Intro to Financing a Car for Teens

Intro to Financing a Car for Teens

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What comes to mind when you turn 15? Getting the latest iPhone? Throwing a birthday party with all of your friends? Perhaps even making a smarter financial decision, and saving your money? Shockingly, most teens anticipate getting their learner’s permit. A 2018 study conducted by the Next Gen of Personal Finance reported that over 44% of teens obtained their driver’s license within the first 12 months of being eligible to do so.

With such a large portion of the teenage world beginning to drive, it’s important to understand the finances behind owning a car.

When it comes to driving these hefty vehicles, many jump to buying a car. However, before entering the DMV, a teen should learn about what paperwork is actually needed to buy a car, and how dealerships profit from customer’s poor financial decisions.

Credit Report

The first document you’ll need to learn about is the credit report. A credit report is a document that allows potential lenders to assess whether they can offer you a loan, and under what terms. Typically, your credit report shows a three digit score that ranges from 300-850, with an ideal credit score being in the 720-850 range. The higher the credit score, the more trustworthy the company views you as a client, and the less perceived risk they’d take while providing you a loan.

The less risk you pose on defaulting a loan, the more value the company views in providing you a better deal, and the lower interest rates you receive on the loan.

Out of Door Financing

“Out of door” financing is a process by which the customer receives the total price of the car before entering the DMV. Knowing the total price of the vehicle before financing the transaction, allows you to easily cross reference the prices of the car and veers your attention towards the better deal. Oftentimes, dealerships trick you into buying a worse deal for the buyer, via lower monthly payments in exchange for higher interest rates over a longer period of time. Keeping track of the total cost is essential in ensuring that you get the best deal.

Saving up for a Down Payment

The third piece of advice is to consider saving up for a down payment on the car, as it tends to reduce your total financing cost of the car. If you’re curious as to why this is, consider checking out our article on the “Time-Value of Money” with this link.

In short, there are 2 main ways of obtaining a car: finance and leasing. Financing a car is done through direct lending or dealership financing.

Financing a Car: Direct Lending

Direct lending means borrowing a certain amount of money from a bank or credit union, and agreeing to pay it back over a certain amount of time plus an interest fee given to the banks for borrowing the money. Once you decide on which car to buy, you use a loan to purchase it. Direct lending allows you to know the credit terms in advance, and what APR (Annual Percentage Rate) you’re paying for. Usually the terms also include the length of the loan, and the maximum amount the dealership will allow you to borrow.

Financing a Car: Dealership Financing

Dealership financing is done through a dealership. You sign a contract with the dealership, and agree to pay the car over a certain period of time, plus the interest fees. The dealer then sells the contract to the bank that services the account and monitors your payments. Although this option introduces a third party, it does allow for more freedom with regards to payment plans, and financing options.

Leasing a Car

Unlike buying a car, leasing a car is the payment of a car for an agreed amount of time and mileage. When you lease a car, you’re paying for the costs of driving the car, not for buying it. This important difference leads to the fact that the cost for leasing is calculated through a car’s ED, or expected depreciation. This is the value that the car is expected to lose over time. Although leasing a car has smaller monthly payments compared to financing a car, you’re still responsible for financing all the damages and servicing for the car.

Final Thoughts

Before you drive to the DMV to purchase that new Tesla, it’s important to understand the behind the scenes, in buying these vehicles. Oftentimes, we find ourselves slogging through the busy paperwork, and end up paying more for these valuable assets.

The next time you see a Christmas deal on the next hottest car, skip the glitz and glory, and make sure to read the fine print: literally!

About the author

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Vyom writes about economics, finance, and education. He hopes to bring awareness for financial literacy through his posts and inspire other teenagers to take initiative and begin saving their own money! He is currently a rising sophomore at American Heritage, in Plantation Florida.