April 5, 2008

A short time ago the AA did some research that showed that car buyers spent an average of one month researching what car they were going to buy, but less than a week studying how they are going to pay for it.

Such hurried decisions can lead to expensive mistakes, especially if you end up taking overpriced credit from car dealers, as many buyers do.

These days there is a wide range of bewildering finance schemes to help you get behind the wheel of a new or used car – and for less money than you think.

Here we run through the various options.

Add to the Mortgage

Releasing some money from your property to buy a car is probably the cheapest way in terms of the interest-rate you’ll pay, given that mortgage rates are available at around 5%-6% – considerably cheaper than personal loan rates which vary between 7%-10%.

It’s relatively quick and simple to do, though there may be an arrangement fee of a few hundred pounds to release the funds, unless you have a flexible mortgage which allows you to access your equity whenever you wish.

However, if you do add the cost of a car to your mortgage, you should always remember to make overpayments to clear the extra debt as quickly as possible, otherwise the money you spend on the car will end up accruing a fortune in extra interest over the long mortgage term. With so many people now changing their mortgage when their discount period is up this will present the most logical point to add to the mortgage and upgrade your car without incurring another mortgage set up fee.

Pros: Probably the cheapest rate of interest.

Cons: The loan is secured against your home. Although the APR may look low, the longer you take to pay off the loan the greater the total cost of the credit will be.

Cost: £15,000 at rate of 6% on mortgage term of 20 years will mean monthly repayments of £107.46 and cost a total of £25,790.40 an extra payment of £10,790.40 but if the extra money was paid off over 5 years the extra premium would be £289.99 and cost a total of £17,399.40 making the extra cost of credit a more bearable £2,399.40.

Personal Loans

Personal loans are probably the simplest way to borrow, with loans available from high street banks and specialist lenders.

To gauge the real cost, always ask for a “total cost” figure, including interest, after the full term has expired.

Because personal loans work in a variety of different technical ways, some of which are fairer than others, this total cost figure can be lower on deals which appear to have a higher rate of interest (don’t ask how, it will make your head spin, they just do!).

The lowest total cost figure should generally be the one to go for, but also look out for expensive early repayment penalties.

Pros: You get to own the car outright from the start, and many personal loans are relatively cheap at the moment.

Cons: Some loans may be secured against the car which can then be repossessed if you default on payment. Check for early repayment penalties if you pay off the loan before the end of the agreed period.

Cost: Rates vary considerably, but assuming a £15,000 loan at a rate of 7.4% with monthly repayments over three years would be £465.90 monthly totaling £16,772.57, and over five years, £299.86 per month, totaling £17,991.42.

Personal contract purchase plan (PCP)

This is the type of finance plan most car retailers will try to sell you, largely because it is the most expensive. It works like this. The retailer establishes a guaranteed minimum future value (GMFV) for your new car.

This is the amount they estimate the car will be worth after the contract period ends You pay a deposit — typically 10% to 20% of the car’s value — then fixed monthly repayments for the duration of the contract (usually between two and five years). When the contract period finishes you can either just give the car back and walk away, or pay off the GMFV — sometimes called the “balloon” payment — and keep the car yourself.

Pros: Monthly repayments are lower.

Cons: You often have to pay the car’s list price rather than haggling. Sometimes the contracts place limits on annual mileage which seriously diminish the MGFV if exceeded.

Hire purchase

With this very traditional finance plan you make a deposit then borrow the remainder from the finance company, making repayments over an agreed period, usually between one and five years. You do not own the car outright until the end of the period, so if you default on your payments for some reason the retailer could come and take the car back from you.

HP plans also tend to be expensive, with typical APRs exceeding 10% and handling fees included in the contracts. Usually best avoided.

Pros: Easy to arrange and since the showroom earns a commission on the HP deal you may be able to haggle on the car’s price.

Cons: Expensive and the car belongs to you only after the final payment.

Personal Contract Hire and Contract Hire

Contract Hire is simply a rental agreement where a you make regular payments for the use of the car over periods one to four years.

With a personal contract hire agreement you have use of a car for a contracted period – usually referred to as the ‘lease period’. The car is not yours to own. Instead, you make fixed monthly payments to a leasing company for the duration of the contract – and when the contract expires you simply return the car to the leasing company or take out a new personal contract hire deal.

Payments are calculated in a similar way to PCP deals. The personal contract hire company will work out the ‘residual value’ of the vehicle – that is its estimated value at the end of the contractual period once depreciation is taken into account.

To estimate this value, the company will ask you to stick to a strict mileage limit while you drive the car – exceeding this limit could see you penalised at the end of the term.

To determine your payments, the company will deduct the estimated future value from the retail price of the car – and you pay the difference in monthly instalments.

Pros: Fixed prices – You can hire both new and used cars at fixed prices and not have to worry about interest charges. This can help you budget.

Cost effective – The monthly instalments for a personal contract hire agreement will generally be lower than those of a personal loan.

Road fund licence – This should be included in the agreement.

Maintenance packages – Most personal contract hire deals will include maintenance packages so you don’t have to worry about the general upkeep of the vehicle.

Cons: Comprehensive car insurance – You will not be able to take out third party car insurance, you’ll need a comprehensive deal as the car is not yours.

You never own the vehicle.

No option to buy – Unlike a personal contract purchase agreement, there is no chance to buy the vehicle at the end of the contract.

Contract Hire

Contract Hire is a variation that suits businesses who want to reduce the financial risk by hiring rather than owning, also meaning they don’t have the administration work involved in selling and maintaining the car.

If you are a VAT registered business, a proportion of the rentals may be tax deductible. Contract Hire is also classified as an operating lease for taxation purposes, and is therefore regarded differently to "purchase" contracts so that your business may benefit from certain other tax advantages.

When you come to buy a new car there are a wide range of methods that you can use to fund your purchase. If you take a little time to plan how you’re going to pay for your new car you will be in the best place to make your money work most efficiently and will almost certainly end up paying less in the long run. If you familiarise yourself with the different options you will have a greater chance of getting the sort of finance package that suits your needs. Whatever form of car credit you opt for always make sure that you have detail of the overall cost because without it you’ll have no reference point for comparison.

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