Managing Debt

Managing Debt

Are you ready to test your knowledge about managing your debt? This ten-question multiple-choice quiz will explore some fundamentals of debt, how it works, and how to tackle it. After completing all ten questions, click "What's my grade?" at the end of the quiz to see how you did.

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Which of the following would be considered "bad" debt?
Good debt helps you generate income and increases your net worth. Investing in your education, buying a home, or using a loan to expand your small business can be classified as good debt. Using your credit card to purchase clothing or other non-durable consumer goods does little to improve your income situation or net worth. If you do use a credit card for such items, it is best to pay off your balance in full each month and look at your credit card as a convenience item or as a way to accumulate rewards points.

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When considering a 0% APR credit card balance transfer offer, you should:
It is important to understand all of the terms of any credit card you acquire. This is especially true if cards offer promotional terms, and you either transfer a balance when you open the card or expect to carry a balance moving forward. In addition to the items mentioned above, check to see if there is an annual fee associated with the card (and that the benefits you receive from using the card are worth the annual fee) and if interest rates are different for existing balances versus new purchases. If you decide to take an interest-free card offer, use the promotional period to pay down your existing account balance or eliminate it together.

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Under a "debt-snowball" repayment strategy, you:
The debt snowball strategy is advantageous if you have many small debts that you have a hard time tracking. The snowball method is beneficial because you will quickly pay off the smallest debts and reduce the number of accounts and payments you have to track. The snowball strategy can also give you a quick win so that you stay motivated to pay down your debt, and continuously eliminating individual debts will help you stick to your plan. The debt avalanche method is also effective, but it focuses on paying down debt with the highest interest rate rather than the lowest balance.

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In today's economy, if you receive a lump sum payment, such as a tax refund, inheritance or employment bonus, it makes the most financial sense to:
Treating yourself to a new purchase or relaxing vacation sounds tempting, I'm sure. So might rolling the dice in Las Vegas to see if you can grow that lump sum into something even bigger. But neither should be your priority if you have large amounts of high-interest credit card debt or inadequate savings to help you withstand emergencies or fund a college education or retirement. In today's economy, however, it's probably best to get rid of any high-interest credit card debt you might be holding before you starting stashing the money away in a savings account or CD. Interest earned on savings is still pretty low, and you will probably save more by paying down debt.

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You can calculate your debt to income ratio by:
Your debt-to-income ratio, also known as your back-end ratio, tells you how much of your monthly salary is eaten up by all of your expenses, not just housing. Your expenses would include any recurring payment, such as your mortgage loan, car payment, student loan payment, credit card debt, and child support. Most lenders want your total monthly debts to account for no more than 36 percent of your monthly income. To determine your maximum affordable debt-to-income ratio, multiply your annual salary by .36 and divide the resulting figure by 12. For a $50,000 annual salary, the maximum amount of monthly debt obligations you'd be able to afford would be $1,500. Remember, that figure includes your mortgage payment and all other monthly debts.

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The Fair Debt Collection Practices Act (FDCPA) is a federal law that protects consumers from creditors. It forbids your creditors, or those collecting on their behalf from:
In 1977, Congress enacted the Fair Debt Collection Practices Act (FDCPA) to protect consumers from harassment, deceit, and unfair tactics by debt collectors. The FDCPA applies to personal and household debts collected by third parties, which happens when the lender you owe sells the debt to another company or hires another individual or company to collect the debt from you on their behalf. You need to understand your rights under the FDCPA and know what to do if a collector has violated your rights.

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If you take out a $20,000 car loan at 4.9% APR for a 60-month term, you will have a monthly payment of $376.51. If you add $50.00 to that monthly payment each month, how many months sooner will you pay off your car loan?
On any loan, your monthly payment is divided between two purposes. First, part of the payment is used to cover the interest that has accrued on your balance since you made your last payment. Second, any remaining portion of your payment goes toward reducing your loan balance. Because of this, once you have paid the interest for a month, any extra money you add to your monthly payment will go directly toward reducing your loan balance. This can save you a lot of money in the long run. Most of your savings come from the fact that your interest payment for every future month on your payment plan will be less than it would have been if you hadn´t made the extra payment. And the less interest you pay, the more your regular monthly payment will pay down the principal. The effects really do snowball, often to significant-end results.

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Most financial experts, and lenders, advise that your total monthly payments for loan obligations, excluding your mortgage payment, represent what percentage of your monthly income?
Lenders will typically look at both your housing ratio and your debt-to-income ratio. Your housing ratio, which is determined by dividing your monthly mortgage payment by your monthly income, should be no more than 28 percent. To determine your debt-to-income ratio, you should divide all of your loan payments, including your mortgage payment, by your total monthly income. Most lenders want your total monthly debts to account for no more than 36 percent of your monthly income.

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Under which of the following circumstances would it be financially beneficial to borrow money to buy something now and repay it with future income?
Smart borrowers understand the difference between 'good' debt and 'bad' debt. Good debt helps you generate income or increases your net worth. It should be used to help you get a better job or to purchase assets that will increase in value over time. There are often no guarantees when taking on 'good' debt, but 'bad' debts are pretty obvious. Items that fit into this category include all debts incurred to purchase depreciating assets. In other words, if it won't help you generate income or increase in value, you shouldn't go into debt to buy it.

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Which of the following will help lower the cost of a major purchase?
The best option would be to pay cash for your purchase, eliminating any finance charges that you will pay if you incur a debt to fund the purchase. Since interest is charged each month on your outstanding loan balance, a lower outstanding balance will result in the lowest cost. The longer it takes you to pay off the account balance, the higher the purchase's overall cost will be.

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