Unit 2: Credit and Debt Management

Answer: A — The correct answer is A because the primary purpose of using a 0% promotional period is to strategically reduce debt without interest charges accumulating. A cardholder should develop a concrete repayment plan to pay down the principal balance before the standard APR (typically 15-25%) kicks in after the 12-month period ends. Option B is incorrect because transferring maximum debt increases the total obligation without necessarily addressing the root spending problem. Option C is incorrect because making only minimum payments means little to no principal reduction during the promotional window, leaving a large balance to accrue high interest once the promotion expires. Option D is incorrect because closing accounts would actually harm the credit score by reducing available credit and increasing credit utilization ratio, and it doesn't address the debt strategically. This question tests understanding of how to use credit tools effectively rather than just knowing definitions.

Answer: C — Tom's monthly payment of $25 is less than the interest charged each month, which is $7.50 (18%/12 * $500). This means that Tom is paying more in interest than he is paying towards the principal balance. Option A is incorrect because it would take Tom more than 2 years to pay off his debt. Option B is incorrect because Tom's monthly payment does not cover the interest charged each month. Option D is incorrect because while making monthly payments on time can help improve Tom's credit score, it is not the only factor considered in credit scoring.

Answer: A — Card 2 is the correct answer because it addresses both credit score optimization and interest minimization. Card 2 has a 25% utilization ratio ($500/$2,000), which is the highest among all cards and significantly impacts FICO scores. Payment priority should focus on cards with utilization ratios above 10%, as these negatively affect the credit utilization component (30% of FICO score). Additionally, Card 2 has the highest APR at 18%, meaning the $1,000 payment will save the most in interest charges compared to other cards. By paying down Card 2, Elena reduces both her utilization ratio on that card substantially and minimizes future interest accumulation. Why the other options are incorrect: B) While Card 1 has the largest balance, it has a healthy 40% utilization ratio, which is already reasonable for credit scoring. Prioritizing it over Card 2 ignores the more problematic utilization ratio on Card 2. C) Card 4 has the lowest APR, but debt payoff strategy should balance interest savings with credit score impact. Card 4's 37.5% utilization ratio ($1,500/$4,000) is concerning but still lower than Card 2's immediate impact. More importantly, the 9% APR means interest savings are minimal compared to Card 2's 18% APR. D) Card 3 already has a $0 balance, so there is nothing to pay down. This option tests whether test-takers read carefully and understand that paying a zero-balance card doesn't improve credit scores—utilization is calculated only on cards with balances.

Answer: A — The correct answer is A. This question tests understanding of the debt avalanche method combined with interest rate analysis. Thomas should prioritize the credit card because it carries the highest interest rate (16% APR vs. 4.5%). By eliminating the high-interest debt first, he minimizes the total interest accrued across both loans. With a $500 monthly payment on the $2,000 credit card balance at 16% APR, he would pay it off in approximately 4-5 months while accumulating significantly less interest than if he spread payments. Once the credit card is eliminated, the full $500 can attack the student loan principal, reducing overall interest paid. Option B is incorrect because splitting payments means the high-interest credit card debt continues accruing interest at 16% longer than necessary, increasing total interest costs. Option C is incorrect because the student loan's much lower interest rate (4.5%) means it should be serviced last; the larger balance is irrelevant when the rate is so favorable. Option D is incorrect because it defers debt repayment unnecessarily, allowing compounding interest to accumulate and contradicting the stated goal of minimizing total interest paid. This requires analysis of APR impact and strategic repayment sequencing.

Answer: A — The correct answer is A because this strategy applies the debt avalanche method, which mathematically minimizes total interest paid. The credit card at 18% APR is charging significantly more interest than the 6% personal loan. By prioritizing payments toward the highest-interest debt after meeting minimum obligations, Jennifer reduces the principal that accrues interest at the highest rate, resulting in lower overall interest charges. Option B is incorrect because splitting payments equally ignores the interest rate differential; equal payments don't optimize interest savings. Option C is incorrect because paying extra toward the lower-interest loan is less efficient—the 6% debt costs less to carry, so prioritizing it wastes the opportunity to attack the more expensive 18% debt. Option D is incorrect because focusing on the largest balance (rather than highest interest rate) ignores the cost of carrying debt and may result in paying significantly more interest overall. This question requires students to analyze the relationship between interest rates, payment strategy, and total cost of debt.