Exercises: Debt Management, Bankruptcy, and Alternative Financial Services

Describe two warning signs that a person has too much debt. Then list two actions that could be part of a plan for repaying debt.

Name the two main types of personal bankruptcy that people file as individuals: Chapter 7 and Chapter 13. Match each description to a chapter: (a) liquidation, in which certain assets may be sold to pay creditors; (b) reorganization, in which the debtor follows a court-approved repayment plan over several years.

A payday loan lender gives Marcus a two-week loan of $\$300$ and charges a fee of $\$45$. How much must Marcus repay at the end of two weeks? What is the fee as a percent of the amount borrowed?

Priya has three debts: a credit card with a $\$3,000$ balance at 24% APR, another card with a $\$1,200$ balance at 18% APR, and a car loan with a $\$6,000$ balance at 7% APR. She has an extra $\$200$ per month beyond the minimum payments.

(a) Under the "avalanche" method, which debt gets the extra money first? Why?

(b) Under the "snowball" method, which debt gets it first? Why?

(c) Name one advantage of each method.

Jayden is considering two options for his debts: working with a nonprofit credit counseling agency to set up a debt management plan (DMP), or hiring a for-profit debt settlement company that tells him to stop paying creditors and save money in an account.

Compare the two options, mentioning at least three differences, such as fees, effect on credit, risks, and how debts are repaid. Which seems safer, and why?

Emma borrows $\$400$ from a payday lender with a $\$60$ fee for a two-week term. She cannot repay on time, so she pays the $\$60$ fee to "roll over" the loan for another two weeks, and she does this 4 times before finally repaying the $\$400$.

(a) How many total fees does she pay, and how much is that in dollars?

(b) How much does she pay in total, including the original $\$400$?

(c) Explain how this shows a debt cycle.

Daniel has $\$38,000$ in unsecured debt, mostly credit cards and medical bills. He earns $\$2,600$ per month after taxes, and his essential expenses are $\$2,300$. He owns a car worth $\$7,000$ with no loan and has no other significant assets. He is falling behind on payments and is considering bankruptcy.

(a) Explain how Chapter 7 and Chapter 13 would each work for his situation.

(b) Describe two long-term consequences of filing for bankruptcy.

(c) Before filing, name two alternatives he should consider and explain why each might be better or worse.

(d) Recommend a course of action with reasoning.

Aiden needs $\$500$ for a car repair. A payday lender offers a two-week loan with a $\$75$ fee. A credit union offers a small personal loan of $\$500$ at 18% APR to be repaid over 6 months, and a credit card has a cash advance at 28% APR.

(a) Compute the effective cost of the payday loan as a percent of the amount borrowed for the two weeks, and estimate the annualized rate by multiplying by 26 two-week periods.

(b) Estimate the simple interest for 6 months on the credit union loan, using $I = Prt$, and for the cash advance if repaid after 6 months.

(c) Rank the three options by cost and explain why a payday loan often leads to a debt cycle.

(d) Describe one way Aiden could avoid needing such a loan in the future.