FIN 420 Week 2 Credit and Debt Management Example

Two Credit Cards, Two Car Loans and a Student Loan: Ordering the Whitfields' Payoff, Protecting Their Credit Score and Deciding Whether to Consolidate

[Student Name]

University of Phoenix

FIN/420: Personal Financial Planning

Week 2 Assignment

[Instructor Name]

[Date]

The Whitfields and their debts are composites written for a model paper; credit rules, scoring factors and research findings come from the sources listed and are stated generally.

The Whitfields, the composite Phoenix couple from Week 1, freed $250 a month for debt repayment beyond their minimums. Their debts are a store card with $2,300 at 29.9 percent interest and a $25 minimum, a bank card with $7,500 at 24 percent and a $150 minimum, a car loan of $15,500 at 6.9 percent, a second car loan of $12,000 at 11.5 percent and Jasmine's federal student loan of $21,000 at 5.5 percent on a standard ten-year plan. Five lenders each want a payment, but only a plan decides which of them gets the extra dollars, and that choice can save or waste thousands. This paper makes that choice.

How Card Interest Accrues

Credit card interest is usually charged on the average daily balance at a daily rate, the annual rate divided by 365 (Kapoor et al., 2020). At 24 percent, a $7,500 balance accrues about $4.93 a day, or about $150 a month, roughly the whole minimum payment. That is why the bank card balance has barely moved in two years: the minimum covered the interest and little else. The store card's 29.9 percent rate charges even more per dollar.

Two Payoff Methods

The avalanche method directs every extra dollar to the highest-rate debt while paying minimums on the others, then rolls that payment to the next highest rate. The snowball method pays the smallest balance first for a quick win. For the Whitfields, the two orders are the same for the first card, since the store card has both the highest rate and the smallest balance. The difference comes next: the avalanche turns to the bank card at 24 percent, then the 11.5 percent car loan; the snowball would turn to the second car loan of $12,000 only after the bank card, but would rank the car loans by balance rather than rate.

Paying $425 a month toward both cards, the $175 of minimums plus $250 extra, starting with the store card, clears the store card in about ten months and the bank card about 22 months after that, roughly 32 months in all. Total interest on the cards over that period is about $3,600. Paying only minimums would take many years and cost several times as much.

How People Actually Repay

Gathergood et al. (2019) studied people holding several credit cards in the United Kingdom and found that most did not direct extra payments to the card with the highest rate. Instead they spread repayments in proportion to balances, a habit the researchers called balance matching, which raised interest costs. The Whitfields' previous pattern, paying a little extra on whichever bill arrived first, was similar. Writing the order down and automating the extra payment to one card at a time avoids that habit.

The Balance Transfer Offer

The bank card's issuer offered to move the store card balance and the bank card balance to a new card at 0 percent for 15 months with a 3 percent transfer fee. Moving $9,800 would cost a fee of $294 but avoid most of the roughly $3,600 of interest the cards would otherwise charge. The risk is that any balance left after 15 months returns to a rate near 25 percent. At $425 a month, about $6,400 would be repaid within the promotional period, leaving roughly $3,700 at the high rate. Raising the payment to about $675 a month clears the $10,094 balance, fee included, within 15 months. The couple found the extra $250 by pausing Maya's $100 college contribution for those months and trimming restaurants and allowances by another $150. The couple accepted the transfer on that condition.

Consolidating With a Personal Loan

A credit union offered a three-year personal loan at 12 percent to consolidate the cards. It would reduce the rate and give a fixed end date, but it costs more than the transfer offer, and paying off the cards with a loan can tempt people to run the cards up again. The couple chose the transfer and kept the loan offer as a backup if they missed the 15-month target.

The Car Loans

The second car loan, at 11.5 percent, is the next target once the cards are cleared. Refinancing it at a credit union rate near 7.5 percent would save about $500 a year in interest. The first loan at 6.9 percent is not worth paying early while higher-rate debt remains.

The Student Loan

Jasmine's federal loan carries 5.5 percent, the lowest rate the couple pays. Federal loans offer income-driven repayment plans that set payments as a share of discretionary income and may forgive remaining balances after many years, along with deferment and forbearance in hardship. Program rules have changed frequently in recent years and should be checked on the official federal student aid website before any switch. Because her payment is affordable and the rate is low, the couple will keep the standard plan and not prepay.

Their Credit Scores

Credit scores weigh payment history most heavily, followed by the amount owed relative to limits. Their cards are at about 70 percent of their limits, which depresses their scores. As balances fall, utilization drops and scores should rise, which will matter when they apply for a mortgage in three to four years. The couple should keep the store card open with a zero balance, since closing it would reduce available credit. Under federal law they can obtain free credit reports and dispute errors; Jasmine found a closed account wrongly shown as past due and filed a dispute.

Why Regulation Matters

Agarwal et al. (2015) studied the federal law of 2009 that limited credit card fees and required clearer statements and found that it reduced the fees consumers paid by billions of dollars a year without a matching rise in other charges. Some protections now help households like the Whitfields, but understanding their own debts remains their responsibility.

Rules to Stay Out

The couple adopted three rules: no card balance carried past the due date after the transfer is paid, irregular costs paid from the savings account set up in Week 1 and any new purchase over $500 discussed and waited on for a week.

Conclusion

The Whitfields will clear their credit cards within 15 months using a balance transfer and a payment of about $675 a month, then target the 11.5 percent car loan and leave the low-rate student loan on schedule. Ordering debts by rate, automating payments, protecting their credit scores and setting rules against new balances turn a pile of bills into a dated plan.

References

Agarwal, S., Chomsisengphet, S., Mahoney, N., & Stroebel, J. (2015). Regulating consumer financial products: Evidence from credit cards. The Quarterly Journal of Economics, 130(1), 111-164. https://doi.org/10.1093/qje/qju037

Gathergood, J., Mahoney, N., Stewart, N., & Weber, J. (2019). How do individuals repay their debt? The balance-matching heuristic. American Economic Review, 109(3), 844-875. https://doi.org/10.1257/aer.20180288

Kapoor, J. R., Dlabay, L. R., Hughes, R. J., & Hart, M. M. (2020). Personal finance (13th ed.). McGraw Hill Education.