Teaching Financial Literacy to Teens: Cars and College
The two biggest expenses on many teens' radars are cars and college. Without enough cash to pay for these large expenses outright, many teens (and parents) borrow money.
Secured and Unsecured Loans
There are two types of loans: secured and unsecured. A secured loan is backed by collateral (something of value that the lender can take if you default on the loan). Because the collateral reduces the lender’s risk, interest rates are lower than for unsecured loans. A car loan is a secured loan: If you stop making payments, the lender can take the car and sell it to recover some of the money.
An unsecured loan, on the other hand, is not backed by any collateral. Because this exposes the lender to more risk, interest rates are comparatively higher. A student loan is a type of unsecured loan.
Buying a Car
In general, you must be at least 18 years old to be approved for a car loan. If your teen is not yet 18, you (or another adult) can be a co-signer on the loan. You can get a car loan from banks, credit unions, finance companies and car dealerships. It often pays to shop around to find the best loan terms, including the most favorable annual percentage rate (APR), fees and finance charges. (For more, see Getting a Loan Without Your Parents.)
Before your teen buys a car, help your teen understand that paying for the car is only the first expense. Associated costs – including insurance, gas and maintenance (and any tickets and resulting increase in insurance premiums) – should be taken into consideration when deciding whether a car makes financial sense. If these expenses will be too much of a financial strain, encourage your teen to wait. (For related reading, see The True Cost of Owning a Car.)
Because you’ll likely be a co-signer on the loan, it’s in your best interest to make sure the payments are made on time and in full each month. If your agreement was that your child would be responsible for the full payment each month, hold him or her to it. Resist the urge to bail him or her out. However, if you're a co-signer, you need to find a way to do this without destroying your credit in the process.
To avoid a bailout, consider telling your teen that you’ll cover a specific number of monthly payments over the life of the loan – in essence, a payment pass. That way, if your teen really does get into a bind one month, you are not bailing him or her out – you’re just holding up your end of the agreement. Point out that the pass should only be used if necessary, and can be applied to the final X number of payments if they haven’t been used yet.
Paying for College
There's no doubt about it – college is expensive, and costs are only rising. Aside from tuition, a college's "sticker price" also includes expenses like meals, housing, fees and books. These costs can be viewed as an investment in your child's future: People with a bachelor's degree or higher earn more and enjoy more job security than people with an associate's degree or high school diploma.
One way to reduce college expenses is to take classes at a community college, where tuition is typically low. Many classes are transferable to four-year institutions through articulation agreements, which are intended to provide a simplified and guaranteed transfer process between community colleges and four-year institutions. The agreements typically outline the specific courses (and required grade point average) that will transfer to the partner four-year institution. It’s a good idea to check in advance to make sure your child's classes will transfer.
Many communities now offer high school students the opportunity to earn a two-year college degree by the time they graduate from high school. These "Early College" and "Concurrent Enrollment" programs are free to eligible teens and are an excellent way to both challenge high achievers and save significantly on college costs.
If you and your teen need help paying for college, you have some options, including:
- Financial Aid. Federal Student Aid (FSA) provides more than $120 billion each year to help more than 13 million students attend college. FSA programs include the Pell grant, student loans and college work study programs. The first step is to complete the Free Application for Federal Student Aid (FAFSA). Apply early for the best chance of receiving nonfederal student aid.
- Federal Loan Programs. If grants and scholarships are not enough to cover college expenses, you can explore federal loan programs. You must first fill out the FAFSA to apply for federal loans – which include Federal Direct Loans and Federal Perkins Loans.
- Private loans. A private student loan is issued by a lender, such as a bank or credit union. These loans typically have higher interest rates than federal loans, require a credit check and do not offer deferment options. For these reasons, it’s generally better to exhaust federal student loan options before seeking a private loan.
Tip: Visit the Federal Student Aid website for information about grants, scholarships, loans, work-study jobs and to fill out the Free Application for Federal Student Aid (FAFSA). The site has lots of helpful information, including checklists for academic and financial preparation.
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