Teenagers. Desperate for responsibility, not quite experienced enough to handle it.
If your son or daughter is learning to drive, chances are soon they will want their own car. It gives them freedom, the ability to get to work if they need to and teaches them about looking after something expensive.
The problem is you might not be able to afford to buy them a new car with cash. Cheap cars are cheap for a reason, and you will probably worry that it will cost a lot in repairs or be unsafe, so it can be worth spending a little bit more to get a decent vehicle.
Car loans can be a great solution to this problem, but when it comes to a teenager getting a car, what do you do? You can take the loan out entirely in your name, but then your son or daughter won’t feel like it’s really their car and the lack of financial involvement in it might make them take it for granted. If they have to pay for it themselves they are more likely to take responsibility for it.
However for young people, getting a loan is often impossible. They haven’t been able to build up a credit profile so most loan companies can’t approve them – it’s a catch 22.
In this situation you can often help by acting as a guarantor for them. This means the loan is in their name and they are responsible for making the repayments, but you have co-signed the loan to say that you will guarantee any payments they miss. You usually have to live at the same address, but check with the lenders for their specific requirements.
This arrangement basically offers reassurance to the lender that they will be repaid their money, because it is almost impossible for them to judge whether as 17 or 18 year old will successfully make monthly repayments.
When you act as a guarantor, you need to think carefully about the decision. Your instinct may be to help your child out, but there are implications for you and them.
Firstly, the loan will be attached to your name and will appear on your credit file, so defaults can also show up on your report.
Also you need to carefully consider if your child is ready for this commitment. Loans of any sort are a large responsibility. Even if they can afford the monthly payments at the moment, will they be able to keep them up? Additionally, if the car is stolen or written off it can create a financial shortfall – your son or daughter will still have to pay the monthly loan repayments, but they won’t have a car. Insurance payments will cover the cost of the car at the time of the incident, which might be less than the original loan value. This can be frustrating, but could also mean you end up bailing your child out so that they can buy a new car. And remember – young people are proportionally more likely to be involved in car accidents, so there is a higher chance of the vehicle being written off.
Financially, being a guarantor or taking on a joint car loan can make great sense and gives you more options than you might otherwise have, but you need to consider seriously the effect on your financial and credit profile. You also need to make sure your daughter or son is ready for the responsibility and understands the commitment involved, but if they do then this can be a great life lesson for them and will help them to build a credit profile for themselves, which is very useful later in life.
This is a guest post from Kat, a personal finance blogger from Manchester.