What You Need to Know if Your Teen is Considering a Car Loan

Are you considering a car loan for your teenager? Teens are able to get their driver’s license by the age of 16 in most states, and many of those teens begin searching for the first vehicle at the same time. While some parents may encourage teens to obtain a car without using a loan, there are cases when it may make more sense for your teen to take on some debt when they purchase their first car. But before you decide whether this is the right step, there are some things you need to consider.

Age of Teens and Car Loans

As excited as your teen may be to purchase their first auto, the first thing they need to understand that is until they reach the age of 18, they will be unable to secure a loan. This is because in order to enter into an enforceable contract, you must have reached the age of consent. If your teen is below the age of 18, they cannot obtain a loan for an automobile or for any other purpose.

Vicious Circles: Need Credit to Obtain a Car Loan

Once your teen has reached age 18, they may still face some challenges when attempting to obtain a car loan. Most teens have yet to establish their own credit lines, which means when an auto lender pulls their credit, they will find no history.

Good news is, this does not necessarily mean it is impossible for a teen to get a car loan. It merely makes the process more difficult. There are often programs available through car dealerships, colleges, and local banks geared teen car loans enabling them to obtain credit for purchasing a new car. Your teen should be taught the importance of understanding the terms and conditions associated with a car loan before agreeing to accept any loan.

Work History and Teen Car Loans

Lenders generally base their lending decisions on several factors, one of them being their work history. Most teens searching for a car loan may not have an extensive work history or may have a history of working part-time or seasonal jobs. This is a good time to emphasize to your teenager how important a strong work history will be to their financial future.

Higher Interest Rates for Teen Car Loans

In most cases, a car loan which is offered to a teen driver will be offered at a higher interest rate than those which may be offered to a well-established borrower for the same vehicle. There are several reasons for this including the fact many lenders believe that teens who are borrowing money to purchase a vehicle are inexperienced with credit and may therefore be a great default risk.

Co-Signers and Teen Car Loans

Parents are often asked to cosign a car loan for teens. This can make sense for the teen because it may mean a lower interest rate and more favorable terms. This is also a good way for the teen to establish a credit history. Before you agree to cosign a loan for your teen to purchase a car however, there are some additional things you should keep in mind regarding your credit score and your liability for the car loan.

Your credit score may be impacted. This is because credit reporting agencies use a formula that includes credit utilization to calculate your credit score. While the credit is the primary responsibility of the loan’s maker (in this case the teen), you are a cosigner and therefore you are legally responsible for the debt as well. If your currently have a high credit utilization, your overall credit score could drop significantly as a result of being a cosigner on a loan.

You are legally liable for the loan if your teen fails to make payments. If you are cosigning a loan, should your teen fail to make payments and loses the vehicle to repossession your credit will be impacted because legally, you are responsible for the debt that remains unpaid. Have a discussion with your teen before agreeing to cosign for their loan and make sure they keep you informed if they are going to be making payments late or skipping payments, so you do not face credit issues down the line.

Your teen’s enthusiasm for purchasing a car can be contagious and should be celebrated. Car loans are a big responsibility and in addition to making regular payments on a car loan, your teen will also be responsible for maintaining the vehicle in working order and paying for insurance. Make sure you have an honest discussion with your teen before they apply for a car loan. Remember, the more your teen understands the importance of maintaining good credit, the better the chance they will have a strong financial foundation for building for the future.

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All data provided by the Home Mortgage Disclosure Act, at cfpb.gov updated Dec, 19
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