AFC Budgeting & Debt Management 4 — Questions and Answers
Question 1: A client has a $12,000 credit card balance at 22% APR and a $5,000 medical bill with 0% interest. Which debt should they prioritize paying down first using the avalanche method?
- The medical bill because it has a lower balance
- The credit card because it has the highest interest rate (Correct answer)
- Split payments equally between both debts
- Pay minimums on both and invest the rest
Correct answer: The credit card because it has the highest interest rate
The avalanche method targets the highest-interest debt first to minimize total interest paid over time.
Question 2: Which ratio is most commonly used to assess a client's ability to manage monthly debt obligations relative to their gross income?
- Savings rate
- Debt-to-income (DTI) ratio (Correct answer)
- Net worth ratio
- Liquidity ratio
Correct answer: Debt-to-income (DTI) ratio
The debt-to-income ratio compares total monthly debt payments to gross monthly income and is a key indicator of debt load.
Question 3: A client's take-home pay is $3,500/month. Under the 50/30/20 budgeting rule, how much should be allocated to savings and debt repayment?
- $700 (Correct answer)
- $1,050
- $1,750
- $525
Correct answer: $700
The 20% category covers savings and debt repayment: 20% of $3,500 = $700.
Question 4: What is the primary risk of using a home equity loan to consolidate unsecured credit card debt?
- Higher interest rates than credit cards
- Converting unsecured debt into debt secured by your home (Correct answer)
- Reduced credit score immediately after closing
- Longer repayment terms increase monthly payments
Correct answer: Converting unsecured debt into debt secured by your home
Using a home equity loan puts your home at risk of foreclosure if you default, whereas credit card debt is unsecured.
Question 5: A client wants to use the envelope budgeting system. Which scenario best describes this method?
- Automating all bill payments through online banking
- Allocating physical or virtual cash into spending category envelopes each month (Correct answer)
- Reviewing bank statements weekly to categorize spending
- Setting spending alerts on a debit card
Correct answer: Allocating physical or virtual cash into spending category envelopes each month
The envelope system pre-allocates cash into labeled envelopes for each budget category, preventing overspending.
Question 6: Which type of student loan repayment plan bases monthly payments on the borrower's discretionary income?
- Standard 10-year repayment
- Graduated repayment plan
- Income-driven repayment (IDR) plan (Correct answer)
- Extended repayment plan
Correct answer: Income-driven repayment (IDR) plan
Income-driven repayment plans cap payments at a percentage of discretionary income, making them accessible for low-income borrowers.
Question 7: A client has $400 in monthly cash flow after all expenses. They have no emergency fund and $6,000 in credit card debt at 19% APR. What is the AFC-recommended first step?
- Put all $400 toward the credit card debt immediately
- Build a small starter emergency fund of $500–$1,000 first, then attack debt (Correct answer)
- Open a high-yield savings account and save for 6 months before paying extra debt
- Transfer the balance to a 0% card and invest the $400
Correct answer: Build a small starter emergency fund of $500–$1,000 first, then attack debt
Financial counselors typically recommend a small starter emergency fund to prevent new debt from unexpected expenses while also paying down existing debt.
AFC Budgeting & Debt Management 4
A client has a $12,000 credit card balance at 22% APR and a $5,000 medical bill with 0% interest.
Which debt should they prioritize paying down first using the avalanche method?