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Personal Finance: Turning Money into Wealth, 7e (Keown)

Chapter 7 Student and Consumer Loans: The Role of Planned Borrowing


7.1 Consumer Loans-Your Choices
1) Consumer loans are less formal than credit cards and/or other open credit.
Answer: FALSE
Diff: 2
Topic: Open Credit / Revolving Credit
AACSB: Analytical Thinking
2) Consumer loans can range from unsecured, fixed-rate, single-payment loans to secured,
variable-rate, installment loans.
Answer: TRUE
Diff: 2
Topic: Consumer Loan
AACSB: Analytical Thinking
3) Bridge loans provide short-term funding until longer-term or additional financing is found.
Answer: TRUE
Diff: 1
Topic: Bridge Loan
AACSB: Information Technology
4) Unsecured loans are generally less risky to lenders than secured loans. Therefore secured
loans typically charge a higher APR than unsecured loans.
Answer: FALSE
Diff: 1
Topic: Unsecured Loan
AACSB: Reflective Thinking
5) Defaulting on a secured loan may lead to the collateral being repossessed.
Answer: TRUE
Diff: 2
Topic: Secured Loan
AACSB: Analytical Thinking
6) A balloon loan calls for repayment of both interest and principal at regular intervals, with the
payment levels set so that the loan expires at a preset date.
Answer: FALSE
Diff: 1
Topic: Single Payment Loan / Balloon Loan
AACSB: Analytical Thinking

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7) If your before-tax cost of a home equity loan is 12 percent and you are in the 30 percent
marginal tax bracket, your after-tax cost of the home equity loan is 9 percent.
Answer: FALSE
Diff: 3
Topic: Interest Rates
AACSB: Analytical Thinking
8) Variable-rate loans tied to long-term rates expose you to more risk of rate changes than
variable-rate loans tied to short-term rates.
Answer: FALSE
Diff: 2
Topic: Variable Interest Rate Loan
AACSB: Analytical Thinking
9) A recourse clause defines whatever actions a lender can take to recover money from you in
case you default on the loan.
Answer: TRUE
Diff: 1
Topic: Recourse Clause
AACSB: Diverse and Multicultural Work Environments
10) An acceleration clause states that if you default on a secured loan, not only can the lender
repossess whatever is secured, but if the sale of the asset does not cover what you owe, you can
also be billed for the difference.
Answer: FALSE
Diff: 2
Topic: Acceleration Clause
AACSB: Diverse and Multicultural Work Environments
11) According to the Keown book, a(n) ________ is a loan involving a formal contract that
details exactly how much you're borrowing and when and how you're going to pay the loan back.
A) balloon loan
B) consumer loan
C) bridge loan
D) installment loan
Answer: B
Diff: 1
Topic: Consumer Loan
AACSB: Analytical Thinking

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12) An example of a consumer loan is a(n)


A) unsecured loan.
B) pre-payment loan.
C) interim loan.
D) both A and C.
Answer: D
Diff: 2
Topic: Consumer Loan
AACSB: Analytical Thinking
13) Which statement is false regarding consumer loans?
A) Consumer loans are usually used for bigger purchases.
B) Consumer loans can range from open credit to credit cards.
C) Consumer loans are sometimes called "planned borrowing."
D) Consumer loans can range from single-payment loans to installment loans.
Answer: B
Diff: 3
Topic: Consumer Loan
AACSB: Analytical Thinking
14) Which of the following is the correct formula to calculate the after-tax cost of a home equity
loan?
A) After-tax cost of a home equity loan = before-tax cost (1 + marginal tax rate)
B) After-tax cost of a home equity loan = before-tax cost (1 - marginal tax rate)
Answer: B
Diff: 3
Topic: Home Equity Loan
AACSB: Analytical Thinking
15) A short-term loan that provides funding until a longer-term loan can be secured is called a(n)
A) bridge loan.
B) gap loan.
C) straddle loan.
D) amortized loan.
Answer: A
Diff: 1
Topic: Bridge Loan
AACSB: Analytical Thinking

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16) A(n) ________ loan calls for the repayment of both the interest and the principal at regular
intervals and is commonly referred to as loan amortization.
A) term
B) simple interest
C) installment
D) personal
E) none of the above
Answer: C
Diff: 1
Topic: Installment Loan
AACSB: Analytical Thinking
17) You are considering building a new deck on your home, what factors should you consider
when deciding whether to borrow the money or take the money out of your savings account?
A) You should compare the after-tax return on your savings with the after-tax APR on your loan.
B) It's simple, if you can afford to pay cash then you should not take out the loan.
C) What impact the savings withdrawal will have on your liquidity.
D) Both A and C are correct.
Answer: D
Diff: 2
Topic: Financing
AACSB: Reflective Thinking
18) Which of the following characterize secured loans?
A) They are typically easier to get.
B) Interest rates tend to be lower than unsecured loans.
C) They reduce the lender's risk.
D) They are backed with either physical or investment assets.
E) All of the above
Answer: E
Diff: 1
Topic: Secured Loan
AACSB: Reflective Thinking
19) A ________ is tied to a market interest rate, such as the prime rate or the six-month Treasury
bill rate.
A) prime-rate loan
B) convertible-rate loan
C) flexible-rate loan
D) variable-rate loan
Answer: D
Diff: 1
Topic: Variable Interest Rate Loan
AACSB: Diverse and Multicultural Work Environments

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20) Variable-rate loans


A) usually have rate caps that prevent them from varying too much.
B) always adjust every month.
C) are never a better option than fixed-rate loans.
D) all of the above.
Answer: A
Diff: 2
Topic: Variable Interest Rate Loan
AACSB: Diverse and Multicultural Work Environments
21) What are the risks to the borrower with adjustable-rate loans?
A) During times of inflation your salary may increase during the term of the loan.
B) That the market rates of interest may increase during the term of the loan.
C) It is harder to budget for loan payments that may increase during the term of the loan.
D) Both B and C are correct.
Answer: D
Diff: 2
Topic: Variable Interest Rate Loan
AACSB: Analytical Thinking
22) Alice has fallen behind on her signature loan. She recently received a notice from the lender
that her wages were going to be garnished to pay off the debt. What is the loan clause that allows
the lender to take this action against Alice because she was in default?
A) Recovery clause
B) Default clause
C) Recourse clause
D) Deficiency payments clause
E) None of the above
Answer: C
Diff: 1
Topic: Recourse Clause
AACSB: Diverse and Multicultural Work Environments
23) What is the loan clause stating that if you default on a secured loan, the lender can repossess
whatever is secured, as well as bill you for the difference if that repossession does not cover what
you owe?
A) Insurance clause
B) Default clause
C) Recourse clause
D) Deficiency payments clause
E) None of the above
Answer: D
Diff: 2
Topic: Default
AACSB: Diverse and Multicultural Work Environments

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24) What is your potential liability from the deficiency payments clause if you default?
A) Nothing, since the loan is in default it invalidates all loan clauses.
B) You will have to pay any legal or repossession fees incurred by the lender.
C) You will have to pay the remainder of the loan balance if the proceeds from the repossession
are not sufficient to pay off the loan.
D) Both B and C are correct.
Answer: D
Diff: 3
Topic: Loan Contract
AACSB: Diverse and Multicultural Work Environments
25) Joshua recently purchased a new home. His lender required him to purchase credit life
insurance on the loan in the event that he died before the mortgage is paid off. What is the loan
clause that allows his lender to require him to purchase this additional insurance.
A) Insurance agreement clause
B) Default contingency clause
C) Early payment clause
D) Recourse clause
E) None of the above
Answer: A
Diff: 2
Topic: Acceleration Clause
AACSB: Diverse and Multicultural Work Environments
26) Suppose you borrowed the money you needed to purchase an automobile and then failed to
make a scheduled payment by the due date. Technically, you
A) are bankrupt.
B) are in default.
C) are usually not given a chance to make good on the overdue payment.
D) none of the above
Answer: B
Diff: 1
Topic: Default
AACSB: Diverse and Multicultural Work Environments

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27) The "Repo Man" recently repossessed your car for failure to make payments. You still owed
$5,000 on the loan, but since it was always broken, you were glad to get rid of it anyway. The
bank sold the car at a wholesale auction for $3,000. The bank also paid the "Repo Man" $200
and paid attorney fees of $300. Based on the deficiency payments clause in your loan, what are
you liable for?
A) $0; repossession means the bank must "eliminate" the debt
B) $500
C) $2,000
D) $2,500
E) None of the above
Answer: D
Diff: 3
Topic: Default
AACSB: Analytical Thinking
28) What is the name of the formal document that outlines the legal obligations of both the
lender and the borrower?
A) Default
B) Claim
C) Debenture
D) Note
E) Tort
Answer: D
Diff: 3
Topic: Loan Contract
AACSB: Diverse and Multicultural Work Environments
29) Which one of these clauses is not found in a typical loan contract?
A) Recourse
B) Deficiency payments
C) Acceleration
D) Withdrawal terms
E) Insurance agreement
Answer: D
Diff: 3
Topic: Loan Contract
AACSB: Diverse and Multicultural Work Environments

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30) The loan contract is a formal document called a(n) ________ and may contain a(n) ________
specifying who retains control over the item being purchased in the case of default.
A) agreement, insurance clause
B) indenture, security agreement
C) note, security agreement
D) agreement, indenture
E) note, legal transaction
Answer: C
Diff: 3
Topic: Loan Contract
AACSB: Analytical Thinking
31) The quoted rate on a home equity loan is 10% and you are in a 28% marginal tax bracket.
What is the effective after-tax rate on this loan?
A) 7.2%
B) 5.4%
C) 4.1%
D) 2.8%
E) None of the above
Answer: A
Diff: 2
Topic: Home Equity Loan
AACSB: Analytical Thinking
32) You are considering a home equity loan. Your marginal tax bracket is 25%. You want to
borrow $30,000 and are quoted an APR of 10%. How much money would you save in taxes each
year if you use the tax-deductible home equity loan?
A) $1,300
B) $920
C) $750
D) None of the above
Answer: C
Diff: 2
Topic: Home Equity Loan
AACSB: Analytical Thinking
33) What happens when you default on a car loan where your Title is held as collateral?
A) You damage your credit history but you keep the car.
B) You lose the car and damage your credit history.
C) You face liability under the deficiency payments clause.
D) Only choices B and C are correct.
E) All of the above choices are correct.
Answer: D
Diff: 2
Topic: Automobile Loan
AACSB: Reflective Thinking
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34) If you own a home with a market value of $175,000 and you have an outstanding balance on
your mortgage of $60,000, your home equity is
A) $57,500.
B) $97,750.
C) $115,000.
D) $235,000.
Answer: C
Diff: 3
Topic: Home Equity Loan
AACSB: Analytical Thinking
35) Home equity/second mortgage loans have two important advantages over most other types of
loans. They are
A) tax deductibility of payments and longer terms.
B) tax deductibility of interest and lower interest rates.
C) no risk for borrower and less amortization.
D) increase in future financing flexibility and no recourse clause.
E) none of the above.
Answer: B
Diff: 2
Topic: Home Equity Loan
AACSB: Analytical Thinking
36) Explain the purpose of a convertible loan.
Answer: A convertible loan has the potential of overcoming the disadvantages (to the borrower)
of variable-rate and fixed-rate loans. The borrower can enjoy the lower cost of a variable-rate
loan while still being able to lock in the savings of a fixed-rate loan when a low interest rate
comes along.
Diff: 2
Topic: Convertible Loan
AACSB: Reflective Thinking
37) Name the advantages and disadvantages of an unsecured loan.
Answer: Unsecured loans require no collateral, only a signature. Larger unsecured loans are
generally given only to borrowers with excellent credit histories. The major fault with these type
of loans is that they require higher interest rates.
Diff: 1
Topic: Unsecured Loan
AACSB: Reflective Thinking

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38) Describe the four major parts of a typical loan contract.


Answer: The loan contract will contain an insurance agreement clause which requires you (the
borrower) to purchase credit life insurance to pay off the loan in the event of your death. An
acceleration clause states that if you miss one payment, the entire loan comes due immediately.
Usually, however, the lender will give you some time to catch up on the payments. The
deficiency payments clause requires that if you default on a secured loan, not only can the lender
repossess whatever is secured, but if when that asset is sold it does not cover what you owe, you
can be billed for the difference. A recourse clause defines what actions a lender can take to claim
money from you in case you default on the loan.
Diff: 1
Topic: Loan Contract
AACSB: Reflective Thinking
39) What is the distinguishing feature of an automobile loan?
Answer: The automobile is used as collateral and will be repossessed if the borrower defaults on
the loan. The duration of these loans is usually very short, often for only 24 to 60 months.
Although they can be as long as 72 months. Some lenders offer a very low 3% or less interest
rate for this purpose.
Diff: 1
Topic: Automobile Loan
AACSB: Analytical Thinking
40) What are the advantages of a home equity loan, and what, if any, are the disadvantages?
Answer: It is usually easier and less expensive to obtain a home equity loan than other types of
loans. After securing a home equity line of credit, you merely ask for the money each time you
need some, without reapplying for it. The interest you pay is usually a tax deduction, within
income limitations. The one major disadvantage is that you place a lien on your home.
Diff: 2
Topic: Home Equity Loan
AACSB: Reflective Thinking
7.2 Cost and Early Payment of Consumer Loans
1) A payday loan is a reasonable option if you need a luxury item like a big screen TV.
Answer: FALSE
Diff: 3
Topic: Payday Loans
AACSB: Diverse and Multicultural Work Environments
2) Payday loans are a dangerous way to borrow money, and charge an annual interest rate of
almost 400%.
Answer: TRUE
Diff: 3
Topic: Payday Loans
AACSB: Diverse and Multicultural Work Environments

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3) The simple interest method is the most common method of calculating payments on an
installment loan.
Answer: TRUE
Diff: 3
Topic: Variable Interest Rate Loan
AACSB: Diverse and Multicultural Work Environments
4) Loans using the add-on method are a relative bargain, and should be sought out.
Answer: FALSE
Diff: 3
Topic: Fixed-Interest Rate Loan
AACSB: Diverse and Multicultural Work Environments
5) The annual percentage rate is the simple percentage cost of all finance charges over the life of
the loan on an annual basis.
Answer: TRUE
Diff: 1
Topic: Annual Percentage Rate
AACSB: Diverse and Multicultural Work Environments
6) With a discount method single-payment loan, the entire interest charge is subtracted from the
principal before you receive the money, and at maturity you repay the principal.
Answer: TRUE
Diff: 1
Topic: Single Payment Loan / Balloon Loan
AACSB: Analytical Thinking
7) Ronald is borrowing $20,000 using the discount method. His bank is offering him an annual
percentage rate of 8.5% and he is taking out the loan for 24 months. How large of a check will
Ronald receive from this loan when he leaves the bank? How much will he repay?
A) $20,000; $23,400
B) $16,600; $20,000
Answer: B
Diff: 2
Topic: Financing
AACSB: Analytical Thinking
8) The APR is larger when money is lent under the discount method than when it is lent under
the simple interest method.
Answer: TRUE
Diff: 1
Topic: Fixed-Interest Rate Loan
AACSB: Analytical Thinking

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9) Amortization refers to the process in which a large proportion of the early payments of an
installment loan goes to cover interest, and the later payments have a larger proportion going
towards the payment of principal.
Answer: TRUE
Diff: 2
Topic: Amortization
AACSB: Analytical Thinking
10) Which of the following is not required by law to be on a loan disclosure statement?
A) Annual percentage rate
B) All finance charges
C) The total amount financed
D) The total amount of payments
E) All of the above are required.
Answer: E
Diff: 2
Topic: Loan Disclosure Statement
AACSB: Analytical Thinking
11) The finance charges for a loan may include
A) fees for a credit check.
B) required insurance fees.
C) interest payments.
D) only choices A and B.
E) All of the above choices.
Answer: E
Diff: 2
Topic: Debt
AACSB: Analytical Thinking
12) Fred ran short on cash and borrowed $300 through a Payday Loan company. The company
charged him a fee of $60 to borrow the $300 for 14 days. Using the simple interest method
calculate what interest rate was Fred charged for the aforementioned loan.
A) 5.21%
B) 52.13%
C) 521.29%
D) None of the above
Answer: C
Diff: 2
Topic: Payday Loans
AACSB: Analytical Thinking

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13) Payday lenders


A) make money by providing one-time assistance during a time of financial need.
B) make money by keeping borrowers in debt.
C) encourage repeat borrowing.
D) all of the above.
Answer: D
Diff: 2
Topic: Payday Loans
AACSB: Diverse and Multicultural Work Environments
14) Veronica was offered a loan using the discount method of calculation by her bank. She will
borrow $10,000 for one year at an APR of 11%. How large will the check be that Veronica
receives? How much must she repay?
A) $11,100; $11,100
B) $10,000; $11,100
C) $8,900; $11,100
D) $8,900; $10,000
E) None of the above is correct.
Answer: D
Diff: 2
Topic: Payday Loans
AACSB: Analytical Thinking
15) In driving around town one day, you noticed most of the payday loan companies were
located close to the college and the local military base and there were none out in the newer
neighborhoods. Why do you think this is so?
A) The rent on these locations is less expensive.
B) Payday lenders tend to focus on less experienced borrowers who typically don't make a lot of
money.
C) Because their terms are so affordable people with low incomes really take advantage of them.
D) There are zoning laws that require these types of locations for these types of services.
Answer: B
Diff: 3
Topic: Payday Loans
AACSB: Analytical Thinking

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16) Steven is beginning a new job but has not yet been paid. He needs $400 to pay his rent this
month. Steven is going to borrow the money through a Payday Loan establishment. They are
charging him an $80 fee to borrow the money for 10 days until he receives his first paycheck.
What is the actual interest rate that Steven is being charged?
A) 7.3%
B) 73.0%
C) 730.0%.
D) .073%
E) None of the above
Answer: C
Diff: 1
Topic: Payday Loans
AACSB: Analytical Thinking
17) A rule to determine what proportion of each loan payment is principal and interest is
A) the law of 72.
B) the N-ratio method.
C) the rule of 78.
D) the principal-interest mix.
E) the add-on method.
Answer: C
Diff: 1
Topic: Rule of 72
AACSB: Analytical Thinking
18) A simple interest installment loan calculates interest on the unpaid balance. An add-on
A) calculates the same way with the addition of a factor.
B) calculates interest on the original balance.
C) is less costly.
D) is more costly.
E) both B and D.
Answer: E
Diff: 3
Topic: Interest Rates
AACSB: Analytical Thinking
19) Congratulations! You have just graduated from college and are determining what your
monthly student loan payments will be. After consolidating all of your loans, you have a balance
of $18,000. At 8% APR for 10 years, what will your monthly payments be?
A) $1,866.66
B) $161.50
C) $218.39
D) $1,440.14
Answer: C
Diff: 3
Topic: Principle 3: The time-value-of-money
AACSB: Analytical Thinking
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20) You just bought a car and borrowed $15,000 for 5 years at 8% APR. Using the simple
interest method; by the time you pay off this loan your total finance costs will be closest to which
of the following?
A) $6,000
B) $3,249
C) $3,784
D) $1,200
Answer: B
Diff: 3
Topic: Financing
AACSB: Analytical Thinking
21) A loan that is paid back in a single lump sum payment at the due date of the loan is
commonly called a(n)
A) fully amortized loan.
B) balloon loan.
C) installment loan.
D) secured loan.
E) none of the above.
Answer: B
Diff: 1
Topic: Single Payment Loan / Balloon Loan
AACSB: Analytical Thinking
22) You are headed to the mountains for some climbing this summer and you need some gear.
The local mountaineering shop is offering 6% financing on all purchases before the end of the
month. Your savings account is currently paying 5%, and you are in a marginal tax bracket of
28%. Which of the following is true?
A) Borrow from the mountain shop it is cheaper.
B) Take the money out of savings it is cheaper.
C) It does not matter where you get the money; it will cost the same.
D) You should seek competent financial help.
E) None of the above are true.
Answer: B
Diff: 2
Topic: Interest Rates
AACSB: Analytical Thinking

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23) Your brother, a banker, has just approved a loan for you, an add-on interest loan. You will
borrow $2,000 for one year with a 12% annual interest rate. What is your monthly payment?
A) $166.67
B) $186.67
C) $240.00
D) $256.78
E) None of the above
Answer: B
Diff: 3
Topic: Interest Rates
AACSB: Analytical Thinking
24) What is the name of the interest rate banks charge to their most creditworthy customers?
A) Main rate
B) Blue chip rate
C) Prime rate
D) Premier rate
E) None of the above
Answer: C
Diff: 1
Topic: Prime Rate
AACSB: Reflective Thinking
25) You just received a loan from your banker to buy seed and plant your alfalfa field. The loan
is a discount loan and is for $5,000 for 1 year and the quoted rate was 10%. What is your APR?
A) 10.00%
B) 11.11%
C) 12.23%
D) 14.33%
E) None of the above
Answer: B
Diff: 3
Topic: Financing
AACSB: Analytical Thinking
26) Calculate the interest on $6,000 borrowed at an annual rate of 9% under the simple interest
loan method for 9 months.
A) $270
B) $360
C) $405
D) $450
E) $540
Answer: C
Diff: 3
Topic: Interest Rates
AACSB: Analytical Thinking
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27) Gary is taking out a $5,000 loan for 1 year at an APR of 12%. His bank has offered him a
loan using the add-on method. Using first the financial calculator method and the add-on method
calculate Gary's monthly loan payment.
A) $444.24; $466.67
B) $475.00; $448.94
Answer: A
Diff: 2
Topic: Financing
AACSB: Analytical Thinking
28) The ________ is the true simple interest rate paid over the life of a loan and provides a
reasonable approximation for the true cost of borrowing.
A) APP
B) APR
C) ADR
D) ARR
E) none of the above
Answer: B
Diff: 1
Topic: Annual Percentage Rate
AACSB: Analytical Thinking
29) You have just obtained a personal loan for a new home movie system under the simple
interest method. You have borrowed $12,000 for 9 months at an annual rate of 10%. Your
marginal tax rate is 28%. What are the total interest charges you would pay if the loan is paid off
on time?
A) $1,200
B) $1,080
C) $900
D) $648
E) None of the above
Answer: C
Diff: 2
Topic: Interest Rates
AACSB: Analytical Thinking
30) Which is better, a fixed-rate loan or a variable-rate loan?
A) A fixed-rate loan, because the lender bears the risk that interest rates will go up
B) A fixed-rate loan, because they generally cost less than variable-rate loans
C) A variable-rate loan, because they generally cost less than fixed-rate loans
D) A variable rate loan, because the lender bears the risk that interest rates will go up
E) Neither is necessarily better; the choice illustrates the "risk and return go hand in hand"
principle.
Answer: E
Diff: 3
Topic: Variable Interest Rate Loan
AACSB: Analytical Thinking
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31) What strategy should you use to obtain the lowest possible APR on a loan?
A) Get a variable-rate loan.
B) Keep the term (length) of the loan as short as possible.
C) Make a large down payment.
D) Provide collateral.
E) All of the above
Answer: E
Diff: 3
Topic: Interest Rates
AACSB: Diverse and Multicultural Work Environments
32) Give five things you can do to obtain the most favorable rates on loans, which in essence will
allow you to lower the lender's risk.
Answer:
- Develop a strong credit rating.
- Use a variable-rate loan.
- Keep the term of the loan as short as possible.
- Provide collateral for the loan.
- Put a large down payment toward the purchase.
Diff: 2
Topic: Credit Risk
AACSB: Reflective Thinking
33) Explain why add-on installment loans are more expensive than simple interest loans.
Answer: The add-on method generally results in an APR of close to twice the level of the stated
interest rate because you are paying interest on the original principal over the entire life of the
loan. Even though the amount of outstanding principal keeps decreasing as you pay back the
loan, you still pay interest on the entire amount you originally borrowed.
Diff: 2
Topic: Installment Loan
AACSB: Reflective Thinking
34) Why is the discount method more costly than the simple interest method on a single-payment
loan?
Answer: Under the discount method, with the interest taken out before you receive the loan, you
actually receive a smaller principal than the stated principal of the loan.
Diff: 2
Topic: Single Payment Loan / Balloon Loan
AACSB: Analytical Thinking

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7.3 Getting the Best Rate on Your Consumer Loans


1) Which of the following does not require you to have a good credit rating to issue you a loan?
A) Your family
B) Savings and loan
C) Commercial bank
D) All of the above require a good credit rating to issue a loan.
Answer: A
Diff: 2
Topic: Finance Company
AACSB: Reflective Thinking
2) Which of the following statements would most correctly complete the following sentence? As
the interest rate on a loan increases
A) the loan maturity would decrease (other things held constant).
B) the payment amount would decrease (other things held constant).
C) the amoritization would increase (other things held constant).
D) the payment amount would increase (other things held constant).
E) none of the above.
Answer: D
Diff: 2
Topic: Interest Rates
AACSB: Analytical Thinking
3) Which of the following statements regarding the risk-return relationship is most accurate?
A) Lower credit scores are associated with lower APRs.
B) Higher credit scores are associated with lower APRs.
C) Longer loan length is associated with lower APRs.
D) Shorter loan length is associated with higher APRs.
E) Both B and D are correct.
Answer: B
Diff: 2
Topic: Principle 8: Risk and return go hand in hand
AACSB: Diverse and Multicultural Work Environments
4) With a(n) ________ installment loan, interest charges are calculated using the original
balance, and these charges are then added to the loan.
A) simple interest method
B) partial amortization method
C) discount method
D) add-on method
E) none of the above
Answer: D
Diff: 2
Topic: Installment Loan
AACSB: Diverse and Multicultural Work Environments
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5) Of the following possible sources of credit, which typically has the lowest borrowing rates?
A) Savings and loans
B) Personal finance company
C) Credit union
D) Commercial bank
Answer: C
Diff: 2
Topic: Consumer Loan
AACSB: Information Technology
6) What is the type of loan where the entire interest charge is subtracted from the loan principal
before you receive the money, and at maturity you repay the entire principal?
A) Simple interest method
B) Partial amortization method
C) Discount method
D) Add-on method
E) None of the above
Answer: C
Diff: 2
Topic: Single Payment Loan / Balloon Loan
AACSB: Analytical Thinking
7) Neal's life insurance policy has a cash value of $100,000. He wants to purchase a second
home to rent out. How much can Neal borrow against the surrender value of his life insurance
policy?
A) $50,000
B) $75,000
C) $95,000
D) $100,000
Answer: C
Diff: 3
Topic: Finance Company
AACSB: Analytical Thinking
8) List examples of loans or loan sources that fit into the categories of inexpensive, more
expensive, and most expensive.
Answer:
- Inexpensive: family, home equity loans, secured loans, loans against the cash value of life
insurance
- More expensive: credit unions, S&Ls and commercial banks, unsecured loans
- Most expensive: financing from retail stores, finance and small loan companies
Diff: 2
Topic: Interest Rates
AACSB: Analytical Thinking

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9) Why is the debt limit ratio and 28/36 rule more important to conservative lenders like Banks
and Credit Unions and not so important for lenders like small Finance companies and Payday
lenders?
Answer: Principle 8 states that risk and return go hand in hand. With the conservative lenders
like Banks and Credit Unions, they are lending their depositors money and not their own money.
They are also regulated by the FDIC and NCUA. This means that they generally will not lend
money to people with no or poor credit or collateral, it's just too risky for them to do so. With the
other, more aggressive lenders, it's their investors' money. These investors voluntarily provide
money to earn the higher return associated with riskier loans. Even if a portion of the loans fail,
the return on the performing loans outweighs the losses. These aggressive lenders take advantage
of desperate or naive people who can't borrow from the conservative lenders for whatever
reasons. Desperate and naive people do desperate and naive things, many times causing severe
financial distress.
Diff: 3
Topic: Financial Institutions
AACSB: Analytical Thinking
7.4 Controlling Your Use of Debt
1) The 28/36 rule says that as long as your total debt payments are under 36 percent of your gross
income then you are not overextended.
Answer: TRUE
Diff: 3
Topic: Debt Limit Ratio
AACSB: Analytical Thinking
2) Lenders tend to like to see borrowers put down large down payments for loans because this is
seen as increasing the borrower's desire to pay off the loan since the borrower now has equity in
the collateral.
Answer: TRUE
Diff: 2
Topic: Credit Risk
AACSB: Analytical Thinking
3) Not having health insurance could lead to filing for bankruptcy if one has incurred large
medical expenses and is unable to pay these bills off in a timely manner.
Answer: TRUE
Diff: 3
Topic: Bankruptcy
AACSB: Analytical Thinking

21
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4) Debt consolidation loans are very appealing because


A) they offer liquidation to those who are in good standing with their creditors.
B) they offer hope to those who can't keep up with their current payment schedules.
C) they offer relinquishment of all debts and financial obligations to those who can't keep up
with their current payment schedules.
D) all of the above
Answer: B
Diff: 3
Topic: Debt Consolidation Loan
AACSB: Reflective Thinking
5) Suppose that you are interested in buying a home, but are unsure of how much you can afford.
What is the best way to determine your prospects for obtaining a mortgage?
A) Calculate your debt limit ratio.
B) Figure the 28/36 rule.
C) Determine what your mortgage payment will be.
D) Determine what your income taxes will be.
E) Both B and C are correct answers.
Answer: E
Diff: 2
Topic: Credit Risk
AACSB: Analytical Thinking
6) Many lenders use the 28/36 rule in evaluating mortgage applications. If your mortgage
payment itself is 28% of your gross income, that means that the remainder of your monthly debt
must be ________% or less.
A) 6
B) 7
C) 8
D) 28
E) 36
Answer: C
Diff: 2
Topic: Debt Limit Ratio
AACSB: Analytical Thinking
7) Many lenders will hold Dave to the 28/36 rule in evaluating his application for a mortgage.
What does the 36 mean?
A) A down payment of 36 months is required.
B) A down payment of 36% is required.
C) Debt payments including mortgage must be less than 36% of his gross monthly income.
D) Debt payments must be less than 36% of his monthly take-home pay.
E) Mortgage insurance is required during the first 36 months of the loan.
Answer: C
Diff: 2
Topic: Credit Risk
AACSB: Analytical Thinking
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8) Sharry is interested in buying her first home. Currently her monthly gross income is $3,000.
From this she makes a car payment of $240, a personal loan payment of $300 and a student loan
payment of $85. Based on this information would a bank approve Sharry for a mortgage?
A) Yes
B) No
Answer: B
Diff: 3
Topic: Debt Limit Ratio
AACSB: Analytical Thinking
9) Brenda found out that reputable lenders use the 28/36 rule when determining mortgage
qualification. Brenda currently grosses $6,000 per month. From this she pays a $200 car
payment; a personal loan of $100 and a student loan payment of $90. Based on this information,
would Brenda qualify for a mortgage?
A) Yes
B) No
Answer: A
Diff: 2
Topic: Credit Risk
AACSB: Analytical Thinking
10) What will the courts do if you file Chapter 7 personal bankruptcy?
A) Confiscate most of your assets.
B) Liquidate most of your assets to pay off creditors.
C) Eliminate most of your debts.
D) Allow you a chance to start again financially.
E) all of the above
Answer: E
Diff: 3
Topic: Bankruptcy
AACSB: Analytical Thinking
11) A Chapter 13 personal bankruptcy is characterized by all of the following except
A) you continue to pay at least a portion of most of your debts.
B) you maintain title and possession of your assets.
C) your creditors vote on restructuring your debt repayments.
D) a new debt repayment schedule is determined.
E) you get relief from harassment by bill collectors.
Answer: C
Diff: 3
Topic: Bankruptcy
AACSB: Analytical Thinking

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12) What can a couple seeking to get out of debt do?


A) Avoid future use of credit card debt, except on a emergency basis.
B) Use savings to pay off current debt.
C) See if their creditors will restructure their loans.
D) Seek help from a reputable credit counselor.
E) All of the above are correct.
Answer: E
Diff: 2
Topic: Credit Counselor
AACSB: Reflective Thinking
13) Which of these are possible options for most people who cannot pay their bills?
A) Get help from a credit counselor.
B) Obtain a debt consolidation loan.
C) Declare Chapter 13 personal bankruptcy.
D) Declare Chapter 7 personal bankruptcy.
E) All of the above are possible options.
Answer: E
Diff: 2
Topic: Credit Counselor
AACSB: Reflective Thinking
14) What are some of the leading causes of bankruptcy?
Answer: Major illness: This generally comes with major costs and can mean the loss of a job.
Credit: Easy availability of credit leads to living beyond your means.
Divorce: It's expensive, what with lawyers, child support, alimony, and splitting up assets.
Job loss: Bills continue to come in, and with no income, savings can be wiped out.
Diff: 2
Topic: Bankruptcy
AACSB: Application of Knowledge
15) How do you know how much debt you can comfortably afford?
Answer: By applying the debt limit ratio you can see, from a lender's point of view, the
limitation on consumer debt. It is calculated by dividing your monthly non-mortgage debt
payments by your total monthly take-home pay. Ideally, it should be below 15% because you will
still have some borrowing reserve for emergencies and the unexpected, and it will be easier to
obtain additional borrowing. You should put a maximum of 20% on consumer debt. Once you
pass this point, it will be difficult to borrow more, and your ability to meet your monthly
financial obligations will be severely limited.
Diff: 2
Topic: Debt Limit Ratio
AACSB: Reflective Thinking

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16) Debt consolidation loans can be a very good thing for some people but they can also be
dangerous to some. Explain the benefits and dangers of a debt consolidation loan.
Answer: If you are fortunate enough to have sufficient collateral and credit score to obtain a
consolidation loan with an affordable APR and term, you can generally lower your monthly
payments, especially when eliminating expensive credit card debt. You have to choose however,
whether the fixed payment commitment of an installment loan and, possibly, higher finance
charges over the length of the loan outweigh the financial pressures of the original debt. You also
have to weigh your personal discipline and self control to not run up new debt on top of the
consolidation loan. Some unfortunate people end up worse off with additional debt than when
they started. If you use the equity in your home for collateral for the new loan, now you have put
your home in financial jeopardy. The non-profit Credit Counselors recommend cutting up your
credit cards to remove the temptation.
Diff: 3
Topic: Debt Consolidation Loan
AACSB: Reflective Thinking
17) Samuel is having financial troubles. He owes a significant amount of money to his ex-wife
for child support payments, he is also behind on his student loans and has not paid his taxes for
the last five years. Sam is considering filing for personal bankruptcy. Why might this not be a
wise financial decision for him?
Answer: This would not be wise decision because none of his listed debt: child support, student
loans and back taxes are dischargeable through a bankruptcy filing. He cannot get away from
paying these debts.
Diff: 3
Topic: Bankruptcy
AACSB: Analytical Thinking
7.5 Student Loans and Paying for College
1) Today, about 75 percent of high school graduates choose to attend four-year colleges,
community colleges, technical schools, or the workforce.
Answer: FALSE
Diff: 1
Topic: Student Loan
AACSB: Analytical Thinking
2) Student who are awarded grants must pay back a percentage of the amount after graduation.
Answer: FALSE
Diff: 2
Topic: Student Loan
AACSB: Analytical Thinking

25
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3) Income-based repayment plans are based on a percentage of discretionary income, not the
amount owed, and provide a 25-year term of payments before loan forgiveness.
Answer: TRUE
Diff: 2
Topic: Student Loan
AACSB: Analytical Thinking
4) A 529 plan is a tax-advantaged savings plan designed to encourage parents to save for future
college costs for their children. The plan comes in two forms: pre-paid tuition plans and college
savings plans.
Answer: TRUE
Diff: 3
Topic: Savings for College
AACSB: Analytical Thinking
5) Direct subsidized loans are made only to undergraduates who demonstrate financial need.
Answer: TRUE
Diff: 2
Topic: Student Loan
AACSB: Analytical Thinking
6) The interest that you pay on your student loans will lower your taxable income if you meet
IRS guidelines.
Answer: TRUE
Diff: 3
Topic: Student Loan
AACSB: Analytical Thinking
7) Student loans are loans with federally subsidized interest rates given, based on financial need,
to students making satisfactory progress in their degree programs.
Answer: TRUE
Diff: 1
Topic: Student Loan
AACSB: Information Technology
8) Under a Stafford Loan, parents borrow money for their child's education.
Answer: FALSE
Diff: 3
Topic: Student Loan
AACSB: Information Technology
9) Under a Federal Direct Loan, you don't begin making payments until six months after
graduation.
Answer: TRUE
Diff: 3
Topic: Student Loan
AACSB: Information Technology
26
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10) Student loans are a smart source of financing for school because you only pay part of the
interest charges and the rest is subsidized by the lender.
Answer: FALSE
Diff: 1
Topic: Student Loan
AACSB: Diverse and Multicultural Work Environments
11) Frank ran up a large credit card bill as an undergraduate student, he also took out as much in
student loans as possible. He is now unable to pay his credit card debt and his student loan debt.
However, he has decided to declare bankruptcy to eliminate his debt. Frank will be able to
eliminate his federally subsidized student loan debt by declaring bankruptcy.
Answer: FALSE
Diff: 3
Topic: Student Loan
AACSB: Diverse and Multicultural Work Environments
12) The ________ is the automatic repayment plan with a 10-year term.
A) extended repayment
B) standard repayment
C) income-based repayment
D) graduated repayment
Answer: B
Diff: 1
Topic: Student Loan
AACSB: Analytical Thinking
13) ________ is when a borrower is allowed to temporarily stop making student loan payments
for a qualified reason such as an illness, financial hardship, or serving in a medical or dental
internship or residency.
A) Deferment
B) Delinquency
C) Forbearance
D) Default
Answer: C
Diff: 2
Topic: Student Loan
AACSB: Analytical Thinking

27
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14) When borrowing for college, one thing to keep in mind is that you're not just paying for one
year of school. About half of all colleges practice what is called "front loading of grants," which
means that
A) grants awarded in the fall will be worth more than grants awarded in the spring semester.
B) your grants as a freshman will be more generous than your grants as a sophomore, junior, or
senior.
C) your grants will progressively increase as your graduation date approaches.
D) the more your parents or guardians pay upfront for your college expenses, the less grants you
will receive.
Answer: B
Diff: 3
Topic: Student Loan
AACSB: Analytical Thinking
15) Which statement is true regarding direct unsubsidized loans?
A) The federal government pays the loan's interest while the student is still in school.
B) Such loans are made to undergraduate, graduate, and professional students.
C) Students have to demonstrate financial need in order to receive the loans.
D) All of the above are true.
Answer: B
Diff: 3
Topic: Student Loan
AACSB: Analytical Thinking
16) When do the payments on a Stafford Loan begin?
A) When your school receives the money from the government
B) When your loan balance gets over $5,000
C) You can choose when your payments begin anytime within 24 months of your graduation
date.
D) None of the above is correct.
Answer: D
Diff: 3
Topic: Student Loan
AACSB: Diverse and Multicultural Work Environments
17) A federal direct subsidized loan has tremendous advantages over other types of loans,
including
A) the interest is deferred while you are in school.
B) they have low monthly payments and a 20% balloon payment after 5 years.
C) they use the add-on method to determine your monthly payment.
D) none of the above.
Answer: A
Diff: 3
Topic: Student Loan
AACSB: Analytical Thinking

28
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18) An advantage that direct or subsidized student loans have over other types of loans is
A) the after-tax interest rates are very attractive compared with other loans.
B) you can borrow at a below-market rate, regardless of your credit situation.
C) in an emergency, you can declare bankruptcy and avoid repayment.
D) you have the rest of your life to pay it back.
E) both A and B are correct.
Answer: E
Diff: 2
Topic: Student Loan
AACSB: Diverse and Multicultural Work Environments
19) Name the four common loans available for college students.
Answer: The four common loans include the Stafford Loan, Perkins Loan, Parent Loan, and
Supplemental Loan for Students.
Diff: 1
Topic: Student Loan
AACSB: Analytical Thinking
20) What are the opportunity costs associated with Student loans?
Answer: Depending on the amount you borrow and how long you are in school, you may end up
with a fairly large loan balance to repay upon completion or termination of your education.
Ideally, your education will allow you to obtain a decent salary that is sufficient to allow you a
good standard of living while repaying the loan. Regardless, student loan payments are included
in the debt limit ratio and 28/36 rule so they may prevent you from obtaining additional credit or
a mortgage until you payoff the student loan. Student loan payments can be a burden on young
families with children. You can't avoid or evade student loan debt via bankruptcy either.
Diff: 3
Topic: Student Loan
AACSB: Reflective Thinking
21) Name two tax credits available to help offset education costs.
Answer: American Opportunity Credit: allows you to claim $2,500 per year for the first four
years.
Lifetime Learning Credit: allows you to claim $2,000 per year for college costs.
Diff: 1
Topic: Tax Credit
AACSB: Application of Knowledge

29
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22) According to the Keown book, how do you finance your college education without
mortgaging your future?
Answer: The answer is to understand:
The consequences of your choice of school and of your course of study.
The costs, including tuition and living expenses, and how to borrow less and borrow smarter.
How to manage your money well while on campus.
How to repay your loans without sacrificing your financial goals.
Diff: 2
Topic: Student Loan
AACSB: Analytical Thinking
23) List three reasons why a student-loan borrower may be granted a deferment.
Answer: The borrower might receive a deferment if he or she is enrolled at least half-time in
school, is unemployed, or meets hardship standards.
Diff: 2
Topic: Student Loan
AACSB: Analytical Thinking
24) Describe the four types of student-loan repayment plans.
Answer: Standard repayment (10-year term; you pay the lowest amount of interest): this is the
automatic repayment plan, unless you choose another plan.
Extended repayment (10- to 30-year term): additional number of payments and additional interest
paid.
Income-based repayment (25-year term of payments before loan forgiveness): based on a
percentage of discretionary income, not the amount owed; yields low monthly payments but
additional interest paid.
Graduated repayment (25- to 30-year term of payments before loan forgiveness): starts low, with
monthly payment increasing every two years; yields low monthly payments but additional
interest paid.
Diff: 3
Topic: Student Loan
AACSB: Analytical Thinking
25) Describe in detail the characteristics of the direct subsidized and unsubsidized student loans
from the Federal government.
Answer: Based on income limitations, you may qualify for the direct, subsidized loan from the
government. With these loans, the government pays your interest on your loan disbursements
while you are actively enrolled in school. This prevents the interest on your loans from accruing
interest while you are still a student. Six months after you complete your degree program or
withdraw from school, your loan amoritization payments with interest will start. With a direct,
unsubsidized loan, the interest starts accruing every time you receive a disbursement, resulting in
the interest accruing interest while you are in school leaving you with a larger loan balance and
payments when you start paying the loan back.
Diff: 3
Topic: Student Loan
AACSB: Reflective Thinking
30
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