Exponential growth and decay (Part 4): Paying off credit-card debt

The following problem in differential equations has a very practical application for anyone who has either (1) taken out a loan to buy a house or a car or (2) is trying to pay off credit card debt. To my surprise, most math majors haven’t thought through the obvious applications of exponential functions as a means of engaging their future students, even though it is directly pertinent to their lives (both the students’ and the teachers’).

You have a balance of $2,000 on your credit card. Interest is compounded continuously with a relative rate of growth of 25% per year. If you pay the minimum amount of $50 per month (or $600 per year), how long will it take for the balance to be paid?

In the previous two posts, I presented the general formula

A = \displaystyle \frac{k}{r} - \left( \frac{k}{r} - P \right) e^{rt}

which can be obtained by solving a certain differential equation. So, if r = 0.25, k = 600, and P = 2000, the amount left on the credit card after t years is

A(t) = 2400 - 400 e^{0.25t}.

On the other hand, if the debtor pays $1200 per year, the equation becomes

A(t) = 4800 - 2800 e^{0.25t}

Today, I’ll give some pedagogical thoughts about how this problem, and other similar problems inspired by financial considerations, could fit into a Precalculus course… and hopefully improve the financial literacy of high school students.

green lineUnder the theory that a picture is worth a thousand words, let’s take a look at the graphs of both of these functions:

creditcardStudents should have no trouble distinguishing which curve is which. Clearly, by paying $1200 per year instead of $600 per year, the credit card debt is paid off considerably quicker.

There’s another immediate take-away from these graphs — especially the graph for k = 600, when the debt is being paid off over 7 years. Notice that the debt is being paid off very slowly in the initial years. Only in the latter years does the pace of paying off the loan pick up. So the moral of the story is: if you can afford to pay extra in the early years of a debt (credit card, mortgage, etc.), it’s much more important to pay off an extra amount in the early years than in the later years.

I believe this to be an important lesson for students to learn before they bury themselves deeply in debt as young adults… and Precalculus provides a natural vehicle for teaching this lesson.

 

 

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  1. Exponential growth and decay: Index | Mean Green Math

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