Seven top ways to pay for a new car

Buying a car is always expensive, so choosing the best way to finance your purchase is vital...

We all know that running a car can be expensive. However, if you're hoping to purchase a brand new one in the near future, how should you finance it?

Save, save and save some more

Perhaps the most obvious and cheapest way to pay for a new car is to save up for it! Simply set up a direct debit to transfer a regular amount of money into a savings account each month - preferably one paying a decent rate of interest - and watch the funds build up. Read Savings rates at highest levels in two years for more advice.  

Personal loan

If saving up isn't a good option for you - and let's face it, it might take a while to do so - you could consider taking out a low-rate unsecured personal loan. Alliance & Leicester, M&S and Nationwide are currently offering loans at an interest rate of 6.7%.

Just make sure you're realistic about the term of your loan. New cars depreciate in value the minute they leave the showroom, so you don't want to still be paying for your car long after its value has hit rock bottom. And keep an eye open for early repayment charges - penalties you are forced to pay if you want to pay off your loan early.

For further tips on personal loans, read New market-leading 6.7% loan.

Credit card

Another way to pay is by using a 0% new purchases credit card. This means you won't have to pay any interest on your purchase for a set period. For example, the Tesco Clubcard Credit Card offers a 0% purchases period for 15 months - so you can enjoy those 15 months completely interest-free!

Of course, if you don't pay off the balance by the time the interest-free period runs out, you'll be hit with a hefty interest rate. So at this point, you'll need to transfer your debt onto a 0% balance transfer card, such as the Barclaycard Platinum with 20 Month BT Visa, which offers an interest-free period on balances for an impressive 20 months. But remember you'll need to pay a transfer fee (3.2% in this case) to do this.

Dealer finance

When buying a new car, the dealership will often try to 'wow' you with fabulous finance deals. Often these state you can purchase a car interest-free over a period of say, four years. But while they can be tempting, you should only take out deals like this if you will be able to pay off the loan completely over those four years.

Of course, not every dealership will be offering interest-free deals, but rates may seem pretty low. However, it's important not to simply focus on how much you will be paying each month, but find out how much the deal will cost you over the total term. Many deals are not interest-free, and if they're not, you should always compare these deals with the rates you'd get if you simply took out an unsecured personal loan.

So it's well worth shopping around to make sure it's definitely the best deal before you sign the dotted line.

It's also worth remembering that by accepting an offer at the dealership, you're much less likely to be able to haggle on the car price!

Hire purchase

Under the terms of a hire purchase agreement, the finance provider owns the car until you've made every repayment. You usually put down a small deposit and then make fixed monthly payments for a set period.

As with dealer finance, it's worth investigating how the agreement you're being offered compares to a personal loan - so make sure you ask for the 'total amount repayable' figure. And don't forget to check the small print for any extra fees or charges.

Once you've paid half the sale price of the car, you can either continue with the payment plan or return the car and walk away.

Of course, this sounds good in theory, but be warned that the lender can take back your car if you're unable to keep up with your payments, and you're also liable for any damage that occurs.

What's more, if the car gets written off in an accident, you're unlikely to receive any insurance money - even if the accident wasn't your fault - and you'll have lost your car. So you could end up paying out a lot of money for nothing. To find out more about hire purchase, read Eight tips about car hire purchase agreements.

Personal Contract Hire

Personal Contract Hire (PCH) is a form of car leasing which allows you to choose the car you want, how long you want to lease it for (usually between two to five years) as well as agree a maximum mileage and monthly payments.

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The benefit of PCH is that monthly payments tend to be lower than financing a brand new car with a loan or hire purchase. This is because you are effectively renting the car, not buying it. You therefore don't have to worry about the car depreciating in value, as it's not your problem. The car is yours until your lease contract expires, at which point you must give the keys back to the company, choose another car to lease, or simply walk away.

Just be aware you'll be asked to hand over a deposit of around three months' payments,  and that PCH contracts are usually pretty inflexible - so if you break the terms of your contract, you will face hefty penalties. If you exceed your agreed mileage, for example, you will be charged for every mile you go over. And if you overestimate your mileage, you'll be paying more than necessary. So taking out a PCH contract will only be worth it if you can make an accurate estimation of your annual mileage.

And bear in mind that you'll never actually own the car - so you won't have anything to show for all those payments you've been making when the contract comes to an end.

Personal Contract Purchase

Alternatively, you could consider Personal Contract Purchase (PCP). This works upon the same principle as Personal Contract Hire, but you can keep the car if you choose to. You'll also be offered what's known as a Guaranteed Future Value for the car.

Again, you pay off part of the cost of the car over a period of three or four years - but in this case the Guaranteed Future Value and your deposit will be subtracted from the cash price of the car and the monthly payments will be based on the balance (plus interest).

When your contract comes to an end, you'll have three options. You can either pay the Guaranteed Future Value and keep the car, or hand it back and walk away, or you can use the difference between the Guaranteed Future Value of the car and the actual value as a deposit towards your next car.

Hopefully, the above tips will help you to decide which is the best option for you! Good luck!

This is a classic article updated for 2011.

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