LO 3.3.1: Design an optimized debt management strategy based on the client’s situation and financial planning priorities.

Question 1

Personal Loans

Answer 1

Most personal loans are obtained through banks or credit unions

• Can be secured, unsecured, installment, or single payment, and with fixed or variable interest rates
• Banks used to be more popular but now credit unions
• • Memberships to credit unions are easier to obtain
• • Credit unions are a competitive alternative to banks bc they have lower interest rates and fees + more personal service

Question 2

Credit cards

Answer 2

Credit card balances should be paid off each month

• Although convenient way to borrow money, use with caution
• Credit cards should only be used if other more reasonable forms of borrowing are not available
• Other risks to credit card holders— credit card fraud and identity theft
• • Check credit reports to monitor credit scores and number of active accounts.

Question 3

Advantages of using credit cards

Answer 3

Convenience, rewards programs, and purchase protection; can help build credit.

Question 4

Disadvantages of using credit cards

Answer 4

High interest rates associated w/carrying a balance; Transaction fees

Question 5

Auto loans

Answer 5

Vehicles depreciate quickly; clients who finance their cars and trucks may find themselves having an auto loan balance greater than actual value of vehicle.

• Clients should use available savings or other funds to purchase a car rather than finance
• Secured by the vehicle
• Terms of 3-6 years, shorter term = higher payments, but less interest paid over life of loan
• Lower interest rates than unsecured loans

Question 6

Advantages of borrowing from a retirement plan

Answer 6

• Ease of borrowing: if vested, credit checks not needed
• Lower interest rates: retirement plan rates are low compared to other lenders
• Simplicity of repayment: repayment of principal and interest by payroll deduction
• No effect on credit rating: retirement plan loans are not reported to credit rating agencies (no impact on credit score)

Question 7

Disadvantages of borrowing from a retirement plan

Answer 7

• No growth of borrowed amount: not going to tax-deferred growth
• Adverse tax treatment: loan repayments are with after-tax dollars, and distributions are taxed
• Possible adverse effect on retirement savings: Difficult to contribute to retirement plans while repaying plan loan
• Retirement accounts could be less than expected
• Tax issues at separation from service: if leaving employer, the loan is due (if not repaid and you’re younger than 59 1/2, early distribution so pay income tax and penalized 10%)

Question 8

Secured loan

Answer 8

A secured loan for which the creditor maintains a security interest in property;

• Property serves as collateral for the debt;
• If debtor falls behind on secured debt payments, lender can repossess the property that secures the debt.

Question 9

Unsecured (signature) loan

Answer 9

Client promises to repay the debt in exchange for the borrowed funds

• In the event of default, lenders can take legal action, but most often will settle for less than amount owed
• This will negatively affect an individual’s credit rating

Question 10

Fixed-rate loan

Answer 10

Interest rate constant until paid in full
* Initial interest rates are higher than variable (adjustable) rate loans, fixed-rate loans offer more security bc the underlying interest rates will not increase considerably during the term of the loan.

Question 11

Variable (adjustable) rate loan

Answer 11

Interest rate adjusts at various intervals throughout loan term; are riskier

• Initial interest rates on these types of loans are typically lower than those of fixed-rate loans.
• Tied to an index, can go up or down depending on the index.

Question 12

Short-term Loan

Answer 12

A loan due within a year (up to and including one year from a specified date)

Question 13

Long-term Loan

Answer 13

A loan due more than one year from specified date.

Question 14

Installment loan

Answer 14

Client borrows a single amount of money and repays the balance w/interest at stated intervals (monthly, quarterly)
* Most loans are installment loans

Question 15

Single payment (bridge) loan

Answer 15

Provides short-term, temporary financing

• Repaid with interest in one lump sum at the end of the term
• Used to provide funds for a time period between two transactions
• • Bridge loan- they’re selling a house to fund the purchase of a house they are buying; set to close, but the close for the house they are buying, is a week ahead of the house that they are buying. Pay off the bridge loan to finalize house they are buying.

Question 16

Why is it important to identify client attitudes toward debt

Answer 16

Debt helps accomplish financial goals such as college education costs, home purchases, and auto purchases.

• Clients should avoid using debt excessively; will create a strain on cash flow
• During data-gathering process-
  
  • discover how clients feel about debt;
  • discuss the causes of excessive, unwanted debt;
  • explain that quick relief is unlikely.

Question 17

How does a financial planner help assist the client with regard to their debt

Answer 17

In these situations, you can assist the client by designing an implementing a debt management strategy.
* In evaluating consumer debt, you should consider the amount of debt and total costs to your client, the consumer.

Question 18

What are the costs of debt when evaluating a client’s debt

Answer 18

The costs to consider include:

* interest payable,
* initiation fees, and
* any bargaining power forgone as a result of using credit rather than cash.

Question 19

Why are clients comfortable with debt while earning an income

Answer 19

they have a means of servicing that debt and the debt will eventually be paid off.

Question 20

Why does a client’s attitude about debt change as they approach retirement

Answer 20

Their primary concern becomes their ability to live a comfortable retirement. Having little or no debt going into this phase will increase the likelihood they can achieve that goal.