FiCEP Debt Management Strategies 2 — Questions and Answers
Question 1: What is the debt avalanche method and when is it most advantageous?
- Paying off the smallest balance first
- Paying off the highest interest rate debt first to minimize total interest (Correct answer)
- Consolidating all debts into one payment
- Making minimum payments equally
Correct answer: Paying off the highest interest rate debt first to minimize total interest
The debt avalanche method prioritizes debts by interest rate, highest first, minimizing total interest paid.
The debt avalanche strategy directs all extra payment capacity toward the highest interest rate debt while making minimums on others. It minimizes total interest paid but the first account may take longer to pay off.
Question 2: A client has $15,000 in credit card debt at 18-26% APR. What consolidation option should be explored first?
- Home equity loan regardless of value
- Balance transfer to a 0% introductory APR card if qualified (Correct answer)
- Payday loan to pay off the cards
- Borrowing from retirement accounts
Correct answer: Balance transfer to a 0% introductory APR card if qualified
A 0% introductory APR balance transfer card can save significant interest if the client qualifies and pays down within the promotional period.
Balance transfer cards offering 0% introductory APR for 12-21 months can be highly effective. The client must factor in the 3-5% transfer fee and have a realistic payoff plan before the promotional period ends.
Question 3: What is a debt management plan and who typically administers them?
- A court-ordered payment plan
- A structured repayment plan administered by a nonprofit credit counseling agency (Correct answer)
- A self-directed spreadsheet plan
- A plan created by debt collection agencies
Correct answer: A structured repayment plan administered by a nonprofit credit counseling agency
DMPs are administered by nonprofit credit counseling agencies, often securing reduced interest rates and waived fees.
DMPs are administered by nonprofit agencies accredited by the NFCC or FCAA. The agency negotiates reduced interest rates, waives fees, and creates an affordable 3-5 year payment schedule. The client makes one monthly payment to the agency.
Question 4: When might debt settlement be appropriate, and what are its major risks?
- It is appropriate for all debt levels with no risks
- It may be suitable for severely distressed borrowers but risks tax liability, credit damage, and lawsuits (Correct answer)
- It is only available for mortgage debt
- It is required before filing bankruptcy
Correct answer: It may be suitable for severely distressed borrowers but risks tax liability, credit damage, and lawsuits
Debt settlement may help severely distressed borrowers but carries significant risks including taxes on forgiven debt and credit score damage.
Debt settlement involves negotiating with creditors to accept less than the full balance. Major risks include forgiven debt over $600 being reported as taxable income, severe credit score drops, potential creditor lawsuits, and high fees from settlement companies.
Question 5: What is the difference between Chapter 7 and Chapter 13 bankruptcy?
- There is no meaningful difference
- Chapter 7 liquidates assets to discharge debts; Chapter 13 creates a 3-5 year repayment plan (Correct answer)
- Chapter 13 is only for businesses
- Chapter 7 requires a repayment plan
Correct answer: Chapter 7 liquidates assets to discharge debts; Chapter 13 creates a 3-5 year repayment plan
Chapter 7 involves liquidation of non-exempt assets, while Chapter 13 sets up a court-supervised repayment plan.
Chapter 7 discharges most unsecured debts through liquidation, available to those passing the means test. Chapter 13 allows debtors with regular income to keep property while repaying over 3-5 years. Neither discharges student loans, recent taxes, child support, or alimony.
Question 6: A client pays only minimums on a $5,000 credit card at 22% APR. Approximately how long will payoff take?
- About 2 years
- About 5 years
- Over 15 years (Correct answer)
- About 10 years
Correct answer: Over 15 years
At typical minimum payments, a $5,000 balance at 22% APR would take over 15 years to repay with total interest exceeding the original balance.
Minimum payment schedules are designed to maximize interest income. The client would pay approximately 18-20 years and over $8,000 in total interest. Counselors should use the Credit CARD Act's statement disclosure as a teaching tool.
FiCEP Debt Management Strategies 2
What is the debt avalanche method and when is it most advantageous?