They say there's nothing like the feeling of driving a brand new car out of a showroom. But the purr of the shiny engine and the smell of fresh upholstery can distract drivers from one of the longer-term implications of buying a new car - paying for it.
Every March and September, when new number plates are launched, brings a frenzy of car buying. More than 435,800 new cars were sold in March last year, a fifth of the total number sold all year.
How you pay for your car can make the difference of around £1,200 over the repayment term, according to price comparison website uSwitch.com, which means with the right choice you could opt for those leather trimmings after all ...
Hire purchase
Hire purchase, also known as a car loan, motor finance and conditional sale, financed 43% of all new car purchases in 2005. This method is popular because, as the borrowing is secured against the car, it's easy for applicants to qualify. A hire purchase agreement can be arranged in a matter of minutes before you're given the keys to the vehicle.
How much you borrow depends on the value of any vehicle you offer in part exchange or the amount you put down as a deposit. Typically, this will need to be at least 10%, which tends to be in cash, the value of your old car, or a combination of the two.
The dealer then contacts the finance company, which, subject to a healthy credit rating, pays the loan amount on your behalf. When you buy a car this way it is registered in your name. However, if you default on your payments it becomes the property of the finance company, and you cannot sell the vehicle until you make the final payment.
Most car loans are available for between 12 and 60 months, although you typically choose the time period over which you think you will keep the car. Interest rates at a current average of 10.12% are not competitive, according to uSwitch.
Take this example of buying a Ford Focus TDCi Sport, which costs £12,995. If you can afford to put down a £3,000 deposit you would then have to borrow £9,995. If you took a hire purchase agreement fixed at 10.3% APR, currently available through the Perrys dealership, you would pay £318.23 in the first month, followed by 58 payments of £208.23, and a final payment of £298.23. Your credit costs a total of £2,698.80.
If you had opted for a personal loan from Moneyback bank, with a typical APR of 5.9%, the same credit would have cost just £1,538.80, saving you the considerable sum of £1,160.
Incentivisation
To soften the blow, some dealerships offer incentives such as free breakdown cover or guaranteed asset protection insurance, which protects a final agreed value of your car. But many perks are already part and parcel of buying a new car, regardless of how you pay, says Tim Bowdler, deputy editor of What Car? magazine.
"Three-year warranty and breakdown cover are standard features when buying a new car, although the dealer may 'gold plate' your hire purchase option by mentioning them. You can buy extended warranties separately but they are expensive," he says.
There are some deals worth looking at, however, such as Vauxhall's 0% APR finance over the entire course of the loan. You will need a bigger deposit for this, though, which would usually be in the region of 30%-40%.
However, according to Nick White, director of financial services at uSwitch, hire purchase usually turns out to be an expensive long-term burden. "The average interest rate for a car showroom finance deal is 4.22% higher than the best personal loan rates available, and nearly double the current Bank of England base rate."
Personal contract purchases
More expensive still is a personal contract purchase (PCP). These deals work in the same way as hire purchase, but allow you to defer repaying part of the loan until the end of the agreement, which usually lasts for three years.
This means that during the term you only pay the difference between the full loan and the deferred amount, plus the interest on both parts. "This is known as a balloon payment and although the rates advertised are cheap, over the course of the term you will be paying well over the odds," says Bowdler.
As well as establishing how much you want to borrow and running credit checks, with a PCP you will also need to agree on a final minimum value of the car at the end of the term. This is the sum that will be deferred, and will hinge on anticipated annual mileage. After this time you can pay off the deferred amount and buy the car outright, hand the car back and walk away, or transfer to another PCP.
Although in most cases PCP schemes prove expensive, they can work well for people with small business that can claim back the VAT on what is effectively the lease of a vehicle.
At least customers taking finance straight from the car showroom are well protected - any car retailers offering motor finance agreements must hold a consumer credit licence from the Office of Fair Trading. The motor finance agreement itself is regulated by the Consumer Credit Act 1974.
External finance
It is worth considering a personal loan when making any vehicle purchase. This type of finance is available up to £25,000, and depending on your balance can be taken for up to 10 years, which has the effect of keeping monthly payments low. The cheapest personal loans are usually found online - Masterloan and Moneyback bank, for example, are both offering APRs of 5.9%, while the AA is offering 6.5%.
"Not only is a personal loan cheaper, by organising the loan before visiting the car showroom, people will not feel pressured to get the cash quickly to secure the car of their dreams," says White.
You could also put the deposit or even the entire purchase on plastic. But this only makes sense if the credit card offers a 0% introductory period. Marks & Spencer's &More MasterCard currently offers 0% interest for 12 months, while the Halifax Online One MasterCard is 0% for nine months. However, these rates revert to 16.9% and 9.9% respectively after this time.
It's therefore crucial you have plans to transfer the balance before the first interest payment bites. "If you transfer it to a 'life of balance deal' such as the 3.9% available from Marks & Spencer it could work out the cheapest finance option on the whole market," says Michelle Slade, researcher for cards and loans at Moneyfacts.
Lastly, there is the old fashioned way of paying cash, which means you know where you stand and don't pay a bean in interest. However, the inevitable depreciation incurred when purchasing a new car, might be harder to bear.
"As soon as you drive off the forecourt, you have lost money, although how much will depend on the car," says Bowdler. "Minis, for example, keep their value well, while you could have lost £2,000 off a new Citröen by the time you get home."
For more information, the Financing and Leasing Association has developed a new website to enable car buyers to asses their funding options.
