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1. To define debt and identify the various
types of debt and bankruptcy.
2. To differentiate between good debt and
bad debt.
3. To analyze the different social and
economic consequences of bankruptcy.
4. To identify the sources and
consequences of excessive debt.
5. To describe the various strategies to
avoid debt and bankruptcy.
6. To analyze debt to income ratios.
2
• Debt
• Bankruptcy
• Avoiding Debt
3
4
• Is a sum of money due to another
• Is an obligation to deliver particular
goods or perform certain acts
according to an agreement, such as
returning a favor
• Is a cause of action in a lawsuit for a
particular amount owed
5
• Can come from
– credit cards
– mortgages
– secured and unsecured loans
– borrowing any amount of money
Secured Loan: legal right to obtain valuable property
(e.g., certificate of deposit, car, boat) of the person
borrowing, in the event they are unable to repay the loan
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• Revolves around two systems:
– open-ended credit
– close-ended credit
7
• Is credit for which debtors are given a
borrowing limit which may be increased or
decreased by the creditor
– credit cards
– department cards
• Accounts for an estimated 36 percent of
consumer debt
Debtor: an individual or business seeking to borrow credit
(cash) from a financial institution
Creditor: institution who lends an individual or business
entity cash to purchase goods
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• Is credit for which debtors are given a
specified amount of credit to purchase
specific consumer goods and intangible
goods
–
–
–
–
car loan (consumer good)
house (consumer good)
franchise startup costs (intangible good)
debt consolidation (intangible good)
Debt Consolidation: taking debt from various
sources and composing it into one debt to obtain a
lower interest rate or payment
9
• In the United States
– consumer debt consisted of more than $2.5
trillion at the end of 2011
– the average household credit card debt is
$15,956
– 36 percent of consumer debt is open-ended
credit
– in 2010, 78 percent of U.S. consumers owned
a credit card
10
• Good debt includes:
– student loans
– real estate loans
– home mortgages
– business loans
• Bad debt includes:
– automobile loans
– credit cards
– department store cards
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• Should be debt which can produce
additional wealth in the long run
– student loans  high wage earning job
– real estate  value increases with the
passage of time
• Should be tax deductible
– reduces your tax liability
Tax Liability: the amount of taxes you owe the government
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• You obtain a student loan
for $30,000
– 6.8 percent interest rate
– repay within 10 years
– making minimum payments of $50
 total interest paid: $11,428.97
 cost of education: $41,428.97
13
• First year salary with an education is
$28,000 and without an education is $22,000
• Over the 10-year term of the loan you
earned:
– $280,000 with a college education (28,000 X 10)
– $220,000 without education (22,000 X 10)
• You have earned $60,000 dollars more than
a person without a college education
(280,000 – 220,000)
• You profited $18,571.03 from your initial
investment of $41,428.97 (60,000 –
41,428.97)
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• Involves purchasing goods with high
interest rate cards
• Can happen when opening a
department card to save 10 to 20
percent on your first purchase
• Even includes automobile loans
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• You purchase a t-shirt for $20 on your credit
card
• You pay 14.99 percent on the purchase
since you did not pay the bill in full at the end
of the month
– the t-shirt cost an additional $2.99 or $22.99
• Two months pass by
– additional interest is charged and the t-shirt cost
is now $26.43
– the t-shirt shrinks, fades and is no longer popular
• Was purchasing the t-shirt for “$20.00”
worth the cost?
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• Often require an automobile loan
– accrues interest  reducing your wealth
• Depreciates over time
– you generally cannot sell an automobile for the
purchase price or an appreciated value
• Requires high maintenance
– registration
– inspection
– oil change
• Do NOT generate future wealth, making an
automobile a bad debt choice
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1. Debt is a sum of money someone owes
you.
A.True
B.False
2. Debt revolves around which of the
following?
A.Open-ended credit
B.Close-ended credit
C.Both open- and close-ended credit
D.Neither open- nor close-ended credit
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3. Open-ended credit accounts for an
estimated 75 percent of consumer debt.
A.True
B.False
4. Which of the following is an example of
open-ended credit?
A.Car loan
B.House
C.Department cards
D.Debt consolidation
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5. Good debt reduces your tax liability.
A.True
B.False
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22
• Is a legal process for debtors to liquidate
their assets and repay their creditor(s)
• Classified into four types:
– Chapter 7
– Chapter 11
– Chapter 12
– Chapter 13
Liquidate: sale of assets; exchanging goods for cash
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• Can be filed voluntarily or involuntarily
– creditors can involuntarily declare a debtor
bankrupt
 if the debtor has 12 or more creditors; three
creditors must petition the bankruptcy courts
• Is the desire to rebuild a debtor-creditor
relationship
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• Involves business organizations only
• Requires a business plan to be
developed and approved by creditors
and a bankruptcy court
• Is the desire to remain in business but
reorganize and pay off debts
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• Affords family farmers an opportunity
to get out of debt without selling their
assets
• Forces family farmers to develop a
plan to repay the debt and run the farm
• Requires 80 percent of debt to be a
result of farm expenses
Family Farmer: a household receiving one-half of
their total income from farming
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• Is available to individuals only
• Forces individuals to develop a plan to
repay the debt
– exempting debtors from paying creditors
for up to three years
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• Will be reflected on your credit report for 10
years (Credit Bureau Documents )
• Becomes a matter of public record (Legal and
Government Documents)
• Results in consequences
– social consequences
– economic consequences
Credit Bureau Documents: items which collect information
not dating back more than ten years which compose your
credit score; includes credit card balances, bankruptcy
filings, and credit card payment history
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• Can effect
– receiving a job offer (economic
consequence)
– obtaining a loan (economic consequence)
– receiving insurance coverage (economic
consequence)
– standing and reputation in the community
(social consequence)
– your ability to rent an apartment or house
(social consequence)
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• You are a landlord
• You have an applicant who has recently
declared bankruptcy
• You are aware of the social consequences
(e.g., difficulty receiving a job)
• Would you rent a dwelling unit to this
person?
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• Can cause devastating economic
losses
• Requires you to sell some assets to
generate cash to pay creditors
• Effects credit score and ability to obtain
future loans
– higher interest rates on open-ended credit
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• Increases costs for other consumers (social
consequence)
• Increases tension within the household
(social consequence)
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• Causes problems for the Federal Reserve Board,
including inflation, changing interest rates, and other
monetary issues
– debt is expressed in a form of monetary
denomination
 debt increases the “monetary supply,”
however the economy is not increasing
resulting in an economic imbalance
– creates industry bubbles  increase in production
– once debt is under control, deflation occurs
resulting in a reduction of consumption (demand)
– the supply and demand curve changes and
disrupts economic equilibrium
Federal Reserve Board: a government agency charged with the
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responsibility to maintain a healthy economy in the United States.
Chapter
Qualifying Debtor
Purpose
Chapter 7:
- Everyone (except
- Expire old debts and
Ordinary Bankruptcy essential services:
begin a clean slate
banks, insurance
- Willing to lose assets
companies & railroads)
- Voluntary or involuntary
Consequences
- Lose assets
- Effects credit record
- Selling of assets makes a
public display of your
financial situation
Chapter 11:
Reorganization
- Partnerships
- Corporations
- Individuals (DBAs)
- Effects net income
- Effects relationship with
creditors
- Effects trust with
shareholders
Chapter 12: Family
Farmer Debt
Adjustment
- Family farmers who
- Family farmers who
- Effects credit record for up to
receive one half of their need help with farms
10 years
total income from the
- Willing to adopt a plan of - Court appointed officer
farm
action
oversees finances
Chapter 13:
Individual Debt
Adjustment
- Individuals only
- Businesses want to
continue operations and
reduce debt
- Has a plan of action
- Individuals not willing to - Effects credit record for up to
lose assets
10 years
- Will adopt a plan of
- Court appointed officer
action
oversees finances
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35
1. Bankruptcy is classified into how many types?
A.Ten
B.Five
C.Four
D.Three
2. Chapter 7: Ordinary Bankruptcy can only be filed
involuntarily.
A.True
B.False
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3. Which bankruptcy classification is the desire to
rebuild a debtor-creditor relationship?
A.Chapter 7
B.Chapter 11
C.Chapter 12
D.Chapter 13
4. Chapter 11: Reorganization involves business
organizations only.
A.True
B.False
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5. Declaring bankruptcy is not a matter of public
record.
A.True
B.False
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39
• Through budgeting your finances
– calculate income sources (fixed and variable)
 salary
 benefits (Social Security, alimony)
– calculate expenses (fixed and variable)
 rent
 utilities
 food
Variable Income/Expense: income or expenses changing
frequently in a short period of time (dividend income,
interest income, utilities)
Fixed Income/Expense: income or expenses not
changing for a relatively long period (rent, salary)
40
• My expenses exceed my income?
– cut down
 do you need to eat out so much?
 are you getting the best prices you can?
– increase income sources
 invest in stacked certificates of deposit
 obtain another job
Stacked Certificates of
– consolidate debt
Deposit: Investing money
 consumer loan
with a bank at a high yield
interest rate; stacking
 home equity loan
allows you to generate
short- and long-term
income
41
• My income exceeds my expenses?
– research investment and savings options
 certificates of deposit
 401(k)/IRA plans
 mutual funds
 stock market
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• Assist in planning financial situation
throughout the year
• Identify shortages before they happen
• Act as a control mechanism in regards
to the way money is spent
• Allow you to see the larger picture and
assist in reorganizing finances to
reduce debt or increase savings
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• By paying more than the minimum
payment
– because finance charges are typically
higher than minimum payments, paying
only the minimum payment causes debt
to increase
• By using the rule of thumb
– rule of thumb: minimum payment +
interest charged + additional 2 percent of
your balance = monthly payment
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In this example, the minimum payment is between
2 and 3 percent of card balance and the interest
rate is 16 percent.
Card
Balance
Minimum
Payment
Finance
Charge
Remaining
Balance
2000
60
320
2260
2260
65
361.60
2556.60
2556.60
75
409.06
2890.66
2890.66
85
462.50
3268.17
If paying only the minimum payment, the card
balance increases by more than 60 percent
over four months, even if new purchases are
not being added.
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In this example, the minimum payment is between
2 and 3 percent of card balance and the interest
rate is 16 percent.
Card
Balance
Minimum
Payment
Finance
Charge
Additional Remaining
2%
Balance
2000
60
320
40
1580
1580
45
252.80
31.60
1250.60
1250.60
35
200.10
25.01
990.49
990.49
28
158.48
19.81
784.20
If paying using the rule of thumb, the card balance
decreases by more than 60 percent over four
months, assuming no new purchases are added.
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• By shopping for new credit cards
− call your credit card company and
ask for an interest rate reduction
− compare interest rates and transfer
balances to low-interest-rate cards
47
• By tapping into your savings
– why earn 1-2 percent on interest when you
are paying 9-30 percent interest to the credit
card industry
• By consolidating debt
– develop a relationship with your bank
– secure a loan paying off all of your
debt at a much lower rate
• By refinancing
– could cost you more in taxes
– consult a financial planning professional
about refinancing options
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• Determines the amount of income
needed to meet the debtor’s total
monthly debt obligations
• Compares sources of income to
fixed monthly obligations
– income: verified by employer (take-home pay)
– monthly obligations: verified by a credit report
• Does not include daily living expenses
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• You want to purchase an additional piece of
property you can use for hunting
• 36 percent debt-to-income ratio indicates you can
afford this new piece of property
– if you were to go over 40 percent you probably
should think about getting a cheaper piece of
property or find a way to increase your income
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Monthly Debt Payments
New Real
Estate
800
Monthly Gross Income
Car Loan
250
Your Gross Income
Spouse's Gross
Income
House Payment
Total Monthly
Debt
Payments:
1200
Income on Savings
150
2,250
Total Monthly Gross
Income:
6,250
Debt-to-Income 2,250/ 6,250
Ratio
3,900
2,200
36.00 %
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52
1. Debt can be avoided through which of the
following?
A.Frivolous spending
B.Investing in high risk opportunities
C.Budgeting finances
D.Employer benefits
2. Which of the following is NOT a solution if
expenses exceed income?
A.Cut down
B.Increase income sources
C.Consolidate debt
D.Mutual funds
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3. A rule of thumb for paying more than the
minimum payment is minimum payment
+ interest charged + additional 2 percent
of total balance = monthly payment.
A.True
B.False
4. Consolidating debt allows you to secure
a loan paying off all your debt at a higher
rate.
A.True
B.False
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5. Debt-to-income ration includes daily
living expenses.
A.True
B.False
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Assessment
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1. Which of the following defines debt?
A.Sum of money due to another
B.Institution which lends an individual or business
entity cash to purchase goods
C.Individual or business which seeks to borrow
credit from a financial institution
D.Legal process for debtors to liquidate their assets
2. Open-ended credit is credit for which debtors are given
a specified amount of credit to purchase specific
consumer goods and intangible goods.
A.True
B.False
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3.
Which of the following is NOT a good debt product?
A. Real estate loan
B. Student loan
C. Car loan
D. Business loan
4.
Bankruptcy is a legal process for debtors to _________
their assets and repay their creditor(s).
A. Improve
B. Liquidate
C. Keep
D. Refurnish
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5.
Chapter 7: Ordinary Bankruptcy must be filed
voluntarily.
A. True
B. False
6.
Which Chapter of Bankruptcy does NOT require a plan
of some sort to be developed?
A. Chapter 7 (Ordinary Bankruptcy)
B. Chapter 11 (Reorganization)
C. Chapter 12 (Family Farmer Debt Adjustment)
D. Chapter 13 (Individual Debt Adjustment)
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7.
Credit Reporting Agencies can report a declaration of
bankruptcy for the remainder of your life.
A. True
B. False
8. Inflation, Interest Rate Ceilings, Monetary Policy are
three issues the Federal Reserve Board encounters as
a result of insufficient debt.
A.True
B.False
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9.
You only lose assets for declaring Chapter 7
Bankruptcy (Ordinary Bankruptcy).
A.True
B.False
10. Which of the following is NOT a way of getting out of
debt?
A.Tapping into savings
B.Opening and closing accounts
C.Debt consolidation
D.Refinancing
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• (n.d.). Retrieved October 6, 2008, from U.S. Census Bureau:
http://www.census.gov/
• (2008). Retrieved October 6, 2008, from Board of Governors of
the Federal Reserve System: http://www.federalreserve.gov/
• Compare Mortgage Rates. (2008). Retrieved October 6, 2008,
from Bankrate.com:
http://www.bankrate.com/brm/news/debt/debt_manage_2004/g
ooddebt-baddebt.asp
•
Garner, Bryan (2004) Black’s Law Dictionary. New York, NY:
Thompson West.
•
Hempel, George & Simonson, Donald (1999) Bank Management
Text and Cases. Hoboken, NJ: John Wiley & Sons, Inc.
62
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