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How financially literate are you?

According to a 2007 survey conducted by LendingTree, nearly five in ten Americans (48 percent) are uncomfortable with the total amount of household debt they are carrying. Take this financial literacy quiz to find out if you have the knowledge you need to build a sound financial future.

Choose the correct answers:

1. What is the highest recommended percentage of your after-tax income that should be spent on housing?
a) 10 percent
b) 25 percent
c) 30 percent
d) 45 percent

2. What is the maximum percentage of your budget that you should aim to spend on transportation?
a) 20 percent
b) 15 percent
c) 10 percent
d) 5 percent

3. When it comes to credit cards, it’s better to have:
a) No credit cards.
b) One credit card and carry a balance from month to month.
c) One or more credit cards, but pay off the balances every month
d) One credit card that is never used

4. If you purchase a new sofa for $1200 on a credit card with an 18 percent interest rate and only make the required minimum payment each month (2% of the balance), how long will it take to pay it off?
a) Four years
b) 10 years
c) 25 years
d) More than 40 years

5. What do your payments go towards in a fully-amortizing mortgage?
a) The principal only
b) The interest only
c) The interest only initially, and then a combination of interest and principal
d) A combination of interest and principal

6. If you take out an adjustable rate mortgage with a margin of 2 percent and an original index of 4.5 percent, what will your mortgage rate be at your adjustment if the index rises to 6 percent? (Not taking into consideration rate caps.)
a) 6 percent
b) 8 percent
c) 8.5 percent
d) 9 percent

7. If the market value of your home is $300,000 and the balance of your mortgage is $180,000, how much home equity do you have?
a) $75,000
b) $100,000
c) $120,000
d) $180,000

8. What is a smart use of home equity?
a) A vacation
b) Credit card consolidation
c) A major expense, such as a new boat
d) All of the above

9. One of the best ways to save money for an emergency fund is to:
a) Deposit everything you have left at the end of the month into a savings account.
b) Set up a regular automatic transfer from your checking account to a high-yield savings or money market account.
c) Wait until you have accumulated a large sum and then purchase a certificate of deposit (CD).
d) Invest regularly in the stock market.

10. How many months of expenses should you set aside in an emergency fund?
a) One to two.
b) Three to six.
c) Six to eight.
d) Eight to twelve.

Answers:

1. What is the highest recommended percentage of your after-tax income that should be spent on housing?

The answer is c. Unless you live in an area where accommodation is particularly expensive, such as New York City, 30 percent is a good percentage to aim for. Spending less than 30 percent is even better, especially if are carrying a heavy debt load.

2. What is the maximum percentage of your budget that you should aim to spend on transportation?

The answer is b. This should include car payments, insurance, gas, parking and transit.

Weren’t sure about these answers? Learn how to create a budget and how to save by reading Smart ways to budget.

3. When it comes to credit cards, it’s better to have: .

The answer is c. In order to build a strong credit score, which is a key component of your financial future, it is best to use a couple of select, low-interest credit cards and pay the balances in full every month.

4. If you purchase a new sofa for $1200 on a credit card with an 18 percent interest rate and only make the required minimum payment each month (2% of the balance), how long will it take to pay it off?

The answer is d. In fact, it will take you just over 50 years to pay off the sofa. The total interest you’d pay would be almost $3500, bringing the final cost of the sofa to nearly $4700. It’s best to avoid using high interest cards to purchase items that you are unable to pay off quickly.

For more ideas on using credit wisely, read Smart ways to use credit cards.

5. What do your payments go towards in a traditional fixed rate or adjustable rate mortgage?

The answer is d. In a traditional fixed rate or adjustable rate mortgage, you are always contributing to both interest and principal with every payment. This is an effective way to build equity in your home. Beware of interest-only mortgages that provide low monthly payments but do nothing to help you build equity.

6. If you take out an adjustable rate mortgage with a margin of 2 percent and an original index of 4.5 percent, what will your mortgage rate be at your adjustment if the index rises to 6 percent?

The answer is b. Since the margin remains constant throughout the life of a loan, changes in the index rate dictate how your mortgage rate will change at each adjustment date. Therefore a 2 percent margin plus a 6 percent index rate equals an 8 percent mortgage rate.

Did you miss question 5 or 6? Read Choosing the right home loan.

7. If the market value of your home is $300,000 and the balance of your mortgage is $180,000, how much home equity do you have?

The answer is c. Your home equity is the difference between the market value of your house and the balance of your mortgage.

8. What is a smart use of home equity?

The answer is b. Using your home equity to consolidate high-interest credit card debt can be a smart decision. However, using your home equity to finance a vacation or to purchase a luxury item can be a risky move. Remember, a home equity loan is not free money. You now have to make monthly payments toward this loan in addition to your first mortgage. And, if you can’t keep up with your loan payments, you could lose your home.

For more information on using your home equity, read Smart ways to use your home equity.

9. One of the best ways to save money for an emergency fund is to:

The answer is b. A high-yield savings account is one of the best ways to earn a good rate of return while keeping your savings liquid in case you need to access them quickly in case of an emergency. If you “pay yourself first” after every paycheck, you’ll be more successful in building a healthy savings account.

10. How many months of expenses should you set aside in an emergency fund?

The answer is b. Three to six months of expenses is a good benchmark to aim for. Don’t forget to account for any extra expenses that you may incur, such as tuition fees for your college-bound child.

Make sure you’re saving your money wisely, read Smart saving choices.

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What your score indicates:

8 to 10: You are financially literate. Chances are you’re already on the fast-track to building a successful financial future.

6 to 7: You are financially aware. You have a basic grasp of sound financial practices but rereading the answers to the questions you missed could help you to become better prepared to manage your money wisely.

Less than 5: You could benefit from learning a little more about smart money management. A good place to begin is by reading the other articles in the LendingTree Smart Borrower Financial Literacy Guide.

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 Visit the Financial Literacy Guide.

 

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