Ch.6BA218 Personal Finance

Interest is the price you pay for using credit; it is the money that you pay to the lender for borrowing the lender's money. When interest is stated in dollars, interest makes up part of the ___ , which is the total dollar amount paid to use credit (including interest and other required charges or fees).

Finance Charge

Suppose that Dana has a gross annual income of $43,000. Her annual deductions for taxes, 401(k) retirement plan contributions, and health insurance amount to $9,400. This leaves Dana with an annual disposable income of $33,600. Dividing Dana's annual disposable income by 12, you can determine that Dana has a monthly disposable income of $ ___ . This is Dana's budget for her monthly disposable income: Rent - $1,100 Savings and Investments - $200 Food - $300 Utilities - $100 Insurance - $75 Transportation Expenses - $125 Charitable Contributions - $30 Entertainment - $70 Clothing - $50 Vacations and Long Weekends - $50 Medical/Dental Expenses - $64 Newspapers and Magazines - $20 Cable TV - $50 Personal Care - $50 Gifts and Holidays - $30 Health Club Membership - $50 Miscellaneous Expenses - $100 Debt Repayments - $336

$2,800 *MATH* $43,000 - $9,400 = $33,600 $33,600 / 12 = $2,800

Which of the following statements regarding the credit utilization ratio are true? Check all that apply. 1. The Fair Isaac Corporation believes that a borrower should not maintain a balance that is greater than 30% of the credit limit of a single credit card. 2. The purpose of the credit utilization ratio is to identify how heavily a borrower relies on individual cards as well as all your cards. 3. The credit utilization ratio indicates the percentage of your total debt obligation held in the form of credit cards balances. 4. The credit utilization ratio is used to evaluate a borrower's payment history, and indicates the percentage of credit cards that have been paid late during the last three years.

1 & 2

Although you should strive to keep your debt to a level appropriate for your financial situation, there are several good uses of credit. Which of the following are good uses of credit? Check all that apply. 1. Using a credit card for convenience, but only if the balance is paid in full each month. 2. Using a credit card to protect yourself against seller rip-offs and frauds. 3. Taking advantage of free-credit promotions such as a reduced interest rate or a "same-as-cash" plan. 4. Obtaining a mortgage to purchase a home. 5. Obtaining a student loan to finance your education. 6. Using a loan to open a business. 7. Using credit to pay for unexpected expenses such as emergency medical services or automobile repairs. 8. Using one credit card to make payments on another credit card. 9. Using a credit card to pay for groceries or gasoline when you cannot afford to pay the balance in full each month. 10. Using a credit card for hotel or car rental reservations. 11. Purchasing an overly expensive or otherwise unaffordable vehicle.

1-7, 10

What factors affect your credit (FICO) score? 1. Payment History ___% 2. Amounts Owed ___% 3. Length of Credit History ___% 4. Taking on More Debt ___% 5. Types of Credit Used ___%

1. 35 2. 30 3. 15 4. 10 5. 10

Read each statement below and indicate whether it is a good or bad reason for using debt. 1. You have unused credit available on your credit card 2. Debt provides the means to purchase big ticket products sooner rather than later 3. The habit of buying on credit can lead to overspending and over indebtedness 4. Debt provides protection against rip-offs and fraud 5. Debt provides financial flexibility and convenience when making payments 6. Debt provides the means to pay for an education 7. Debt allows you to take advantage of "free" credit offers 8. A potential for overspending often accompanies the availability of credit cards or easy credit 9. Debt reduces your future financial flexibility and buying power

1. Bad Reason 2. Good Reason 3. Bad Reason 4. Good Reason 5. Good Reason 6. Good Reason 7. Good Reason 8. Bad Reason 9. Bad Reason

There are two forms of bankruptcy: Chapter 7 of the Bankruptcy Act (also called the Immediate Liquidation Plan or Straight Bankruptcy), and Chapter 13 of the Bankruptcy Act (also called the Wage Earner Plan or the Regular Income Plan). In the following table, indicate whether each statement better applies to Chapter 7 bankruptcy or Chapter 13 bankruptcy: 1. This plan is designed for individuals with regular incomes who might be able to pay off some or all of their debts 2. This plan involves submitting a debt repayment plan in order to pay off your debt in three to five years 3. Under this plan, the court issues an automatic stay preventing collection efforts and wage garnishment. 4. Under this plan, the debtor must follow a strict budget; if the debtor makes all scheduled payments, then the debtor is discharged of any remaining amounts due. 5. This plan provides for immediate liquidation of your assets, which are usually turned over to a bankruptcy trustee or returned to the lender (for assets used as collateral). 6. This option is permitted when it would be highly unlikely that you could make substantial repayment of your debts. 7. Before you can file for this form of bankruptcy, you must pass a "means test" to ensure that your income is not too high.

1. Chapter 13 2. Chapter 13 3. Chapter 13 4. Chapter 13 5. Chapter 7 6. Chapter 7 7. Chapter 7

Think about activities that can contribute to creating a strong credit history. Which of the following actions will contribute to this outcome? 1. Use your credit card frequently and accrue a large outstanding balance 2. Close most of your old existing credit card accounts 3. Ask a bank for a small, short-term loan, put the money in savings; and pay the loan back on time 4. Open a savings account and manage it properly 5. Repay any outstanding loans late or after their due dates 6. Have your cell phone and utilities billed in your name and pay the bills on time 7. Apply for a bank credit card and use it responsibly

1. No 2. No 3. Yes 4. Yes 5. No 6. Yes 7. Yes

What is Dana's debt payments-to-disposable income ratio? Round your answer to nearest whole number.

12 % *MATH* $336 / $2,800 = 12%

Which of the following is true regarding setting personal debt limits? Check all that apply. 1. Your mortgage loan and all credit card charges, especially those paid in full every month, are included in the debt payments-to-disposable income method. 2. The debt limit according to the continuous-debt method is a four-year payoff period. 3. Under the debt-to-income method, the recommended maximum debt limit should be 50%. 4. For most people, your debt limit should be lower than what creditors are willing to offer.

2 & 4

Place the following items in order of most to least weight on your FICO score. Items that are of equal weight should be listed in alphabetical order. Length of Credit History Payment History Amounts Owed Types of Credit Used Taking on More Debt

3 1 2 5 4

Which of the following is an indication that you are using too much credit and may be approaching or in financial distress? Check all that apply. 1. Your credit card balances are within 30% of the card's credit limit 2. You pay your bills in full and on time 3. Using cash advances to pay other credit cards 4. Having an asset repossessed 5. Using debt-consolidation loans 6. Running out of money 7. Experiencing a foreclosure

3-7

Credit cards allow ___ use of credit as long as regular ___ payments are made

Repeated; Monthly

Step 3 - The Lender Decides Whether to Accept the Application and Under What Terms The approval or rejection of credit is based upon the lender's judgment of the willingness and ability of the applicant to repay the debt. If the application is accepted, a contract is created that outlines the rules and terms governing the account. For credit cards, this contract is called a ___ . For loans, the contract is called a ___ .

Credit Agreement; Promissory Note

The credit approval process There are three steps to the credit approval process: you apply for credit, the lender obtains your credit report, and the lender decides whether to accept your application and under what terms. Complete the following descriptions of these steps using terminology related to the credit approval process: Step 1 - You Apply for Credit A ___ is a form or interview that provides information to the lender about your ability and willingness to repay your debts. This information comes, in part, from your ___ , which is a continuing record of your credit usage and repayment of your debts.

Credit Application; Credit History

Step 2 - The Lender Obtains Your Credit Report After receiving your completed credit application, the lender conducts a ___ and compares the findings with the information from your application. Lenders want to know about your prior credit usage and repayment patterns, your income, the length of your employment, and your home-ownership status. The lender obtains your credit report from a ___ , which is a firm that collects and maintains records of the credit histories of many borrowers. Lenders will also obtain your ___ , which is a statistical measure used to rate an applicant on various factors deemed relevant to your creditworthiness and the likelihood that you will repay your debt.

Credit Investigation; Credit Bureau; Credit Score

A major ___ of credit is that it can lead to overspending. This is often because credit cards make it easy to purchase items immediately that you would have had to save up for if you had not used credit. And once you are used to carrying debt, it may seem easier to keep buying on credit before you have paid off your existing debt.

Disadvantage

A loan is usually repaid in ___ payments over a set period of time

Equal

To determine your personal debt limit, you may choose to use the continuous-debt method. To use the continuous-debt method, strive to keep your debt level low enough that you can get yourself completely out of debt (except for a mortgage loan) within ___ years. If you are unable to pay off your debts within this time frame, you are likely leaning too heavily on debt to maintain your lifestyle. You may also be paying substantial amounts of your income in finance charges. This is like throwing away money and also makes it very difficult to pay off your debts.

Four

Knowing the APR allows you to make comparisons between credit options. For example, a loan with an APR of 8% will generally cost you ___ than a loan with an APR of 10%, assuming the other fees and charges are the same. Generally you should try to obtain credit with the ___ possible APR.

Less; Lowest

Dana's debt payments-to-disposable income ratio is ___ than the recommended debt limit of 15%.

Lower

Taking on more debt usually has a ___ impact on your overall credit score because this can be a sign that you are living ___ your means.

Negative; Beyond

Using credit can bind you to a financial obligation to your lender. As such, taking on debt can reduce your financial freedom. In addition, the money that you spend each month on repaying your debt is money that you could have spent elsewhere on other opportunities. Using credit can ___ your ability to save and invest for the long term. You can also think of credit as a promise to "work for the creditor" in the future to pay off your debt.

Reduce

Your personal financial success depends on your ability to make the sacrifices necessary to ___ less than you ___ . This means that you should use credit wisely, use credit only when necessary, try to obtain credit with ___ interest rates, make payments on time, and try to repay debts as quickly as possible.

Spend; Earn; Low

Regardless of the type of bankruptcy, you should view declaring bankruptcy as a last resort. Bankruptcy remains on your credit report for ___ years. People who have declared bankruptcy often face years of trouble renting housing, obtaining home loans, and getting credit cards. Discharged debtors often emerge from bankruptcy with ___ net worth but a very ___ credit score.

Ten; Greater; Low

It is recommended the debt limit of a two-income household be based on ___ .

The higher of two incomes

Lenders often offer lower interest rates to applicants with the highest credit scores. This practice is known as ___ . If your credit score is too low, or if the lender considers your application to be too risky for any reason, the lender may decide to deny your application for credit. However, even people with low credit scores can usually find a lender that will approve credit, although usually at a higher interest rate.

Tiered Pricing

When is the use of borrowed money for an education justified?

When the cost of your education is less than the estimated additional income that the education is expected to provide

The finance charge can be stated either in dollars or as an annual percentage rate (APR). The APR expresses the cost of credit on a ___ basis as a percentage rate. For example, a single-payment, one-year loan for $100,000 with a finance charge of $13,000 would have an APR of ___ %.

Yearly; 13

According to this pie chart, which of the following is the most important factor in determining your overall credit score?

Your Payment History