Types of Credit

Which of the following is an example of revolving credit?

• mortgage

• credit card

• car loan

• student loan

Answer explanation

Credit cards are revolving credit because when you use them for transactions, you receive a statement balance. As you pay off the money spent on the credit card, you are able to continue using it as needed. Just be careful relying too much on credit card debt. Credit card APRs (interest rates) tend to be high and if you only make the minimum payment, you will be charged interest on the remaining balance that you have.

What is the main feature of installment credit?

• You can borrow money repeatedly up to a limit.

• Interest rates are always variable.

• You repay the loan in fixed payments over a set period.

• Payments are made only when you use the credit.

Answer explanation

An example of installment credit is if you borrow money to pay for a new refrigerator and you have 36 months to pay it off. The best line of credit to get is zero interest for a set period of time. Your monthly payments will be set at the same amount each month. Obviously you can apply extra money to your monthly payments if you want to pay off the credit/loan faster.

What distinguishes secured credit from unsecured credit?

• Secured credit has no interest rate.

• Secured credit requires collateral.

• Unsecured credit is only available for businesses.

• Unsecured credit requires a co-signer.

Answer explanation

Secured debt would be something like a mortgage. When you take out a loan for a house, the house itself could be collateral if the person cannot pay back the loan. The bank could repossess the house to recover any losses from the loan not being paid back.

Which type of credit is best for a large one-time purchase that you plan to repay over several years?

• revolving credit

• open credit

• payday loan

• installment loan

Answer explanation

Installment credit typically has lower interest rates, which makes the overall cost of borrowing much less over the loan period. As payments are made on time and the loan principal decreases, this can improve your credit score.

What is the benefit of using revolving credit responsibly?

• It helps you build your credit score over time.

• You do not have to pay interest.

• You are not required to make any payments.

• It automatically increases your income.

Answer explanation

You don't have to pay interest on revolving credit, such as a credit card, if you pay the full statement balance. That is what you owe for the month that you used the credit card. Using revolving credit is especially beneficial for your credit score because you are proving that you can use credit on a continual basis and pay it off in a timely manner.

What is the primary difference between a credit card and debit card?

• Debit cards always charge interest, but credit cards do not.

• Credit cards require a PIN, while debit cards do not.

• A credit card uses borrowed money, while a debit card uses funds from your bank account.

• Debit cards help build credit, while credit cards do not.

Answer explanation

A debit card is used to pay for every day expenses such as food and gas. It comes out of your checking account when you use it. When a credit card is used, it allows you to buy something now but pay it off at a later date.

If you make only the minimum payment on your credit card each month, what will happen?

• Your credit score will automatically increase.

• Your balance will be paid off quickly.

• Your credit limit will increase automatically.

• You will pay more interest over time.

Answer explanation

When you only make the minimum payment, you are avoiding late fees, but you will also pay more interest over time because it will take you longer to pay off the balance.

What does a credit report include?

• a list of your assets and net worth

• your history of borrowing and repayment

• a summary of your monthly income

• recommendations for improving your credit

Answer explanation

Each year you are entitled to a free credit report per year from each of the three credit reporting agencies- Experian, Transunion, and Equifax. By accessing your credit report, you can understand your lending position and identify errors and fraud.

Which of the following describes consolidation debt?

• Debt used to invest in multiple properties

• Borrowing money to refinance an auto loan

• Using a credit card to pay off existing loans

• Combining multiple debts into one loan with a single payment

Answer explanation

There are two benefits to consolidation. One is to combine multiple monthly payments on debt into a single payment. The other is to make the repayment on your debts less expensive.

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?

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

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

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

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

Answer explanation

When you apply an extra payment toward the loan principal each month, it reduces the loan payoff period and you will pay less in total interest.