Types of Credit - Unit Test

1. Which of the following statements comparing credit and debit cards is TRUE?

• Far more businesses accept credit cards than debit cards

• Credit cards pull money directly from your bank account, while debit cards get their money from Visa or Mastercard

• Credit card companies provide you with a monthly statement, while debit cards do not

• With debit cards, you're spending your own money at point of sale, but with credit cards, you're getting a loan that you need to pay back later

Answer explanation

The correct statement highlights that with debit cards, you use your own funds directly, while credit cards allow you to borrow money, which must be repaid later. This distinguishes the two types of cards effectively.

2. Which of the following is most likely to represent a fixed rate, secured debt?

• A student loan

• A credit card

• A prepaid debit card

• An auto loan

Answer explanation

An auto loan typically has a fixed interest rate and is secured by the vehicle itself, making it a clear example of fixed rate, secured debt. In contrast, student loans and credit cards may vary in rates, and prepaid debit cards are not loans.

3. Which of these statements best explains why it's often a good idea to pay more than the monthly amount due on an amortized loan?

• Every time you pay extra, the lender will reduce the interest rate they're charging by a small amount

• The extra payment will be applied to the principal amount you owe, which will pay down your debt more quickly

• The extra payment will be applied to the interest you owe, which will reduce the overall cost of your loan

• Amortized loans typically have much higher interest rates than credit cards, so they're the best place to put your extra cash

Answer explanation

The extra payment will be applied to the principal amount you owe, which will pay down your debt more quickly. This reduces the total interest paid over the life of the loan.

4. If you are having trouble making auto loan payments and are really following a tight budget, which recommendation below represents the WORST advice?

• Find an extra source of income by taking a second job, working longer hours, or borrowing from family if they can afford to help

• Stop making payments on some of your debts so you can focus on getting the most expensive or largest debts under control

• Continue making all payments and call your lenders and see if you can negotiate lower monthly payments, lower interest rates, or longer terms

• Explore whether a free or non-profit credit counseling service could help

Answer explanation

Stopping payments on some debts can lead to severe consequences, such as damage to credit scores and increased debt due to penalties. It's crucial to maintain payments and seek alternatives instead.

5. When loans are amortized, monthly payments are _______ , while the amount of your monthly payment applied to interest ________ and the amount of your monthly payment applied to the principal _______ over time.

• Constant, Increases, Increases

• Constant, Decreases, Increases

• Variable, Decreases, Increases

• Variable, Decreases, Decreases

Answer explanation

When loans are amortized, monthly payments remain constant. However, the portion of the payment that goes to interest decreases over time, while the portion applied to the principal increases, leading to faster debt reduction.

6. Taylor is about to go car shopping, and she has $5000 saved that she can use for a down payment while still having extra cash in her emergency fund. She expects the exact model car she’s looking for to cost $35,000. If her top priority is having the lowest monthly payments possible, which advice should she follow?

• Put in $0 for your down payment, and choose a loan with a short term length

• Put in $2500 for your down payment, and choose a loan with a short term length

• Put in $3500 for your down payment, and choose a loan with a long term length

• Put in $5000 for your down payment, and choose a loan with a long term length

Answer explanation

Putting in $5000 for the down payment reduces the loan amount to $30,000. Choosing a long term length spreads payments over more months, resulting in lower monthly payments, which aligns with Taylor's priority.

7. Shira is trying to decide between getting a debit card, a prepaid debit card, and a credit card. Which statement is true?

• All 3 cards are completely different

• Debit cards and prepaid debit cards are the same

• Debit cards and credit cards are the same

• All 3 cards are completely the same

Answer explanation

All three cards serve different purposes: a debit card links to a bank account, a prepaid debit card is preloaded with funds, and a credit card allows borrowing up to a limit. Thus, they are completely different.

8. Credit card disclosure: "Your due date is at least 25 days after the end of the billing cycle. We will not charge you interest on new purchases provided that you have paid your previous balance in full by the due date each month." Identify the true statement.

• If you make the minimum payment on your card within the 25 day period, the credit card company will not charge you interest

• If you pay your previous balance in full after the due date, the credit card company will not charge you interest

• 25 days is an exceptionally long period without paying a credit card bill

• The 25 days after the end of the billing cycle is referred to as the grace period

Answer explanation

The statement about the 25 days refers to the grace period, which allows you to avoid interest on new purchases if you pay your previous balance in full by the due date. This is a standard practice in credit card agreements.

9. A loan with a shorter term length will have __________ monthly payments, and you will pay __________ in total interest.

• higher, less

• higher, more

• lower, less

• lower, more

Answer explanation

A loan with a shorter term length results in higher monthly payments due to the same principal being paid off in a shorter time. However, you pay less total interest because the loan is paid off faster.

Select the statement below that accurately describes a characteristic of a credit card.

• You owe the same payment every month

• You must have money deposited into a checking account to use the credit card for purchases

• Making full payments on-time every month is the only way to avoid interest charges

• They do not charge interest

Answer explanation

The correct statement is that making full payments on-time every month is the only way to avoid interest charges. Credit cards typically charge interest on any unpaid balance, making timely payments crucial.