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How to Understand Interest Rates for High School Students

by Stacy Zeiger
  • Overview

    Gaining a thorough understanding of how interest rates work is fundamental knowledge for all high schoolers. Once they turn 18 and begin receiving credit card offers and making other financial decisions, a knowledge of interest rates will help students compare offers and make other financial decisions, such as where to save their money or how much they can afford to spend on a car.
  • Earning Interest

 
  • Step 1

    Define interest as the price a person pays to use someone else's money. Interest rates are presented as percentages. The higher the interest rate, the more a person pays to use someone else's money. For example, if you borrowed $100 for one year at 5 percent interest, you would pay back $105. At the same time, banks pay people interest to keep their money in an account. If instead of borrowing $100, you put $100 in a savings account with a 5 percent interest rate, you would have $105 at the end of the year.
  • Step 2

    Tell students that you are going to give them $100 to start a savings account (hypothetical money, of course). They are going to put that money in a savings account that pays 5 percent in interest every year, and they must figure out how much money they will earn if they leave that money in the account for five, 10, 15 and 20 years.
  • Step 3

    Give students the equation FV=P(1+i)^n where FV=the desired future value of the investment, P=the principal or initial investment, i=the interest rate, and n=the number of years invested. For the terms of this assignment, FV=100(1+.05)^n.
  • Step 4

    Have students use a scientific calculator to plug in the values for n to determine how much they would earn at five, 10, 15 and 20 years.
  • Paying Interest

    • Step 1

      Have students browse car ads for local dealerships and choose a car they would like to buy.
    • Step 2

      Tell students that the bank is willing to give them a three-year loan at 6 percent interest or a five-year loan at 4 percent interest. They must figure out which loan is the best deal, using the equation TC=P(1+i)^n where TC=total cost, PP=purchase price, i=interest, and n=years of the loan.
    • Step 3

      Using a scientific calculator, instruct students to plug in the information to get the total cost of the car once all interest is paid. For example, a $15,000 car with a three-year loan at 6 percent interest would be represented by the equation TC=15,000(1+.06)^3. In this equation, the total cost of the car would be $17,364.37. The total cost of the five-year loan at 4 percent (TC=15,000(1+.04)^5) would be $18,249.79.
    • Step 4

      Discuss with students the extra amount paid through financing and explain that even though the five-year loan has a lower interest rate, they will pay more over time.
    • 3
    • Paper Pencil Scientific calculator
    • Paper
    • Pencil
    • Scientific calculator

    References & Resources