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Conceptual Questions
Q: Define the difference between a “good debt” and a “bad debt.” Provide one example of each.
A: Good debt is borrowing that helps build long-term financial value, such as student loans or a mortgage—typically associated with investment in your future. Bad debt refers to borrowing for depreciating or non-essential items with high-interest costs, such as credit card debt for luxury goods. Example of good debt: a federal student loan for a teaching credential. Example of bad debt: financing a vacation with a high-interest credit card.
Q: What are the two main types of student loans? Describe the key features of each.
A: The two main types are federal and private student loans.
– Federal: Offered by the government, fixed interest rates, borrower protections, options like income-driven repayment and forgiveness programs.
– Private: Offered by banks or private institutions, often with variable interest rates, fewer borrower protections, and dependent on creditworthiness.
Q: List three risks associated with taking out a private student loan instead of a federal one.
A:
-
- Higher, often variable, interest rates.
- Lack of access to forgiveness programs like PSLF.
- Fewer protections (no income-driven repayment or deferment options).
Q: Explain the main differences between the “debt snowball” and “debt avalanche” methods.
A:
– Debt snowball: Pay debts from smallest to largest balance regardless of interest. Focuses on motivation and psychological wins.
– Debt avalanche: Pay debts from highest to lowest interest rate. Saves more money over time by minimizing interest.
Q: What is the purpose of loan consolidation, and when might it be a smart financial move?
A: Loan consolidation combines multiple loans into one for simplified payments, often with a fixed interest rate. It’s useful when managing several federal loans and seeking eligibility for income-driven repayment or PSLF.
Scenario-Based Questions
Case Study 1:
Q: What mistakes did Kevin make in his borrowing process?
A: He took out a personal loan without a repayment plan or clear need, used it for depreciating items, and ignored the impact of high interest over time.
Q: How much might Kevin end up paying over time for depreciating assets?
A:
– Loan amount: $2,000
– Interest rate: 14%
– Over 3 years:
Total Interest = $2,000 × 0.14 × 3 = $840
Total Repayment = $2,000 + $840 = $2,840
(If over longer term, it could exceed $3,100 as noted in his case.)
Q: What would you advise someone in a similar situation today?
A: Only borrow for needs that provide long-term value. Understand interest rates, calculate total cost, and avoid loans for luxury items or emotional purchases.
Case Study 2:
Q: What features of this loan made it risky for Crystal?
A:
– Extremely high APR (21%)
– Quick approval without thorough evaluation
– No backup plan for missed payments
– Lack of emergency fund to cover income changes
Q: How could she have better evaluated the lender’s terms before borrowing?
A: She should have reviewed the APR, repayment terms, late fee policies, and compared other lenders. Reading reviews and asking questions about risks would help.
Q: What debt relief strategies could she pursue now to recover?
A:
– Debt management plan through a credit counselor
– Refinancing with a lower-interest loan (if eligible)
– Negotiating payment plans with the lender
– Boosting income and cutting expenses to pay down faster
Case Study 3:
Q: Why was Ashley’s decision to use federal loans a good one?
A: Federal loans offered her protections like income-driven repayment and PSLF eligibility. The fixed interest and grace period gave her time to build her career.
Q: What actions did she take to ensure she qualified for PSLF?
A:
– Worked full-time for a public employer
– Enrolled in an income-driven plan
– Filed annual employment certification
– Made 120 qualifying on-time payments
Q: How might her monthly budget be affected if she had chosen private loans instead?
A: Private loans wouldn’t offer income-based repayment, possibly leading to much higher monthly payments, especially with variable interest and no forgiveness.
Problem-Solving
Q: Calculate the total amount repaid for each loan. Which is more cost-effective and why?
A:
Loan A: $8,000 at 6% for 3 years
Monthly Payment = $243.43
Total Repayment = $243.43 × 36 = $8,763.48
Loan B: $8,000 at 9% for 5 years
Monthly Payment = $166.38
Total Repayment = $166.38 × 60 = $9,982.80
Loan A is more cost-effective due to lower total interest paid, despite higher monthly payments.
Q: Estimate the total amount you’ll owe after 4 years with no payments made during school.
A:
– Principal: $20,000
– Interest per year: $20,000 × 0.05 = $1,000
– 4 years: $1,000 × 4 = $4,000
– Total: $20,000 + $4,000 = $24,000
Q: If you pay $50/month while in school, how much interest could you reduce?
A:
– Total paid over 4 years = $50 × 48 = $2,400
– This amount directly offsets the interest accumulation, cutting the future balance significantly (down to $21,600 instead of $24,000).
Q: Using both the snowball and avalanche methods, list the order in which you would pay these off.
A:
**Snowball:**
-
- $800 medical bill
- $1,000 credit card
- $3,000 personal loan
**Avalanche:**
-
- $1,000 credit card (22%)
- $3,000 personal loan (10%)
- $800 medical bill (0%)
Q: Calculate the APR of this loan.
A:
– Loan Amount: $500
– Interest: $75
– Term: 14 days
APR = (75 / 500) × (365 / 14) = 0.15 × 26.07 = **391% APR**
Q: Calculate their debt limit ratio. Are they within the recommended 15% threshold?
A:
– Total monthly debt = $250 + $100 + $150 = $500
– Monthly income = $2,500
Debt limit ratio = $500 / $2,500 = **0.20 or 20%**
They are **above** the recommended 15% threshold and should reassess their debt load.
