand nancial transactions. They feel that they should already know the answer. Therefore they opt to remain confused rather than risk sounding like they are not nancially savvy. This logic incorrectly assumes that others understand money better than you do. Just because someone is a professional, does not mean that he or she knows how to manage their own money. Further, a high-income individual may not be a successful money manager. His or her nancial bottom line may be much worse than someone from a lower-paying profession. It is not a matter of how much you earn, but rather what you spend in relation to what you earn that counts. Resolve to talk about money as much as possible. Talk with your family and representatives from your local bank. Setting a budget, debt reduction, investment strategies and cost- cutting ideas are ideal topics for money conversations. The frequency of these conversations and the comfort level you have with discussing your nances will almost certainly have a direct correlation. The more you talk, the more comfortable you will be. Your Money, Your Future Chapter 1: Basic Financial Issues 7 Chapter 1 - Activity 1 How Do You Spend your Money? Any time you spend money, it is a nancial activity, right? And any time there is a nancial activity there is some sort of nancial decision involved. Some are relatively minor: How much should I give the waiter for a tip? Should I go see a movie, or wait for it to come out on DVD? In these cases, how you decide to spend your money is not likely to have a big impact on your nancial wellbeing. (Of course, these minor decisions and activities can quickly add up, and their cumulative e ect can be signi cant!) Still, there are some nancial decisions and activities that can have a major impact all by themselves. Should I enroll in a university that will require me to obtain a loan? Should I buy a new phone? Minor Financial Activities Major Financial Activities Movie or DVD rental New cell phone Bus ride University education Co ee Automobile When you are young and live with your parents, your nancial decisions and activities are probably all minor (even though they may not always seem that way!) When you leave home, they increase in number and complexity. So what about now? What kinds of nancial decisions and responsibilities do you have? How do you typically spend your money? Figure Out Your Finances Follow these steps to help identify and analyze your recent nancial decisions and spending activities. Examining your nancial activities and decisions will help you better manage your nances now and in the future. 1. List your nancial activities and decisions over the last month. Your list should provide a picture of how you spend your money and what kind of nancial responsibilities you have. Do not worry about organizing your list — simply write down whatever comes to mind. If there is a consistent activity, such as buying lunch, just list it once. ________________________________ __________________________________ ________________________________ __________________________________ ________________________________ __________________________________ ________________________________ _________________________________ Your Money, Your Future Chapter 1: Basic Financial Issues 8 2. Organize your list. Look at your list and group the nancial activities and decisions, similar to the example below. Create di erent groupings, such as: • Relative size of the activity/decision — Is it a minor spending activity/decision? Is it a major activity/decision? • Frequency of the activity/decision — Are there some activities/decisions that occurred often during the past month? Some that occurred only a few times? Some that happened just once? • Necessity of the spending — Are there some activities/decisions that you had to do? Are there others that you chose to do? • People involved in the activity/decision — Is it an activity/decision that involved only you? Is it one that involved others? Activity Major/Minor? Frequency? Necessary? Others Involved? Lunch at school Minor Daily Yes No 3. Look for patterns and di erences. Are certain activities and decisions consistently grouped together? For example, are those related to entertainment or those involving friends often together? What other patterns do you detect? How are your spending decisions and activities di erent from one another? Take It Another Step Speculate on your alternatives. Another way to look at your nancial decisions and activities is by thinking about what your alternatives were. Pick ve items from your lists and gure out what you could have done di erently. What if you had chosen not to spend your money the way you did? These alternatives are not necessarily positive or negative. As discussed earlier in this chapter, these alternatives are often referred to as your opportunity costs. Look backward and forward. What if you followed these same steps when you were 12 years old? What items would have been on your list? What would some of your opportunity costs have been? What about when you are 30? What do you speculate the items on your list would be? Opportunity costs? Now, here is a BIG question for you: What do you think is consistent about nancial decisions and activities no matter how old you are? What do you think changes as you get older? Is it the number of decisions? Is it the relative size of the decisions? Your Money, Your Future Chapter 1: Basic Financial Issues 9 Chapter 1 - Activity 2 Setting Goals for your Future Where do you envision yourself in ve years? How about ten years? When will you nish university? Are you working in your chosen career eld? How will you get there? What will it cost? Re ecting on your daily life can help you prioritize what is important to you and what you might want to change. Take, for example, that afternoon co ee that you like to buy. Co ee = 1.20 dinars It does not cost much each day, but if you think about it, 5 days / week = 6.00 dinars you probably spend a lot more on co ee over one year than Over one year = 330 dinars you imagined. If one of your goals is to pay for university, you might consider putting your co ee money into savings instead of spending it one co ee at a time. Though some of these everyday actions and nancial decisions may be things that you really do enjoy, your priorities might change when you consider your future. Looking at the Long-Term Follow the steps below to help you think about your goals for the future, and the nancial goals you will need to set in order to achieve them. 1. Answer the following questions to develop a baseline for your ideal future, keeping in mind that you will use the answers to these questions to help de ne speci c goals for yourself. a. Where do you want to go to university? How long will it take to earn a degree? ______________________________________________________________ b. Where will you live while in university? (At home? At school? O campus?) ______________________________________________________________ c. How much money do you think it will cost to attend university? (tuition, books, fees, etc.) ___________________________________________________________ d. How will you pay for school? (Parents? Loans? Work?) ______________________________________________________________ e. What might you have to give up if you go to university? What are the opportunity costs? _________________________________________________________ f. What type of career would you like after university? ______________________________________________________________ Your Money, Your Future Chapter 1: Basic Financial Issues 10 2. Create a list of long-term goals for yourself based on your answers to the above questions. How long might it take to achieve these goals? How much money might be needed to achieve these goals? (At this point, it is ne to just guess.) Goal Length of Time Needed Amount Needed Graduate from a two-year course Two years 10,000 dinars 3. Consider some of the themes that run through your goals. What are some of the main focuses? Can some of your goals be grouped together? What smaller goals would you need to accomplish in order to reach some of the bigger goals? Take It Another Step Discuss your goals with your parents. Ask them about some of the goals they had at your age. Did they consider going to university? How did they accomplish their own goals? What obstacles did they face? Were their own parents supportive of what they wanted to do with their lives? What are some of the goals they still seek to achieve? De ne your learning goals for this Guide. Take a moment to think about the learning goals you have for this Guide. Write them in the spaces below. Then, as you complete Chapters 2 – 7, determine whether the Guide is helping you achieve the levels of learning you desire. _________________________________________________________________________ _________________________________________________________________________ _________________________________________________________________________ _________________________________________________________________________ _________________________________________________________________________ _________________________________________________________________________ _________________________________________________________________________ _________________________________________________________________________ Your Money, Your Future Chapter 1: Basic Financial Issues 11 Chapter 2: Creating and Managing a Budget Your Money, Your Future Chapter 2: Creating and Managing a Budget Although you may not yet have a source of income, understanding how to prepare a budget is a critical element of becoming nancially literate. Talk to your family about this chapter. Work with your parents on their household budget so that you can be aware of di erent costs and expenses that you will incur in the future and how this relates to your future income. If the word ‘budget’ conjures up images of deprivation, think of it not as some unpleasant chore or way to deny yourself, but as an empowering Too often way to reach your nancial goals. Creating a budget is analogous to cleaning a messy room. Although the actual task of cleaning may people be time consuming, the end result is that your room is organized overspend and in order. without even realizing it. This is important because too often people overspend without even realizing it. For example, if you are able to supplement your income with money from your parents or with money from loans, these funds may sustain an overspending situation. A budget will expose the true situation, which has three possible outcomes: 1. You spend more than you make. 2. You spend every dinar you make. 3. You spend less than you make. Creating a budget is particularly important if your life situation has changed because of events that prompt more independence such as attending university and eventual relocation from your parents’ home. Future events like a rst full-time job, marriage or new baby will lead to even more self-reliance over your nancial a airs. These major events may alter your nances dramatically. Throughout your life, as you journey through di erent life stages, the one constant map that will continue to provide you with direction — is your budget. A sensible budget will always allow you to take control of your money and not veer from your course. Remember, a budget is a tool to help you plan, prioritize, and manage your income and expenses. You need to review your budget often and update it whenever you experience a change in circumstances. Here are a few tips to help get you started: • Budgeting is not di cult, but getting started does take motivation. Promise yourself a reward for your e orts. • Pay for items you need before those you want. Basic needs like food, shelter, medical Your Money, Your Future Chapter 2: Creating and Managing a Budget 13 expenses and taxes should be paid rst. Anything left over can then be used for discretionary spending. • Some expenses fall into both categories; they are both a want and a need. Shoes are a necessity but 20 pairs are not. Strive to limit your purchases to actual needs. • There is no right or wrong way to allocate your money. We all have di erent nancial goals that we are striving to achieve. • Do not give up. If you fall o your spending plan one month, readjust your spending the next month. The important thing is that you keep your ultimate nancial goals in mind. • Budgeting takes practice and discipline but gets easier once you get in the habit and see positive results. Step 1: Develop a Spending Plan A spending plan, or budget, is your rst step toward building nancial responsibility. A spending plan organizes your estimated income and expenses over a set period of time — normally a month. Creating a budget means tracking your personal cash ow — that is, how much money comes in and how much goes out. A Spending Plan Can Help You: • Stay out of debt • Identify areas of potential savings • Provide a cushion for unforeseen expenses • Save money for long-term goals • Avoid impulse spending Adding up your monthly income is usually relatively easy, but adding up all your expenses takes a little more e ort. If you have not been keeping good records, you may have to keep track of the money you spend for one month before you can enter numbers into your budget. Advance Preparation: • Gather information about any sources of income you may be receiving. This may include paycheck receipts from a part-time job, regular parental allowance, and monetary gifts for birthdays or holidays. • Collect all your bills, checkbook register, and receipts for groceries, gas or anything else you buy with cash. • Divide annual expense gures by 12 to determine monthly amounts, semiannual gures by 6, quarterly by 3, etc. • Track where your money goes for those categories where you do not receive a bill or have receipts available (i.e. transportation and meals out). These expenses are Your Money, Your Future Chapter 2: Creating and Managing a Budget 14 usually di cult to estimate. Therefore, the best way to get an accurate number is by making entries in a notebook — every time you spend money. This is most accurate when done for one month but two weeks will provide a good estimate (the two week total must be multiplied by two). • Make estimates, when necessary, for any remaining expense categories. For example, most people spend money on “gifts” but it may be that in the particular month when you did the tracking exercise, there were no celebrations. However, keep in mind that most guesses tend to be lower than actual expenditures. • Add your own speci c categories if you have expenses that are not contained in a typical budget. For example, you may engage in a specialized hobby, take lessons for a certain sport or play an instrument. Create a Budget: The rst time you put a budget together, plan on allotting a fair amount of time to make sure that you do the advance work necessary. You may be tempted to skip certain steps, such as tracking your monthly expenditures or doing the math to convert periodic expenditures to monthly ones. However, if you guess and just ll in the blanks with estimates, your budget will not be accurate. Without knowing your genuine nancial situation, you will not be able to develop a nancial plan that has any connection to reality. Once you have completed your budget, future changes only need to be made when there is a change in your income or expenses. For example, if you pay o a car loan, you can eliminate that expense from your budget. Or once you get a full-time job after graduation, you can adjust the entry in the “income” line by replacing your parents’ allowance with a salary. Because a budget is a living document, many people choose to ll it out in pencil. This allows for easy changes by just erasing the previous entry. All budgets have these components in common: • Write down your monthly take-home pay – the amount that you receive from your paycheck after any deductions are taken out. List income you receive from any source, such as a part-time job, gifts, investment income, or allowance from a parent. Add the entries to determine your total take-home or net income3 for that month. • List how much you deposit in savings each month from your take-home income, even if it is only a small amount. If you do not currently set aside any savings, you need to get in the habit of paying yourself rst. This concept is addressed in Chapter 7. • List your “ xed” monthly expenses – the predictable, set amounts for the items and services that you pay for each month – like rent, car payment, or Internet access. • List your “variable” monthly expenses – the amounts that uctuate, as well as the expenses you pay weekly, monthly, quarterly, semi-annually, or once a year. These 3 Net income: An individual’s income after deductions and taxes are subtracted from gross income. Your Money, Your Future Chapter 2: Creating and Managing a Budget 15 may include groceries, clothing, haircuts, tuition fees, textbooks, and gas and electricity. You will need to enter your average monthly amount for each expense. If you completed the advance preparation work, you should already have these numbers. • List monthly estimates for “occasional” expenses – such as birthday and wedding gifts, or holiday gifts and sporting matches. • Total your income and total your expenses. Compare the relationship between the two. • Evaluate your outcome. If you have money left over after subtracting your expenses from your income and putting money in savings, you can carry over the balance for the next month or use it to pay unexpected expenses. If this month’s cash balance is negative, look for ways to cut back on the variable expenses. Step 2: Review Your Progress In some cases, your targeted spending plan and your actual spending habits do not coincide. The goal is to spend according to the plan, but in reality many things may interfere with our ability to stay within the budget constraints. Common categories in which you might overspend may include meals out, clothing, entertainment, and mobile phone costs. Since money management is a continual learning experience, it is necessary to keep records of actual spending each month to compare with the plan. This comparison will allow you to: • Have an actual tally of how much you spent as opposed to estimates. • Identify problem areas where overspending occurred. • Reduce or eliminate some expenses. • Brainstorm ways to increase income, such as nding a better paying job. Step 3: Make Changes This step requires adjusting expenses and/or income to reach your long-term nancial goals, and is usually the most di cult. Many people, when asked to give things up or reduce spending, tend to resist and come up with all kinds of excuses that start with “Yes, but...” • Common excuses include: - I would give up my mobile phone, but what if there is an emergency? - I would give up smoking, but then I will gain weight. - I would give up eating out, but I do not have time to cook. - I would give up entertainment, but then I will not have a social life. The reality is that there are only two ways to improve your nancial situation — either make more money or spend less (or do both). However, many people feel there is another Your Money, Your Future Chapter 2: Creating and Managing a Budget 16 solution. This solution is appealing since it does not involve sacri ces. It is not a proactive solution, but one that relies on someone or something else saving the day: • You are waiting to marry into a wealthy family. • You are waiting for your own family to help you out. • You are waiting to get a good paying job. • You are waiting to inherit money. The problem with all these “solutions” is that they may or may not ever happen. Even if your family does decide to help you out nancially, you will never learn to be truly independent if you continue to request their assistance. Being nancially independent is liberating; you are in control of your own nancial destiny and do not have to rely on anyone else. This can also be frightening since you may fail. However, there have been studies that prove a positive correlation between education in personal nance and resultant behavior. Those with education tend to make wiser decisions regarding their money. So, the incentive to creating and following a budget is to increase your nancial prosperity. The goal should be to end up with more money successes and fewer money messes. Your Money, Your Future Chapter 2: Creating and Managing a Budget 17 Chapter 2 - Activity 1 Where Does Your Money Go? As mentioned at the beginning of this chapter, understanding how to create a budget is an important way to organize and understand your nancial situation. If you do not yet earn an income, work through this chapter with your parents using income and expense gures that mirror your family’s actual budget. Creating a budget is a great way to avoid feeling nancially overwhelmed or disorganized. Not only will you feel more comfortable with your nancial situation, but you will have more exibility to make nancial decisions to help you reach your goals. Even if you have never had a budget before, it is not too late to learn how to budget your money. Use the following activity to evaluate your own budgeting skills. Start to consider where you spend most of your money and the bene ts of these expenses. Your answers will help you formulate a basic spending plan. Your answers will also be helpful in the next activity, where you will examine your own expenses in relation to recommended budgeting guidelines. 1. Enter your estimated monthly income from all sources on the lines indicated below. Even if you do not yet have a formal job, you can still estimate the amount of discretionary money you receive from your parents. If you have additional sources of income, add them on the blank lines. Then, total your income in the space provided. Income Monthly Amount Sample Income 350 dinars Family/Parents Job Total Income 2. Next, estimate the amount of money you spend each month on food, housing, transportation, and other expenses, especially as they relate to the goals you set for yourself in Activity 2 from Chapter 1. Enter the amounts on the lines indicated on the next page. If you have additional expenses, add them on the blank lines. Then, total your monthly expenses in the space provided. Also identify the relative importance of each expense: is it very important, somewhat important, nice to have/do, or not very important? Classifying your expenses this way will help you determine where you might be able to cut back. Your Money, Your Future Chapter 2: Creating and Managing a Budget 18 Expenses Relative Importance Monthly Amount Sample Payment Somewhat important 35 dinars Food Housing (rent/upkeep) Transportation (car/bus/insurance) Utilities Entertainment (concerts/movies/sports) Clothing Savings Medical Student Loan repayment Other debts Miscellaneous Total Expenses 3. Calculate how much money you have left over every month. Simply subtract your expenses from your income to determine this amount. If your expenses are greater than your income, then you need to look for ways to cut back. Total Income Minus Total Expenses - Equals Money Left Over = Take It Another Step Keep track of your actual income and expenses over a one-month period. Save any paystubs, receipts, and bills, and then compare the total monthly amounts with your answers in Steps 1 and 2, above. Did any of the di erences in estimated vs. actual expenses / income surprise you? What changes in your behavior need to take place as a result? Your Money, Your Future Chapter 2: Creating and Managing a Budget 19 Chapter 2 - Activity 2 Budgeting Guidelines Everyone has his or her own preferences about where to spend money. You may wish to spend your money on education or entertainment, or you may just want to save your money so that you can pursue your long-term goals. No matter how you choose to spend your money, issues may arise when you spend more money than you have. Doing so creates debt, which may not be the nancial situation in which you wanted to nd yourself. This activity will help you look at your spending and determine how to make adjustments to better align with your nancial priorities. Follow the steps below to compare your own spending with the recommended amounts for a university student. 1. Fill in the rst column with the amounts you tracked in Activity 1. These should be the actual dinar amounts you spent over one month. 2. Calculate the percentage of your total monthly income that each amount represents. Enter these percentages in the second column. 3. Look at the recommended percentage breakdown for student budgets in the third column. What is your initial reaction to these percentages? What surprised you? 4. Compare your actual spending with the recommended spending percentages. In the last column, write “more” if you spend more than the percentage indicated in the recommended budget, or “less” if you spend less than the recommended amount. Actual Actual Recommended More or Amount Percentage Percentage Less? Housing 30% Transportation 18% Food 16% Miscellaneous 8% Clothing 5% Medical 5% Entertainment 5% Utilities 5% Savings 4% Other debts 4% Source: Visa Your Money, Your Future Chapter 2: Creating and Managing a Budget 20 Take It Another Step Consider the biggest di erences between your budget and the recommendations provided. What caused these di erences? Do you think you need to make some adjustments? Remember how you felt in this section as you go onto the next activity, where you will adjust your budget. Your Money, Your Future Chapter 2: Creating and Managing a Budget 21 Chapter 2 - Activity 3 Prepare for the Unexpected Your budget is a exible document; your income and expenses might vary from month to month and your priorities might change. Sometimes, you might face an unexpected expense and need to make sacri ces in other areas of your spending in order to pay for it. Thus, it is important to know how to work with and adjust your budget. Consider how you would react to the following scenarios, based on the spending plan you developed in the previous two activities. This activity focuses on adjusting your budget based on di erent scenarios that could come up and cause unexpected spending. Think about the following ctional situations. How would you react to them? What nancial decisions would you make? What might you have to give up in order to pay for these expenses? Situation 1: You drive to work everyday, 10 kilometers each way, and you have the exact amount of money budgeted for petrol for the month, based on last week’s price of 5 dinars per gallon. Unexpectedly, the price of petrol increases by 20%. What will you do to pay the extra cost for petrol? Added expense amount per month: __________________ Your course of action (activities and expenses to cut back): ________________________________________________________________ Situation 2: As a clerk at a store in your neighborhood, you make 70 dinars per week. Today you found out that the store is going out of business. How will this drop in income a ect your overall budget? Will you nd another source of income? Will you ask your parents for more money? Or will you cut back in certain areas? Decreased income amount per month: __________________ Your course of action (increase income and/or reduce expenses): ________________________________________________________________ Situation 3: A friend asks you to go away for a weekend to celebrate his birthday. Although you had not planned on spending any more money this month, you really want to go on the trip. With transportation, hotel, food, and entertainment costs, the trip will likely cost 100 or more dinars. Will you go on the trip? How will you pay for it? What might you give up in order to make the trip? Added expense amount this month: ___________________ Your course of action (activities and expenses to cut back): ________________________________________________________________ Take It Another Step Re ect on past experiences and anticipate future issues. If you think about di erent situations that caused a budget adjustment in the past, you may have a better idea of what could happen in the future. What did you do in the past when unexpected expenses came up? Did you have an organized budget then? How will you use what you learned in the past to anticipate future budget changes? Your Money, Your Future Chapter 2: Creating and Managing a Budget 22 Chapter 3: Student Loans Your Money, Your Future Chapter 3: Student Loans Many readers of this Guide aspire to achieve a tertiary education. A student loan is a tool that may allow a student to a ord the costs of tertiary education. A loan connected to the advancement of your education is an investment in your future. With a higher education level, you may qualify for better paying jobs and have more employment choices available to you. The importance of tertiary education is a tenet that is agreed upon throughout the world. For example, the Government of India is renewing its e orts to strengthen higher and technical education to address the “Enhancing current skill shortages in the economy. higher education is considered one of the main Likewise, in Egypt, according to the Ministry of prerequisites in an era of Education, “Enhancing higher education is considered one of the main prerequisites in an era of knowledge knowledge and information and information as it is responsible for preparing a as it is responsible for strong generation able to keep pace with changes preparing a strong generation and help society catch up with the recent progress and civilization in the era of knowledge.” able to keep pace with changes.” Finally, fewer Brazilians are enrolled in higher education compared to other countries in the region and increasing their access to post-secondary education is key to ensuring a better educated workforce and making the country more competitive. A college-educated worker earns about three times more than a person without a college degree, thus making higher education a signi cant factor in improving people’s lives. However, access to tertiary education does have some barriers that must be surpassed. These obstacles may include the competing pressure to enter the workforce, the necessity to pass a placement exam, or the inability nancially to a ord continued education. The increased number of private institutions and rising tuition costs have prompted more students to look at student loans as one option to help fund their tertiary education. It is becoming increasingly common for students and their parents to consider borrowing money as a necessary higher education nancing tool if they lack the resources to pay all or a part of these education costs. To meet this need, more banks and micro- credit organizations have been moving to diversify their product line to include student loans. In simple terms, a loan is an arrangement in which a lender gives money to a borrower and the borrower agrees to repay the money at some future point in time. In the case of student loans, the money is to be used to help pay the cost of tuition. Chapters 4 – 6 discuss debt more in depth. For this service, the lender receives a fee from the borrower for the use of the borrowed money, which is gathered primarily through interest payments. An interest rate is often Your Money, Your Future Chapter 3: Student Loans 24 expressed as an annual percentage of the original amount borrowed. As money is not free, interest represents the cost to the borrower of using the lender’s money. Determine How Much to Borrow The following steps will help you determine exactly how much money you will need to borrow for school. Knowing the correct amount will prevent you from borrowing too little or too much. Coming up short creates an obvious problem but borrowing too much will result in additional and unnecessary debt that will eventually have to be repaid. Step 1: Identify Your Educational Expenses Work with your tertiary education institution’s admissions or student services o ce to identify all expected costs. These expenses may include, but are not necessarily limited to the following: • Tuition • Fees (e.g., registration, permits, etc.) • Housing • Meals • Transport / Parking • Textbooks and supplies • Special equipment (e.g., computer) Step 2: Evaluate Your Existing Financial Resources Because the total cost of borrowing can increase signi cantly as each year of schooling passes, a good strategy is to borrow only what is absolutely necessary. Evaluate non-loan sources rst to pay for many of your educational expenses. Then determine how much might be available and over what time period you can rely on the various sources. Identifying alternative sources of non-loan funding is also important since most student loans only cover the cost of tuition. The other costs associated with an education must be paid for in a di erent way. These sources of funding may include: • Gifts from your immediate family or relatives • Current family income • Savings • Investments Your Money, Your Future Chapter 3: Student Loans 25 • Income during the school year • Scholarships / awards Step 3: Calculate Funding Needed Total Educational Expenses – Total Funding Available = Amount to Borrow Once this amount is determined, you will need to shop around to nd a student loan with the best terms. Lenders will list their “terms and conditions” – see Chapter 4 for more information on “terms and conditions.” Compare loans among the various lenders to determine which has the most favorable terms for your particular situation. Common questions to ask may include: • What is the interest rate (the lower the better)? • Is the interest rate xed or adjustable? • Are payments required while still in school? • Is the total balance due upon graduation? • If not, is there a grace period4 after graduation before payments begin (e.g., six months)? • How will the principal be repaid (e.g., equal monthly sums)? • What are the criteria for approving the loan? • Are there any special fees associated with the loan (e.g., processing charge, late fee)? • Do you have any repayment options if you get behind on payments? Since this loan will be a sizable investment in your future, you should take the time to nd answers to all of these questions. Only when you understand the full extent of your commitment, should you enter into this long-term obligation. Also, discuss the possibility of obtaining a student loan with your family. Revisit the budget exercises discussed in Chapter 2 to see how this student loan would t into your family’s budget. 4 Grace Period: The additional period of time a lender provides to make payment on a debt without a penalty. Your Money, Your Future Chapter 3: Student Loans 26 Chapter 3 - Activity 1 How Will You Spend your Money? Chances are that you are reading this because you are about to enter your next life stage — one that includes the next phase of your education. This chapter has focused on student loans as a way to help increase your understanding of your options for nancing your post- secondary education. This activity will build on the foundation that you started with the previous chapter, in which you identi ed and analyzed your nancial decisions and activities. In fact, it is a good idea to get your work from that activity, so you can refer to it easily. Follow the steps below to help you think about your expected nancial decisions and activities as a university student. 1. List the nancial activities and decisions you might encounter as a university student. Some may happen daily (e.g., meals, cell phone charges), while some may happen only once per semester (e.g., tuition, textbooks). Even if you are unsure about it, go ahead and list it. Do not worry about organizing your list at this point. ________________________________ ________________________________ ________________________________ ________________________________ ________________________________ ________________________________ ________________________________ ________________________________ 2. Organize your list. Now, look at your list and group the nancial activities and decisions, similar to the example below. Create di erent groupings, such as: • Likelihood of the activity or decision occurring — Is it de nite, probable, or merely possible? • Relative size of the activity/decision — Is it a minor spending decision/activity? Is it a major one? • Frequency of the activity/decision — Which ones are you likely to experience daily or weekly? Which ones are monthly or less often? • Necessity of spending — Is there some spending that you will have to do? Some that you think you will choose to do? Your Money, Your Future Chapter 3: Student Loans 27 Activity Likelihood? Major/Minor? Frequency? Necessary? Tuition De nite Major Once/Semester Yes 3. Look for patterns and di erences. Do you notice any patterns within the likelihood category? Di erences? Are there some activities that are dependent on others? Take It Another Step Talk with a current university student. Ask someone you know who is currently enrolled in university (or recently graduated) about some unexpected nancial decisions and responsibilities. What were they? How did they handle the situations? What did they learn from the experiences? Your Money, Your Future Chapter 3: Student Loans 28 Chapter 3 - Activity 2 Paying for your Education In the previous activity, you identi ed some of the nancial activities and decisions you may face in university. Now, you will calculate the total of those activities and determine how much funding you will need in order to pay for university. 1. Add up all of your expected expenses. In the chart below, write down each of the nancial activities that you identi ed in the previous activity. Then, estimate the yearly cost for each. Add all of the estimated costs to come up with a yearly total of educational expenses. Activity Yearly Cost Tuition 5,000 dinars Total Educational Expenses 2. Calculate the funding you will need to attend university. Using the example chart below, enter your total educational expenses (from Step 1). Then subtract your existing nancial resources to determine the additional money you may need to borrow in order to pay for your education. Remember this formula: Total Educational Expenses – Total Funding Available = Amount to Borrow Your Money, Your Future Chapter 3: Student Loans 29 Example Your Funding Total Educational Expenses 5,500 dinars – Scholarships and Grants 500 dinars – Savings 600 dinars – Gifts from Family 1,000 dinars Additional Amount Needed 3,400 dinars Some student nancing programs may limit the amount that a student or family may borrow per year. Therefore, it will be important to discuss the nancing options available to you with your local nancial institutions. Your Money, Your Future Chapter 3: Student Loans 30 Chapter 3 - Activity 3 Ask the Right Questions Deciding how to pay for university is not always an easy process. University and the expenses that come along with it can be expensive, but there are options available for those who are focused on the goal of continuing their education. Now that you know what nancial activities and decisions you might face in university and the amount of funding you will likely need, you can research your nancing options with a clearer picture. One of the best ways to gain insight about student loans is to begin by asking questions. Determine what you already know about student loans and areas for which you need additional information by following the steps below. Remember that many of your questions may be answered throughout this Guide. 1. Make a list of all the things you already know about student loans. This list may include potential lenders, information about the application process, interest (or mark- up) rates on student loans, repayment terms, and factors that in uence the amount of your loan. Community Bank A has low mark-up rates. 2. Write down all the remaining questions you have about student loans. Maybe you are wondering what type of documentation to provide or how the lender works with your chosen university? Knowing which questions to ask a potential lender will prepare you to gain the most relevant information possible. How long will it take to pay back my loan? Keep the above questions in mind as you continue through this curriculum. The goal is to have a better understanding of how student loans work and how they will be able to help you with the costs of higher education. Your Money, Your Future Chapter 3: Student Loans 31 Chapter 4: Establishing Credit Your Money, Your Future Chapter 4: Establishing Credit Credit involves the act of buying goods and services now and paying for them over time. When you obtain credit, you are using borrowed money in lieu of your own. Credit is usually granted through a loan or agreement with a creditor. A good way to understand this concept is that it is similar to paying “rent.” Just as you would pay rent for the privilege of living in someone else’s house, credit allows you to “rent” others’ money to buy goods and services. Debt on the other hand is created after money is lent. Debt refers to the amount owed from the funds that are borrowed. There is a cause and e ect relationship between the two—the granting of credit creates debt. When you borrow Typically it is not a good idea to use credit to money from a bank or other purchase things that are easily consumed (i.e., lender, you agree to pay it back. food, gasoline for your vehicle, etc.) because soon you will be left with only the payments— It is not a gift. In return for this long after the food has been eaten or the car arrangement, you pay fees and runs out of gas. / or interest (commonly called mark-up), as well as the money However, school loans, automobile loans and mortgages are good uses of credit, since they you have initially borrowed require large initial outlays of cash that many (the principal). people nd hard to amass. In exchange, you receive a valuable asset (i.e., your education, car, or home). When you borrow money from a bank or other lender, you agree to pay it back. It is not a gift. In return for this arrangement, you pay fees and / or interest (commonly called mark- up), as well as the money you have initially borrowed (the principal). You are o ered credit because people trust you to repay them within a predetermined period of time. Credit can be an essential nancial management tool. Using credit gives you exibility to make purchases when you need them the most, not just when you have the cash to pay for them. This is both advantageous and disadvantageous. On the positive side, you will have immediate grati cation and need not wait until you have accumulated the money. On the negative side, this may facilitate overspending; it is always easier to spend other people’s money. Regardless, establishing credit is the rst step toward ensuring strong, long-term nancial health. Your Money, Your Future Chapter 4: Establishing Credit 33 Types of Credit There are many di erent types of credit including home mortgages5, car loans, small business loans, student loans, and credit cards. To decipher the language of credit, some helpful translations are listed below: Installment Loan: This is a credit account where you pay back a set amount every month for a period of time. Cars, student loans, and mortgages are all examples of installment loans. Unsecured vs. Secured: A secured debt is one that is linked to an asset, such as a home or an automobile. An unsecured debt is one that does not have an asset attached, such as a credit card. In case of nonpayment of the loan, the creditor may take back the asset linked to a secured debt. Examples include foreclosure6 or automobile repossession.7 For unsecured debts, since there is no property to be seized, the creditors have to rely upon other methods to recoup the money lent (see Chapter 6). Credit and Debit Cards: In many countries, the use of debit cards or cash has far surpassed that of credit cards. Credit cards have only recently emerged as an alternative form of payment. For most university students, credit cards are very di cult to obtain since they do not have a guaranteed job yet. Those students who do possess a credit card have usually obtained it because their parents have the nancial means to back the extension of credit. Credit and debit cards look similar but there is a signi cant di erence between the two forms of payment. • Debit Card: A card that is tied to your bank account. When you make a purchase with this card, the money is automatically withdrawn from your bank account. This is not a form of credit. • Credit Card: A credit account that allows consumers to make purchases up to a pre-determined amount (i.e., credit limit) and pay back what is borrowed, plus interest or mark-up. These payments may be partial. You can continue to use a credit card as long as you do not go over your credit limit. While some payment is required each month, you do not have to pay o the entire balance. However, it is important to always pay your credit card bill on time. If you miss a payment, the credit card company may charge you late fees. These fees can compound over time and be a very expensive way to purchase goods. 5 Mortgage: An installment loan you use to pay for eventual ownership of an apartment or house. A lien is placed on the property until you pay o the loan according to its terms and schedule. 6 Foreclosure:The legal process by which an owner’s right to a property is terminated, usually due to default.Typically involves a forced sale of the property at a public auction, with the proceeds being applied to the mortgage debt. 7 Repossession: The taking back of a borrower’s automobile by the lender, usually due to loan default. Your Money, Your Future Chapter 4: Establishing Credit 34 Remember, having a credit card means that the credit card company has agreed to lend you money. You are required to pay that money back, usually with interest added, for the convenience of borrowing those funds. It is not free money. (See Chapter 6) There is yet another type of card, which resembles a credit card but has a di erent payment structure: • Charge Card: A credit account in which you are required to pay the entire balance you spend at the end of each month. For example, if you spend 1,000 dinars, you are required to pay the entire 1,000 dinars when you receive your bill. Even though there are only two main types of cards that o er you credit, every card is di erent in the credit limit, interest rate, and other fees and terms. Always review credit card agreements carefully before applying for and using a card, and look at your statements closely each month to make sure you understand all the charges. Terms and Conditions When you enter into a credit arrangement, you will have to sign a contract that contains all the terms8 and conditions of the loan. If you understand the terminology, including the vocabulary listed below, you will fully comprehend the nature of your agreement. Finance Charges: The amount of interest / mark-up and other fees (e.g., transaction fees, late fees, etc.) that you are charged from your creditor each month. Some of the most common nance charges are: • Transaction Fees: Transaction fees are sometimes assessed when you transfer a balance from one credit card to another or when you use an ATM to withdraw money from a bank that is not your own. Withdrawals from ATMs in foreign countries are usually charged a higher transaction fee than from ATMs in your home country. • Annual Fee: Sometimes a company will charge you a fee just for using its services. This fee will usually appear on your statement once a year. For credit cards, you may be required to pay this fee even if you never use the card for any purchases. Since many cards have no annual fee, it is worthwhile to shop around. • Cash Advance Fee: This is a fee linked to a credit card for withdrawing money directly from the card, instead of using the card to make a purchase of goods or services. The fee charged for this transaction is usually higher than for a straight purchase. • Over-the-Limit Fee: This is a fee charged if you go over your credit limit. Be aware that your purchase may be approved even if you are over the limit. So it is important to always know your outstanding balance and if you are close to the limit before you make a purchase. • Late Payment Fee: This is a fee charged if a payment is received after the due date. Missing even a few payment deadlines could cause your interest rate to increase. 8 Terms: Your agreement with your creditor that speci es how often you will make payments on an account and for how long. Your Money, Your Future Chapter 4: Establishing Credit 35 • APR: The term APR, or annual percentage rate, refers to the total amount of interest / mark-up and fees you are required to pay per year on a credit account. Your APR may change while you have your account if it is a variable rate and not a xed rate. The higher the interest rate or mark-up, the more money you will have to repay in total on the loan. APR is calculated and expressed in terms of percentages. For example, if your loan has a 10% APR rate, you will pay 10 dinars per every 100 dinars you borrow annually. To calculate your monthly rate you simply divide your annual percentage rate by 12. For example: If your loan has a 10% APR rate, you will pay 18% divided by 12 equals 1.5%. 10 dinars per every If 200 dinars is your account balance then 200 x 1.5% = 3 100 dinars you borrow dinars. This is the monthly cost of credit. That may not sound annually. like a lot, but it can de nitely add up! The most important lesson to remember is this – the time you spend shopping around for the best rate is well worth the savings you will gain in the long run. Qualifying for Credit Some countries are beginning to adopt “credit reports9,” which assist creditors in deciding whether to o er credit to a customer. Local credit reporting companies in addition to government agencies are in the early development stages of these reports. Although the use of credit reports is not yet widespread, creditors can use other methods to determine whether a customer is creditworthy. Banks normally operate on the premise of “Know Your Customer.” You can start to build a relationship with a bank by opening a small savings or current account. Then as the bank gets to know you, your credibility will slowly become established. The more credibility you have, the more nancing options are available to you. Your payment history (whether detailed on a credit report or developed through a relationship with a bank) will be a powerful determining factor as to whether you receive credit and what interest rate or mark-up you will be charged. Thus, it is important to maintain excellent credit management. This is the subject of the next chapter. 9 Credit report: A report containing detailed information on a person’s credit history, which includes identifying information, credit accounts and payment history. It can be obtained by prospective lenders with the borrower’s permission, to determine his or her creditworthiness. Your Money, Your Future Chapter 4: Establishing Credit 36 Chapter 4 - Activity 1 Are You Creditworthy? Where does credit t in your overall nancial plan? It is becoming more common for people to use credit cards. If you get a credit card, will you pay just the minimum amount required each month or buy only things you know you can pay o in one month? What will you have to give up if you take on a loan payment? Will a bank o er you good credit products with your nancial history? These are the types of questions you should ask yourself when considering whether to apply for credit. And they are the same types of questions that a bank will consider before o ering you a loan or a credit card. Answer the following questions about your or your family’s earning, saving, and spending habits. You may not yet have a source of income or have incurred debt before. If this is the case, discuss these questions with your parents. 1. What is the source of the majority of your income? a. Parents/Family c. Full-time job b. Part-time job d. Odd jobs 2. How steady has your income been over the past year? a. Very steady c. Somewhat unsteady b. Somewhat steady d. Very unsteady 3. How much of your income do you save on a regular basis? a. None b. 5-9% b. 1-4% d. 10% or more 4. Which of the following statements best describes your spending habits in relation to your income? a. I earn more money than I spend. b. I spend exactly what I earn. c. I spend more money than I earn. 5. How comfortable are you with your current level of debt? a. Very comfortable c. Somewhat uncomfortable b. Somewhat comfortable d. Very uncomfortable 6. Which of the following big expenses do you plan to take on in the near future? a. Car d. Children b. University e. None of the above c. House 7. When do you normally pay your existing bills? a. Always on time c. Rarely on time b. Sometimes on time d. Never on time Your Money, Your Future Chapter 4: Establishing Credit 37 Now, pretend that you are a loan o cer for a bank. Do the answers to the previous questions exhibit good credit behaviors? Would you o er this person a loan or a credit card based on the answers? Take It Another Step Pick two friends or relatives and either have them answer the above questions, or speculate what their answers would be. After going through the questions, make recommendations as to their level of creditworthiness – Do they exhibit good credit behaviors? Would you o er them a loan or credit card based on their answers? Name Notes about Creditworthiness #1 #2 Your Money, Your Future Chapter 4: Establishing Credit 38 Chapter 4 - Activity 2 Good Credit Creates Good Credit Banks extend credit to consumers who exhibit good credit behaviors. And the better their behaviors, the better credit products the bank can o er. Take mark-up rates, for example. Consumers with “good credit” often qualify for lower mark-up rates. And that means lower monthly payments and lower overall costs paid to the bank. See the following example for a demonstration of how much money you can “save” by establishing and maintaining good credit: 7,000 Dinar Loan for Three Years at Various Mark-Up Rates Mark-Up Rate 4% 6% 8% Monthly Payment 209 215 222 (dinars) Total Mark-Up Paid 445 675 908 Over Three Years (dinars) In this activity, you will examine the credit behaviors of three di erent ctional characters. After reading their descriptions, rate their overall credit behaviors on a scale of 1 to 5 (with 5 being excellent). Then, o er solutions for improving credit and/or maintaining good credit. Sam: Sam recently took a pay cut at his job. He has been unable to pay more than the minimum amount on his credit cards. Sam has also been late paying his rent and utility bills multiple times over the past year. Rating (1-5): _________________________ Solutions: __________________________________________________________________________ __________________________________________________________________________ Catherine: Catherine is a recent university graduate. She lives with her parents and has been working for the same company for three months. She has a credit card and pays at least the minimum payment every month. Recently, she took a trip overseas to visit her cousin, which increased her credit card balance signi cantly. This caused her to pay her bill two weeks late after she returned. Rating (1-5): _________________________ Solutions: __________________________________________________________________________ __________________________________________________________________________ Your Money, Your Future Chapter 4: Establishing Credit 39 John: John is diligent about paying his bills and his rent on time every month. Recently, he decided to buy a home, and is hoping he can get a good mark-up rate on his loan. He does not own a credit card and tries to pay for all of his purchases with cash. Rating (1-5): _________________________ Solutions: __________________________________________________________________________ __________________________________________________________________________ Based on this activity, what do you think people with good credit have in common? What about young people who have not established any credit yet? Do you think they should be judged based on their inexperience with credit? Is that fair? Take It Another Step Research credit card options at di erent creditors’ websites. See what options are available to you now, or what your options might be when you start university. What are the terms and conditions? For which cards might you qualify, based on your own credit behaviors? Fill in the chart below with the information you found. Name of Creditor Credit APR/ Annual Late Transaction Cash Limit Mark-up Fees Payment Fees Advance Rate Fees Fees Community Bank 3545 16.7% 20 25 n/a 25 dinars dinars dinars dinars Your Money, Your Future Chapter 4: Establishing Credit 40 Chapter 5: Managing Debt Your Money, Your Future Chapter 5: Managing Debt After you have applied for and received credit, you need to act in a responsible and prudent manner to ensure that this credit is not misused. When you accept a contract with a creditor, you enter into a relationship in which you must meet certain obligations. Credit is not your money, nor is it a gift. It is a responsibility that needs to be taken very seriously. This chapter will examine certain tactics that will help you use credit wisely. In general, debt management strategies can be used to: • Avoid the overuse of credit • Reduce the total amount of debt • Shorten the repayment time Debt management strategies will be • Reduce nance charges particularly important when you get your rst Debt Management Strategies job and become solely responsible for your This chapter will discuss various debt management strategies, and you should strive to follow as many as possible. student loan. These strategies will be particularly important when you get your rst job after university and become solely responsible for your student loan. However, you should discuss these strategies in depth with your family as soon as you begin to consider a student loan. Incurring any type of debt will a ect your parents’ budget and the implications should be considered carefully. Through commitment and adherence to each recommendation, you will become a better money manager. In the course of your exploration, you may nd that certain tactics are very easy to follow, whereas others are more di cult. Concentrate on those strategies that you are not already implementing. Practice following the advice given, even if it is di cult, and you will soon notice your unhealthy money habits being replaced by more bene cial ones. Student Loan Debt: Depending upon the terms and conditions of the student loan, the repayment may start while in school or shortly after graduation. Either way you must categorize this monthly amount as a need and not as a want in your budget. It should always be paid before any discretionary spending takes place. If you have a shortage and nd it di cult to make this payment, it may require reducing or eliminating other expenses. For those student loans with a grace period, you will have a reprieve before payments come due. However, do not forget to add this upcoming expense to your post-graduation budget. Making nancial plans that do not include this regular payment will result in budgets that underestimate your total expenses. Believing your expenses to be less than they actually are, can result in nancial decisions that do not re ect the reality of your nancial means. Your Money, Your Future Chapter 5: Managing Debt 42 For example, you may select an apartment that is more expensive than you can a ord. This mistake could have been avoided if you had taken your student loan payments into consideration. If you received student loans from various sources, you may want to stagger the due dates so that all the payments are not due at the same time each month. Spreading out the due dates may assist in managing your cash ow. Certain student loans may also allow you to consolidate them. This would result in one payment per month instead of several and it may also lower the interest rate. Decide Between Cash and Credit: Buying on credit nearly always costs more than buying the same item with cash. It is a good idea to get into the habit of asking yourself these questions every time you consider purchasing something on credit: 1. Is this something I need? 2. If so, do I need it now or can I wait? 3. Can I qualify for credit? 4. What is the interest rate or mark-up? 5. Are there additional fees? 6. How long is the tenor and the grace period? 7. How much is the monthly payment? 8. When is the monthly payment due? 9. Can I a ord to pay the monthly payments? 10. How long will it take me to repay the amount borrowed? 11. What will happen if I do not make the payments on time? 12. What is the extra cost of using credit (OR) how much will it ultimately cost me? 13. What will I have to give up if I buy it? What is the opportunity cost? Your answers to these preceding questions will guide your answer to this nal question: “All things considered, is using credit worth it?” Pay Cash for Living Expenses: Do not depend heavily on credit to pay for day-to-day living expenses. If you nd yourself using credit to pay for groceries, gasoline, meals out, personal hygiene items or clothes, try to pay with cash instead. Some people nd they are using credit for these items because they do not have the available cash. This is often a warning sign of being overextended. Your Money, Your Future Chapter 5: Managing Debt 43 Use Credit for Items of Lasting Value: Credit is best used for items whose value will outlast the installment payments. If you purchase furniture on credit, for example, will you still be paying for that couch long after it has fallen apart? What about that meal you ate long before you received the credit card bill? Psychologically it is more di cult to pay for something that you no longer have in your possession. Understand Statements: Check every billing statement for correct information, including purchases, any credit reversals, and payments. Act quickly to correct errors, such as double payments, under- reported payments, or in ated purchase amounts. If there is an honest accounting error, the creditor should easily be able to revise your account. Keeping receipts will assist in presenting your case. Think Ahead: Be proactive, not reactive, about your nances. Make a plan that includes your di erent nancial obligations after graduation. You want to endeavor to be in control of your money and not have your money control you. By being in control, you can make the decisions that you want to make and not have decisions thrust upon you. For example, if you have money in a savings account, you may be able to take more time nding a job that you really want and not be forced to take the rst job that is o ered to you – just because you need the money. Live Within Your Means: Do not open new credit accounts unless they t with your overall budget plan. Remember that numbers do not lie, so if your expenses are as much as – or more than – your disposable income, taking on another loan will de nitely not help you solve your cash ow problems (See Chapter 2). Resist Impulse Buying: Major purchases should never be made without rst doing comparison shopping and then making sure that your budget will allow for the purchase. Impulse buying occurs when your emotions are allowed to supplant your logic. Many To gure out your people regret having made purchases on impulse. debt-to-income ratio, divide And, unless there is a return clause, you cannot take back the item. So make sure you really want it and your total monthly debt can a ord it before you make the purchase. payments (including any automobile,studentloan,and Establish a Safe Debt Level: Your debt-to-income ratio gives a clear picture of credit card payments if you your nancial well-being. If you do not know how have them) by your monthly much debt you can handle, it is easy to get in over your gross income. head. To gure out your debt-to-income ratio, divide your total monthly debt payments (including any automobile, student loan, and credit card payments if you have them) by your monthly gross income. If the resulting percentage is 39% or Your Money, Your Future Chapter 5: Managing Debt 44 greater, you are in the danger zone and need to work on reducing your debt level. You are in great shape if your debt percentage is 15% or lower. (See Chapter 5, Activity 2) Make Payments on Time: Consequences of missing the due date may include higher interest rates as a penalty and late fees until your account is brought up-to-date. Notify creditors when you move so that your bills arrive on time and your payments are never late. If your loan’s due date is approaching and you have not received a statement, call the customer service number located on your credit card or previous billing statement. Not receiving the bill is not a valid excuse for not paying. Credit Card Debt: Credit card usage has been increasing among adults and is projected to increase even more in the future. Therefore, in anticipation that credit cards will become a part of your nancial portfolio as you enter the job market, you need to learn the basics of credit card management prior to your actual receipt of them. Preventative education is the best way to avoid credit mistakes in the future: • Try to restrict your total number of credit cards to only one. • Pay the entire balance when it is due; resist making only a partial payment. • Review your spending habits by analyzing your bill. Identify unnecessary purchases and make an e ort to cut them out in the future. • Set a monthly limit for your total charges and stick to it. • Do not charge your credit cards to the maximum limit and keep them at that level. • Pay your bill as soon as you get it. Depending on how the interest rates are calculated, each extra day could result in additional interest charges. • Never lend credit cards to friends or leave cards or receipts lying around where people can nd them. • Keep a list of your credit card account numbers and creditors’ phone numbers in a safe place in case a card is lost or stolen. If this happens, report it as soon as you notice it is missing. • Do not pay just the minimum amount due. Paying more than the minimum will save you much more money over time. The next chapter has an example illustrating this. Your Money, Your Future Chapter 5: Managing Debt 45 Debt Consolidation Loans: Consolidating your loans may encourage borrowing more than is absolutely necessary. If you elect a consolidation loan for an amount that exceeds what you owe on the accounts to be consolidated, you will end up with more debt than before. However, a debt consolidation approach can be smart if you move your debt to a lower interest loan and do not incur additional debt. Consider this example: Family A and Family B both owe 14,000 dinars in total debt on multiple accounts at an interest / mark-up rate of 18 percent. They would like to become debt free. By getting a debt consolidation loan at a 10 percent interest rate, they could lower their monthly payment signi cantly. Family A borrows only the amount needed to pay o their existing debt and then closes all their accounts. Family B gets a loan for 6,000 dinars more than they need and then they continue to use their lines of credit, eventually bringing them back up to their initial level of 14,000 dinars. Notice the di erence in ending debt levels: Family A Family B Debt consolidation loan 14,000 (10%) 20,000 (10%) New debt 0 14,000 (18%) Ending debt 14,000 (10%) 34,000 (14%*) * 14% computed based on the average interest rate of both loans combined Debt consolidation loans can be a good idea if, like Family A, you only borrow the amount equal to the existing debt and then close the existing credit accounts in order to avoid the temptation to continue using credit. By making the wrong choices, Family B has made their debt situation worse than when they started. Your Money, Your Future Chapter 5: Managing Debt 46 Chapter 5 - Activity 1 The Pros and Cons of Going into Debt Do people go shopping with the intent of going into debt? Do they spend more money than they have because they want to be in debt? Probably not! There are many di erent reasons why people go into debt -- some are avoidable and some are not. Some are actually bene cial and some are not. Common reasons for going into debt: Before going into debt, you should • Buying a home consider a few general questions. Could • Buying an automobile you pay for the expense with cash? How • Poor money management long will you be in debt? How will you • Medical bills pay back your debt? And what are the • Unexpected expenses (e.g., auto repair) opportunity costs of going into debt? • Living beyond one’s means • Loss of income Below are several hypothetical • Saving too little situations where individuals are • Starting a business considering going into debt. Review • Paying for university the situations, and then categorize them according to the likely levels of debt, timeframes for the debt, and whether the debt is avoidable or unavoidable. Finally, decide what you think each person should do in the given situation. There may not be a “right” or “wrong” answer; it is important to examine the bene ts and opportunity costs for both sides of the issue. Scenario 1: Eric took out a student loan to pay for university. Although he originally wanted a career in nance, he has been thinking recently about attending business school after graduation to give him broader career options. He would have to take on additional debt to do so. Alternatively, he could go to work for his uncle at an investment rm after graduation. What are the bene ts of going to business school? What are the bene ts of entering the workforce after graduation? What are the opportunity costs in each situation? Likely Level of Debt Timeframe Avoidable or Unavoidable? What would you do if you were in Eric’s situation? Your Money, Your Future Chapter 5: Managing Debt 47 Scenario 2: Dina really wants a new mobile phone. She does not have the cash for it now. She is considering putting it on her credit card, which she plans to pay o in full once she gets a new job, but she is not sure exactly when that will be. What is the bene t of buying the mobile phone on credit? What is the bene t of waiting to buy the mobile phone with cash? What are the opportunity costs? Likely Level of Debt Timeframe Avoidable or Unavoidable? What would you do if you were in Dina’s situation? Scenario 3: Natasha graduated from university one year ago and has been working at a job in her chosen eld since then. Although she has student loan debt, she has been able to put some money into savings every month. She is considering buying her own house and using some of her savings for the down payment. What are the bene ts of taking out a mortgage to buy a house? What are the bene ts of waiting? What are the opportunity costs? Likely Level of Debt Timeframe Avoidable or Unavoidable? What would you do if you were in Natasha’s situation? Take It Another Step Talk with family members about their experiences with debt. Did they weigh the bene ts and opportunity costs before going into debt? How did they manage their debt? Knowing what they know now, would they have done anything di erently? Learning about family members’ experiences can help prepare for your own decisions about going into debt. Your Money, Your Future Chapter 5: Managing Debt 48 Chapter 5 - Activity 2 Managing your Debt Level Have you already encountered situations where it was necessary to go into debt? As you get older, it becomes more likely that you will go into debt to reach a long-term goal or even to pay for an unexpected expense. Whatever the reason, it is important to remember that managing your debt and paying it back in a timely manner are responsibilities that come with taking on the debt in the rst place. The amount of debt you carry in relation to your income – that is, your debt-to-income ratio – also becomes an important consideration in your overall money management. (Earlier in the chapter, you learned to divide your total monthly debt payments by your monthly gross income to come up with this ratio.) Review the chart below, which examines di erent debt-to-income ratios and how they can a ect one’s personal nancial situation. It is important to note that di erent cultures around the world will have di erent tolerances for levels of personal debt. The chart below re ects a US norm, which may well not be appropriate for all national contexts. Source: Citi Now, you will look at the debt levels of the individuals from the previous activity to determine where they fall on this spectrum – both currently and in the future if they take on the additional debt. Referencing the chart above, ll in the debt categories for their current and potential future debt percentages. Does this change the decision you made about the individual in the last activity? If you would change your decision, describe what you would do di erently and why. Your Money, Your Future Chapter 5: Managing Debt 49 Eric Current Debt Percentage: 29% Category: Fair Potential Future Debt Percentage: 35% Category: _____________ What you would do di erently and why? ________________________________________ __________________________________________________________________________ __________________________________________________________________________ Dina Current Debt Percentage: 15% Category: _____________ Potential Future Debt Percentage: 18% Category: _____________ What you would do di erently and why? ________________________________________ __________________________________________________________________________ __________________________________________________________________________ Natasha Current Debt Percentage: 12% Category: _____________ Potential Future Debt Percentage: 25% Category: _____________ What you would do di erently and why? ________________________________________ __________________________________________________________________________ __________________________________________________________________________ Take It Another Step Calculate your own level of debt. As a student, you may not yet have debt obligations. If that is the case, ll out this exercise with your parents, using the debt obligations of your parents. If you family has not yet incurred debt, think of potential types of debt that you may one day incur. Start by lling in each of your regular debt obligations (i.e., loans, credit card bills, and other debts) in the chart on the next page. Your Money, Your Future Chapter 5: Managing Debt 50 Debts Average Monthly Payments (dinars) Community Bank Student Loan 200 1. Total your monthly debt payments. _________________dinars 2. Enter your monthly gross income (income before taxes and other deductions). _________________ dinars 3. Divide the total on line 1 by the total on line 2, and then multiply by 100 to calculate your own debt percentage. _________________% Into which category do you fall on the above chart? If you fall in the Danger, High, or Fair categories, what could you do to lower your debt percentage? Your Money, Your Future Chapter 5: Managing Debt 51 Chapter 6: Repaying Debt Your Money, Your Future Chapter 6: Repaying Debt This nancial literacy Guide has already covered the rst two stages in the credit continuum. The last stage is repaying your debt. Establishing   Maintaining   Repaying When you enter into any loan agreement, it comes with a responsibility to pay it back. Similarly, by signing an agreement for education funding, you will be required to make regular payments during your period of study with the balance due after graduation. Your repayment amount should be a xed item in your budget. You need to allocate enough money each month to make sure that this payment is made consistently and on-time. It is important to remember that this loan was at least partially responsible for your attainment of a higher education. Some lenders allow a grace period after graduation before you You will need to must start making regular payments. A common grace period is have a clear plan six months – meaning that after the sixth month following your graduation, you will have to start making monthly payments. Your for repayment. “after graduation” spending plan should not neglect to include this expense. Even though this payment will not start immediately upon graduation, it will soon come active so you need to budget for it. You will need to have a clear plan for repayment based on the schedule of debt for your loan as there may be cycles where the debt repayment sum is higher and then tapers o . Be certain to speak to your bank to understand the speci c aspects of how your repayment will work during and after graduation. Most people do not encounter any problems in handling this monthly expense and you should not anticipate any problems either. However if, at any time, you experience di culty in repaying the loan, it is important to contact the lender to work out an alternate arrangement. Some of the outcomes of defaulting10 on your student loans may include: • No additional nancial aid • The entire loan may become due in full. • Collection costs may be added. • Tax lien11 • Paycheck garnishments12 The actual consequences depend on the discretion of your local bank / creditor. Since di erent institutions have varying procedures for dealing with default, it is important to nd out the process for your institution of choice. 10 Defaulting: Failing to make a payment on a loan as agreed in the loan’s terms. 11 Tax lien: A claim on property by the government to secure payment of taxes owed. 12 Garnishment: When an amount is withheld from your paycheck. Your Money, Your Future Chapter 6: Repaying Debt 53 Repayment Di culties Many young adults behave like ostriches when they encounter nancial problems, by hiding their heads in the sand. If they ignore the problem, they think it does not exist. Sometimes the problem seems so overwhelming or insurmountable that denial becomes the most attractive solution. We tend to believe that if we ignore unpleasant news, then our problems will just go away. But avoidance of debt problems only works in the short run; you eventually must confront the issue. Step 1: Admitting the Problem to Yourself The rst step to nding a solution to any debt problem is to overcome any self-imposed barriers you have erected that would prevent you from getting or receiving help. These psychological barriers sometimes cause people to believe their nancial situation is hopeless because they: • Are not good with numbers • Were never taught about money • Are paid on commission, with no steady salary • Are unemployed • Are too old / too young All of these situations present challenges, but no nancial situation is ever hopeless. Sitting back and doing nothing because you do not believe a solution exists will only guarantee that your situation will never improve. However, being willing to admit to yourself that there is a problem... is the rst step toward nding a solution. Step 2: Admitting the Problem to Others Your lenders will be more cooperative if you contact them before they contact you. Imagine a hypothetical situation where you lent money to a cousin. If your cousin runs into a situation where he is unable to pay you back, you would probably prefer that he be honest and explain his repayment problems. However, people are often embarrassed when they are unable to pay back a loan so they instead hide from their friends or family. When this happens, the person who has lent the money feels angry and upset that his family member is not being responsive. If the debt remains unpaid, the situation can cause irreparable damage to the relationship. The same philosophy holds true for a bank-client relationship. It should be honored in the same fashion as any personal loan. By contacting the bank, you will learn of alternative arrangements that may enable you to continue making payments. These repayment options may vary from bank to bank and are subject to availability. Your Money, Your Future Chapter 6: Repaying Debt 54 Student Loan Repayment Options In the case of student loans, the following are some of the options that may be available to you. Depending on your individual situation and the options o ered by your local bank, you may elect to choose one repayment option over the other. The rst two options will link your payment to your income. This may make the payment easier to manage since the amount will be calculated with your income in mind: Income Sensitive: 1. Graduated Repayment Schedule This repayment schedule assumes that borrowers should make more money as they progress in their careers. Payments are initially lower and then increase later in the repayment schedule. 2. Income Sensitive Repayment The monthly payment amount will be established based on your gross monthly Hardship Related: When circumstances cause repayment to become di cult, sometimes a change in the terms of the loan can solve the repayment challenge. For example, in the case of a change in due date, if you fall behind because your student loan is due the same week as the rent or mortgage, car payment or other signi cant bills, contact your lender to see whether you can change the due date and thus stagger your bill payments. It is important to contact your lender and be proactive. Ignoring the situation will not make it go away; it usually only succeeds in making the situation worse. Never make the assumption It is important that there is nothing your lender can do to help. This is usually not the case. to contact your lender and be proactive. Your Money, Your Future Chapter 6: Repaying Debt 55 Repay Credit Card Debt The previous chapter discussed ways to manage your credit obligations and avoid unnecessary debt. However, despite knowing the rules of how to use credit wisely, some people still nd themselves overextended. If one day you nd yourself overwhelmed with credit card bills, follow these steps to get out of debt: 1. Cease using your credit cards. Put them away in a safe place where you will not be tempted to use them. 2. Do not apply for additional credit cards. 3. Pay more than the minimum payment (even a small amount over the minimum reduces both the amount of interest paid on your debt and the time it will take to pay it o ). For example: If you owe US$2,500 dollars on combined credit card debt with an 18 percent APR, and only pay the minimum ($75 or 3% of the balance) every month until the entire amount is paid off, it will take almost 15 years. You will have paid US$2,300 in interest alone—almost the same amount as your original balance! However, if you add the following amounts every month to the minimum payments, look at the results: ADD TO MINIMUM PAYOFF TIME (MO/YRS) TOTAL INTEREST PAID INTEREST SAVINGS 0 180 /15 2,300 0 10 40/3.3 822 1,478 25 32/2.6 657 1,643 50 24/2 495 1,805 4. Send in payments as soon as you receive the bill. (For every extra day you carry a balance, your interest charges may accumulate.) 5. When one card is paid o , make the same payments on another; resist seeing the extra money as spending money. 6. Refuse the credit card issuer’s o er to skip a monthly payment (zero owed that month). 7. Consolidate cards. Make sure to cut up the cards with balances that are now zero or you may be tempted to use them again. 8. Re nance high-rate credit cards. Shop around for the best interest rate. 9. Consider using savings to pay o high-rate credit card balances, but only if you already have a three-to six-month emergency savings fund. Your Money, Your Future Chapter 6: Repaying Debt 56 Credit handled wisely is a wonderful thing. The bene ts of having access to credit cards are numerous. Conversely, not understanding credit cards and making unwise decisions can a ect you negatively for years to come. Repaying Other Debts Other common loans include mortgages, automobile loans, small business, and personal loans. All these loans come with an obligation to pay them back. Depending on the discretion of the bank / lender, there are di erent consequences for nonpayment of these loans. Most commonly, if your bills are past-due13, the bank may immediately foreclose on the collateral or call upon your guarantors. In the rst case, collateral refers to the item that the loan is secured to. For example, in the case of an automobile loan, the vehicle is the secured property. This means that non-payment of this type of loan will initiate e orts to retrieve the vehicle by the creditor. In the second case, your guarantor is the person who has agreed to back your loan. Once the original recipient of the loan is in default, the bank will contact the next in line (guarantor) to attempt to get the loan current. Since the guarantors are equally accountable for repayment of the loan, committing to be a guarantor is a responsibility that should be taken seriously. If you continue to avoid your creditor’s attempts to reach you, you can expect to hear from a debt collector / collection agency. This is someone, other than the creditor, who regularly collects debts owed to someone else. Lawyers who collect debts on a regular basis are considered debt collectors, too. Normally these external agencies are more di cult to work with than the original creditor. This is precisely why you should not ignore the situation and allow your account to end up with a debt collector. The best rule of thumb is to avoid taking on more debt than you can handle. However, if you nd yourself needing loans to fund your lifestyle, you may be living above your means. Go back to your budget (see Chapter 2) and nd areas where you can either reduce or eliminate some expenses. Keeping your debt to a manageable level is the key to avoiding repayment problems. 13 Past-due: An account in which the borrower has failed to make an on-time payment. Your Money, Your Future Chapter 6: Repaying Debt 57 In summary, when you have the urge to ignore the situation, remember the lessons learned in this chapter: The best rule of • Honor your obligations. thumb is to avoid • Open your mail and answer your phone. taking on more • Contact creditors before they contact you. debt than you can • Do your research before you agree to a repayment plan. handle. • Make all agreements in writing. • Try to avoid the minimum payment trap. Your Money, Your Future Chapter 6: Repaying Debt 58 Chapter 6 - Activity 1 Research your Repayment Options As you learned in this chapter, there are some serious responsibilities associated with taking on debt – namely, repaying the debt on time! Once again, here are some nancial scenarios for you to consider. You will research possible nancing options for the people in the scenarios, including their likely terms for repayment. Then, based on what you have learned in this Guide, make a recommendation for each individual. And of course, what would you do in their situations? Scenario 1: Sandra wants to buy a car that will cost her 12,000 dinars. She has saved 3,500 dinars to use as a down payment. She wants the car now, even if it means she has to go into debt to buy it. Option 1 Option 2 Name of Creditor Financing Product Mark-Up Rate Repayment Terms Length of Time to Repay Recommendation: _________________________________________________________ __________________________________________________________________________ Your Money, Your Future Chapter 6: Repaying Debt 59 Scenario 2: Ahmed wants to nd a way to pay for university. His tuition is 12,000 dinars per year. Together, he and his parents can contribute 6,000 dinars per year. He wants to further his education, but has never been in debt before. Option 1 Option 2 Name of Creditor Financing Product Mark-Up Rate Repayment Terms Length of Time to Repay Recommendation: _________________________________________________________ __________________________________________________________________________ Your Money, Your Future Chapter 6: Repaying Debt 60 Chapter 6 - Activity 2 Create Your Own Financial Plans How can you use everything you have learned to create your own nancial plan? You have set goals and gained knowledge of available nancial options. You understand the importance of a budget, how to establish credit, and what to do with regard to debt. This guide has created a reference point — a foundation from which you can plan your nancial future. So, start putting what you have learned to good use! In the activity below, you will create two di erent scenarios for nancing your university education and repaying the debt after you graduate. Consider the following questions in coming up with your plans: 1. Where will the majority of your university funding come from? 2. Does the needed additional funding that you calculated in Chapter 3 (Activity 2) still seem accurate? 3. How might your nancial situation change after each year of university? 4. How will you pay back your university nancing? 5. What type of repayment plan will you choose? How long will it take you to repay your loans? 6. What are the opportunity costs in each scenario? 7. Look back at the list of goals you developed in Chapter 1 (Activity 2). How might your plan a ect your achievement of these goals? Do you need to reprioritize any of your goals? Option 1 Option 2 University funding source(s) Additional nancing needed What are the variables from year to year? How will you pay back your nancing? Repayment plan and terms Opportunity costs How will this plan a ect your goals? What is your level of con dence that this option is available to you? Are there steps you can take in the future to make this option more likely? Your Money, Your Future Chapter 6: Repaying Debt 61 Compare the di erent scenarios. Weigh the bene ts and drawbacks of both. Then, discuss the di erent scenarios with your family. What are their opinions of the di erent scenarios? Take It Another Step Implement your plan. Talk with your advisors at school, your parents/family, and other students. Then, get in touch with universities and begin applying. Decide what is best for you and your family nancially and how this a ects your nancial goals. Stick with the plan and re-evaluate when necessary! Your Money, Your Future Chapter 6: Repaying Debt 62 Chapter 7: Saving and its Bene ts Your Money, Your Future Chapter 7: Saving and its Bene ts You will hopefully reach a point in your life when you earn enough money to meet your basic life expenses and still have some left to either save or invest. As a student, this time may seem far o . However, thinking about how you want to save money in the future will help you meet your longer term goals. When given the choice between saving and spending money, those who seek immediate grati cation choose spending as the more desirable of the two options. Your purchase is something tangible; you can enjoy it without delay. On the other hand, the bene ts of saving are not realized until a later date – one must delay grati cation. For many people, especially young adults, the concept of waiting until a later date is not as attractive as the present moment. Why delay when you can have it now? Unfortunately the mentality of “immediacy” does not lend itself to good saving or investing behavior. Therefore, the rst step to starting a good saving habit is to understand why it is worth the wait. Each person is certain to experience unexpected “life events.” These result in the unexpected expenses that are usually not accounted for in your budget. Life events run the spectrum from everyday annoyances to major emergencies. Sample life events: • Home repairs Each person is certain to experience • Tra c tickets unexpected “life events.” • Auto accidents These result in the • Health issues or illness unexpected expenses that • Birth of a child are usually not accounted for in your budget. • Technology repairs (e.g., computer / mobile phone) • War • Recession • Death in the family • Displaced • Theft • What were some of your recent life events? Your Money, Your Future Chapter 7: Saving and its Bene ts 64 When these life events occur – and they will – you need to make sure you are prepared to pay for them. Otherwise, you may be forced to get an emergency loan or possibly be unable to make the required payment and end up su ering the consequences. Emergency Cash Reserve Having a cash reserve is an important ingredient in post graduate nancial planning. Realistically, while in university, most students have a limited income and any available funds are usually committed to normal living expenses or student loan repayment requirements. However, upon graduation and the attainment of a steady and substantial stream of income, an emergency cash reserve should be a goal. Setting aside money to cover unexpected expenses provides a nancial safety net that lets you deal with “life events” as they arise. For example, if you were to lose a job, an emergency fund can pay your bills in the interim. Most experts recommend an emergency fund equal to three to six months of living expenses. This amount should be easy to calculate after having completed your budget in Chapter 2. You simply take the amount you calculated for your total monthly expenses and then multiply it by 3 and then by 6. The three-month amount should be the minimum that you strive to maintain in this savings account. The amount of your emergency fund also depends upon your age, health, job prospects, and personal nancial situation. An emergency fund covering three months of expenses might be adequate if you are not the sole income earner in the household. In this case, if your household has multiple sources of income or dual wage earners, you can count on those other sources of income in an emergency. The three-month reserve may also be adequate if you have lost a job but have a skill that is in demand and are con dent that you can nd another job without much di culty. However, there are many situations when you may need a cash reserve that is closer to the six-month amount. Maybe you are in business for yourself, your work is seasonal, your job is uncertain, or you rely heavily on sales’ commissions. Additional reasons for erring on the conservative side are: if your health is questionable and you foresee medical expenses; or if you anticipate a large expenditure for the care of a relative in the near future. Your emergency savings should be kept at a nancial institution instead of at your home. The main reason is for security of your money. If there is a re at your house, you can lose your money in the re, or it may be lost due to theft. Saving versus Investing Even though the words ‘saving’ and ‘investing’ are often used interchangeably, there are major di erences between the two. Your Money, Your Future Chapter 7: Saving and its Bene ts 65 Saving provides funds for emergencies and for making speci c purchases in the short-term (usually three years or Since the bank’s good less). The safety of the deposit and liquidity of the funds (i.e., ease of converting to cash) are important aspects of fortunewasmadepossible saving. Because of these low-risk characteristics, savings through the use of their accounts generally do not yield a high rate of return on customers’ deposits, the the initial deposit. logic follows that all The most common ways to save money include depositing parties should reap in the money into a bank savings or checking account. These rewards. funds can normally be withdrawn at any time without penalty. However, if you are willing to restrict access to your money for a period of time, there are savings options that pay a higher rate of return. For example, money market funds or certi cates of deposit are options that pay more than a traditional savings or checking account. Certi cate of deposit (CDs): low risk, low return investments, also known as “time deposits.” The customer agrees to keep the money in the account for a speci ed amount of time, anywhere from three months to six years. Money Market account: a savings account that bears interest, and on which checks can be written. With these two options, in exchange for the higher rate of return, your money is not as liquid. These savings products may require you to leave your money in an account for a period of time. Usually the longer the time period required, the higher the interest rate o ered. Investing, on the other hand, focuses on increasing wealth and achieving nancial goals in the long-term (usually three years or more). There are di erent types of investing, such as purchasing real estate or stocks14. Stocks are listed and traded on stock exchanges around the world. Since investing involves di erent degrees of risk (depending on your type of investment), it should not be considered until you have adequate savings set aside. Given that investing is a much more complex activity than saving, it is always wise to consult a skilled banker or nancial professional. The characteristics of investing – in addition to their complexity – include an element of risk, which can be somewhat mitigated if a professional recommends diversi cation15. Without a professional to ensure a diversi ed portfolio, many individuals tend to invest too heavily in one particular company or type of investment. Smart investing also requires the need to resist emotional decisions when there are changes in the stock market. Oftentimes, when people are faced with the prospect of losing money, they react emotionally and not logically. Having a professional who is in charge of your investments can help you to make rational decisions when, for example, your investments in the stock market lose value. Although it is always wiser to buy low and sell high, many people unfortunately do just the opposite when the value of their investments declines. 14 Stock: If you own a share of a company’s stock, you are a part owner of the company. 15 Diversi cation: is a risk management technique that mixes a wide variety of investments within a portfolio. Your Money, Your Future Chapter 7: Saving and its Bene ts 66 A good nancial advisor will ask you many questions, such as your present age, your desired age at retirement, how much money you would like to accumulate before retirement, and your risk tolerance level. These questions will help the professional formulate the best investment portfolio for you. Since everyone’s individual needs are di erent, no one’s investment mix should be the same. Tips to Encourage Saving Behavior Most people agree that saving is a good thing; they just say that it is impossible because of their nancial situation. In reality, money that comes in has three places it can go – savings, living expenses, or debt payments. The choice is up to you. There is no way to predict whether someone will have a stronger tendency toward saving money or toward spending it. Some researchers believe that these tendencies are ones we are born with. You may know people that save easily; you may even be a natural saver yourself. However, many people do not nd it easy to save, even if they agree that saving is a good thing. They might say that it is impossible and come up with countless excuses as to why “now” is not the best time to save. I cannot save because... • I am a student and not earning any money yet. • I am working at my rst job but not earning enough. • I just became a parent and have childcare expenses. • I have too many household bills. • I am taking care of my elderly parents. • What are your excuses? Get into the habit of paying yourself rst. This is the most e ective Paying yourself way to save money. In fact, money never received cannot be missed. When you get a job, ask if your employer can automatically deposit rst is the most a percentage of your paycheck into a savings or retirement account, e ective way to the money never actually comes into your possession for you to save money. spend. Another option that works on the same principle is to give your paycheck / earnings to another person – someone whom you trust – who will then deposit a certain amount into your savings account. Other tips to make saving easier include: • Never make a signi cant purchase on the rst trip. This is when you are emotional and your logical reasoning may not be present. Go home and think about it before you decide whether to buy. If you still want it a week or a month later, then it is probably not a frivolous purchase. Your Money, Your Future Chapter 7: Saving and its Bene ts 67 • Bring along someone who is conservative with their money when you go shopping. This ensures that any purchase you attempt to make will be di cult since the other person will oppose it. • Identify areas in your budget where you could begin to cut back. You may be surprised at how much you spend on your mobile phone or on eating out. Make a reasoned decision about where you can spend less and put that sum away in savings. • Put someone else in charge of your nances. If money slips like water out of your hands, let someone else take control of it. You may currently receive or have received money in this fashion from your parents in the form of an allowance. • Consider yourself a creditor. When you pay your bills, write a check to yourself. Decide on a monthly amount that you can a ord (experts say we should try and save between 5-10% of our net income) and deposit that money into your savings account. Then, pay your other bills as usual. If you nd that you do not have enough money to cover all your expenses, write down the amount you are short and look for ways to trim your budget. Once you establish a regular savings plan, consider increasing your monthly deposit as time and experience result in your getting pay raises and better paying jobs. Many people in this situation choose to increase their standard of living instead of saving the extra money. It is important to resist this tendency; if you use the additional income to get a better car or a nicer apartment, you are just increasing your expenses to match your increase in salary. Another way to increase your monthly savings amount is after you pay o a debt. Once you pay o your car loan, student loan, or other installment debt, you can deposit that exact amount into a savings account. You will not miss the money since you were not used to receiving it anyway – it went to your creditor. Start Saving – The Sooner the Better As a university student on a tight budget, saving money may be tough. However, the advantage is that you can be aware of the bene ts of saving so that you can begin as soon as you earn an income. Your savings normally accumulate interest, so the more you can set aside, the more your account can earn, so your money grows faster. The interest rate is usually expressed as a percentage, which allows your money to grow through multiplication of the expressed interest rate. There are two common ways that interest is calculated: Simple interest. This is based only on the original amount. If your account has 500 dinars in it and earns 5% simple interest per year, it earns 25 dinars in interest. Multiply the amount by the interest rate to get the return. Your Money, Your Future Chapter 7: Saving and its Bene ts 68 Compound interest. Whenever interest in calculated, it is based not only on the original amount in the account but also on any interest that has been added. The more frequently interest is compounded, the faster the balance grows. The rate that interest is compounded is referred to as the Annual Percentage Rate (APR). Banks usually disclose this amount to you when you open an account. This deceptively small, cumulative growth makes compound interest extremely powerful. Albert The more Einstein once called it one of the most powerful forces in frequently interest the universe. is compounded, the faster the balance Rule of 72. This will give you an approximation of how long it will take to double your money at a speci ed interest rate. The grows. Rule of 72 cites, “Any interest rate divided into the number 72 will give you the number of years necessary to double your initial investment.” For example: An investment earning 3 percent interest: 72 ÷ 3 = 24 years If your initial investment is 200 dinars, it will take twenty-four years to reach 400 dinars and forty-eight years to reach 800 dinars. An investment earning 6 percent interest: 72 ÷ 6 = 12 years If your initial investment is 200 dinars, it will take twelve years to reach 400, twenty-four years to reach 800 and thirty-six years to reach 1,600. This formula is especially useful for nancial estimates and understanding the nature of compound interest. The bene ts of starting to save early far outweigh those of choosing to wait. You should start saving as soon as possible and save consistently throughout your life. With time on your side and a commitment to putting money aside regularly, the money you accumulate will aid you through short-term crises in addition to funding your future retirement. Your Money, Your Future Chapter 7: Saving and its Bene ts 69 Chapter 7 - Activity 1 Saving to Reach your Goals Have you thought about your life after university? You will likely be more nancially independent. You will probably earn more money. You will also have more nancial responsibilities, perhaps including student loans to pay back over time. Hopefully this Guide has convinced you how important it is to be disciplined about paying down your debt. Even if you are good about dealing with your debt, it is also bene cial to have some additional money set aside. Those savings come in handy when you want to purchase something that is not normally part of your monthly budget or pay for an unexpected expense. Saving money is helpful for many reasons and setting goals for saving is a great way to motivate yourself to avoid spending all that you make. It is not di cult to start with short- term savings goals (such as buying a camera) and build up to bigger, longer-term goals (such as paying for a car). Follow the steps below to set up your own savings plan. 1. De ne your goals. Make a list of your nancial goals and all the things for which you want to save money. There is no limit to the list; just write down all the things that come to mind. __________________________________ _________________________________ __________________________________ _________________________________ __________________________________ _________________________________ __________________________________ _________________________________ 2. Organize your list. Prioritize the items you wrote down by numbering them in order of importance. Then, break your list up into short-term and long-term goals using the chart below, with the most important goals at the top of each column. You might think of short-term goals as those you can accomplish in the next six months. Long- term goals will take longer. Short -Term Financial Goals Long-Term Financial Goals A new cell phone A used car Your Money, Your Future Chapter 7: Saving and its Bene ts 70 You will use the chart on the previous page to create an actual savings plan for accomplishing your goals in Activity 3. 3. Think about the bene ts of accomplishing each of your goals. A new cell phone might allow you to talk with your cousins more regularly. Maybe the car will allow you to get to school or perhaps to work quicker. Regardless of the costs associated with your goals, recognize that there is an intrinsic value in achieving them. Take It Another Step Evaluate how your priorities have changed as you have gotten older. Are there things you want to save for that you wanted when you were 12 years old? How have your priorities changed over time? What are some of the things you are thinking about saving for now that may not be on your list in 5 or 10 years? Your Money, Your Future Chapter 7: Saving and its Bene ts 71 Chapter 7 - Activity 2 Consider Your Options Setting aside savings will take some discipline. However, it comes with rewards beyond the assurance of having money available for big purchases or an unexpected challenge. Because of interest or mark-up, saving small amounts over time can add up signi cantly, as illustrated in the hypothetical situation below. Accumulated Savings, Earning 5% Interest Per Year Monthly Savings 5 Years 10 Years 15 Years 20 Years 25 Years 18 dinars 1210 2763 4757 7302 10,580 35 dinars 2416 5514 9493 14,597 21,151 When you have the luxury of time, saving for long-term goals is an easy decision. But there is another important factor in growing your money: the rate of return. Consider the example below, which illustrates what happens to an initial 709 dinars investment at di erent rates of return. Growth of 709 dinars in Savings at Di erent Rates of Return Rate of Return Value in 5 Years Value in 10 Years 1% 745 dinars 781 dinars 2% 784 863 3% 824 954 4% 866 1053 5% 910 1165 6% 956 1286 7% 1005 1421 8% 1056 1569 9% 1110 1733 10% 1167 1914 Your Money, Your Future Chapter 7: Saving and its Bene ts 72 Now, consider the goals that you set for yourself in the previous activity, and answer the following questions: - How long will it take me to achieve each of my short-term goals? _________________________________________________________________ - What about the long-term goals? _________________________________________________________________ - Will I need to access my money while it is in savings? _________________________________________________________________ - How much can I realistically expect to earn on my savings? _________________________________________________________________ Answering these questions may help you determine what type of savings option will be best for achieving your goals, both short-term and long-term. Take It Another Step Visit a bank and learn about the savings options available to you. There are many di erent types of accounts with di erent rates of return. A bank will be able to set you up with an account that is best for you and your short- and long-term goals. Even if you are not ready to open an account yet, review your options, and ask questions you may have about the di erent options. Your Money, Your Future Chapter 7: Saving and its Bene ts 73 Chapter 7 - Activity 3 Create a Savings Plan So, you have de ned some of your short-term and long-term goals. And you have learned the importance of time and the rate of return on helping you save for and achieve your goals. Now it is time to create a savings plan! 1. In the chart below, ll in the rst column with the short-term and long-term nancial goals you de ned in Activity 1. 2. In the next column, enter your estimate of the amount of money needed to achieve the goal. 3. Then, ll in the amount of time needed to save for the goal, and the amount you will save each month toward that goal. For long-term goals, consider any interest you may earn on your savings. For example, with the car purchase below, you would need to earn about a 4% rate of return on your savings in order to accumulate 2000 dinars over two years. Short-Term Amount Needed Length of Time Monthly Savings Financial Goals Contribution A new cell phone 100 dinars 4 months 25 dinars Long-Term Amount Needed Length of Time Monthly Savings Financial Goals Contribution A used car 2000 dinars 2 years 80 dinars Remember, the earlier you begin saving, the earlier you can reach your goals. 4. Consider the opportunity costs. Are there expenses and activities you are willing to give up in order to reach your goals? Your Money, Your Future Chapter 7: Saving and its Bene ts 74 Take It Another Step Consider goals beyond the nancial spectrum. What are some of the things you want to do in your life, regardless of money? Do you want to become a doctor? A parent? Where do you want to spend your time? These are questions that will become relevant when you are developing a nancial plan, as they involve managing both your time and your money. Your Money, Your Future Chapter 7: Saving and its Bene ts 75