AFC - Accredited Financial Counselor Credit and Debt Management 2 — Questions and Answers
Question 1: A client is considering bankruptcy but is unsure which chapter to file. What is the primary difference between Chapter 7 and Chapter 13 bankruptcy?
- Chapter 7 is for businesses only while Chapter 13 is for individuals
- Chapter 7 liquidates assets to discharge debts while Chapter 13 creates a repayment plan over 3-5 years (Correct answer)
- Chapter 13 has no income requirements while Chapter 7 requires high income
- Chapter 7 takes longer to complete than Chapter 13
Correct answer: Chapter 7 liquidates assets to discharge debts while Chapter 13 creates a repayment plan over 3-5 years
Chapter 7 involves liquidating non-exempt assets to discharge most unsecured debts, while Chapter 13 allows the debtor to keep assets while repaying debts through a court-approved plan.
Chapter 7 (liquidation) discharges most unsecured debts but may require surrendering non-exempt assets. It requires passing a means test (income below the state median or insufficient disposable income). The process takes 3-6 months. Chapter 13 (reorganization) allows debtors to keep all assets while repaying creditors through a 3-5 year plan based on disposable income. It is available to individuals with regular income and debts below statutory limits. Financial counselors should refer clients to a bankruptcy attorney for legal advice but can help them understand the implications of each option for their overall financial plan.
Question 2: What is a debt consolidation loan and what risk should the counselor highlight before a client pursues one?
- It combines debts into one payment with no downsides
- It combines multiple debts into a single loan, but the risk is running up new balances on the paid-off credit cards (Correct answer)
- It eliminates debt through negotiation with creditors
- It transfers debt to a government program
Correct answer: It combines multiple debts into a single loan, but the risk is running up new balances on the paid-off credit cards
Debt consolidation combines multiple debts into a single loan with potentially lower interest, but the primary risk is accumulating new debt on the freed-up credit cards.
A debt consolidation loan pays off multiple debts and replaces them with a single payment, ideally at a lower interest rate. While this simplifies payments and may reduce interest costs, research shows that many consumers who consolidate debt end up in worse financial position because they continue using the credit cards that were paid off, effectively doubling their total debt. Financial counselors should address the behavioral component: close or freeze the paid-off accounts, create a budget that prevents new debt accumulation, and monitor the client's progress to ensure the consolidation achieves its intended purpose.
Question 3: A client's credit card statement shows a balance of $5,000 at 18% APR. The minimum payment is $100. Approximately how long will it take to pay off making only minimum payments?
- 2 years
- 5 years
- 9 years (Correct answer)
- 30 years
Correct answer: 9 years
At 18% APR with $100 minimum payments on $5,000, it takes approximately 9 years to pay off, with total interest of roughly $4,300.
The Credit CARD Act of 2009 requires credit card statements to show how long payoff takes with minimum payments and the total cost. In this scenario, the $100 monthly payment initially covers $75 in interest and only $25 in principal. As the balance slowly decreases, more of each payment goes to principal, but the process takes approximately 9 years and costs about $4,300 in total interest, nearly doubling the original balance. Financial counselors should use this calculation to motivate clients to pay significantly more than the minimum. Increasing payments to $200/month would reduce payoff to about 2.5 years and save approximately $2,800 in interest.
Question 4: What is the Fair Credit Billing Act and how does it protect consumers in credit disputes?
- It limits credit card interest rates to 20%
- It establishes procedures for resolving billing errors and unauthorized charges on credit accounts (Correct answer)
- It prevents creditors from reporting late payments to credit bureaus
- It guarantees credit approval for all applicants
Correct answer: It establishes procedures for resolving billing errors and unauthorized charges on credit accounts
The FCBA establishes the process for consumers to dispute billing errors and unauthorized charges, requiring creditors to investigate and respond within specific timeframes.
The Fair Credit Billing Act protects consumers by establishing a formal dispute process for open-end credit accounts (credit cards). Key provisions include: consumers must submit written disputes within 60 days of the statement date, creditors must acknowledge within 30 days and resolve within 90 days (two billing cycles), the creditor cannot report the disputed amount as delinquent during investigation, and consumers are not liable for unauthorized charges over $50 (most issuers offer zero liability). Financial counselors should help clients understand the dispute process and the importance of the written notice requirement.
Question 5: A client received a pre-approved credit card offer with 0% APR for 18 months on balance transfers. What key terms should the counselor advise them to examine?
- Only the promotional interest rate matters
- The balance transfer fee, post-promotional APR, and whether the promotional rate is voided by late payments (Correct answer)
- The card's annual fee only
- The credit limit is the only important factor
Correct answer: The balance transfer fee, post-promotional APR, and whether the promotional rate is voided by late payments
Balance transfer offers have critical fine print including transfer fees (typically 3-5%), the regular APR after the promotional period, and conditions that could cancel the promotional rate.
Financial counselors should help clients evaluate: (1) Balance transfer fee, typically 3-5% of the transferred amount ($150-$250 on a $5,000 balance); (2) Post-promotional APR, which can be 20%+ and applies to any remaining balance; (3) Whether a late payment triggers the penalty APR and cancels the promotional rate; (4) Whether the 0% applies to new purchases or only transfers; (5) Whether the client can realistically pay off the balance within the promotional period. A balance transfer is only financially beneficial if the fee savings minus the transfer fee exceed what the client would have paid in interest, and the client can pay off the balance before the promotional period expires.
Question 6: What is the difference between a secured and an unsecured debt?
- Secured debts have lower interest rates; unsecured debts have higher limits
- Secured debts are backed by collateral that can be seized upon default; unsecured debts have no collateral (Correct answer)
- Secured debts are owed to the government; unsecured debts are owed to private companies
- Secured debts cannot be discharged in bankruptcy; unsecured debts always can
Correct answer: Secured debts are backed by collateral that can be seized upon default; unsecured debts have no collateral
Secured debts are backed by a specific asset (collateral) that the lender can repossess if the borrower defaults, while unsecured debts have no collateral backing.
Secured debts include mortgages (secured by the home), auto loans (secured by the vehicle), and home equity loans. If the borrower defaults, the lender can foreclose on or repossess the collateral. Unsecured debts include credit cards, medical bills, personal loans, and student loans. Without collateral, creditors must pursue other collection methods (lawsuits, garnishment). Secured debts typically carry lower interest rates because the collateral reduces lender risk. Financial counselors should help clients understand this distinction because it affects debt prioritization: defaulting on secured debt risks losing essential assets, while unsecured debt default primarily affects credit scores and may result in collection actions.
AFC - Accredited Financial Counselor Credit and Debt Management 2
A client is considering bankruptcy but is unsure which chapter to file.
What is the primary difference between Chapter 7 and Chapter 13 bankruptcy?