What are my car finance options?

Financing a car can be a minefield to the uninitiated, especially when the salesperson starts bandying about terms like hire purchase, novated leases, residuals and balloons.

But despite the confusing nature of the jargon, most of the finance products on offer are fairly simple and with a little understanding you can make sure you are getting the best deal for your situation.

With the wide range of car prices now existing you need to consider the choices carefully. Unless you plan to hand over cold, hard cash for your next car – and if you've ruled out leasing – then you are one of thousands of car buyers annually who finance their purchases through a car loan of some kind.

Your car-buying experience will include two separate purchases – one for the car and one for the car loan. They can be researched and shopped for separately. Research your financing options and check that you qualify for a car loan before visiting dealers to shop for the car.

When car shopping, don't discuss financing until after the price of the car and the value of your trade-in have been settled. Avoid discussing car prices in terms of monthly repayments. Shop for car loans aggressively, comparing them and asking lenders to give you their best rates. Don't view the process as asking for assistance.

Develop a working knowledge of financial terms and arrangements, and have current local interest rates at your fingertips before you discuss financing with the dealership.

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Shop around. Telephoning and searching the Internet for information usually work for obtaining ballpark figures on interest rates. But when you get serious, make an appointment and visit loan officers in person. There are a number of alternatives for finance, ranging from the dealer where you buy the car to credit unions to banks.

Depending on your employment and income, you may find certain financial arrangements generate tax breaks that can significantly cut the bottom line. A visit to an accountant may allow you to buy a better car than you first thought. Key words to check out are leasing, novated leasing and salary sacrifice.

If you are after financing with a bit more flexibility, then you should probably investigate specialised finance companies. These basically fall into two categories; those associated with the banks like Esanda which is 100 per cent owned by the ANZ Bank or those tied in with car makers such as Ford Credit or GMAC. Banks will lend money for either a used car or a new car, but the car company's own financing arm is less likely to finance a used car.

Interest rates vary little between the two types but those associated with the car makers, called vendor finance companies, probably have a slightly wider range of products because they are solely focussed on automotive financing.

Either way they both claim a far greater flexibility than the banks and are able to tailor finance packages and interest rates to individual circumstances. Financing is also usually arranged at the dealer at the same time as you buy the car and approvals can often be made within a couple of hours.

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While your first impression may be to forgo dealer finance as being more expensive than other kinds, it pays to consider the option carefully.

It can be convenient – a one-stop deal. Typically, you can get a car loan approved while you're at the dealership. Convenience doesn't necessarily cost more. Indeed, subsidies available to dealers from manufacturers for the sale of a new car can allow a dealership to undercut other lenders.

Banks are also very active in the car loan market, typically offering a variety of loan types. Some banks give lower rates to customers who open, or already have, cheque and savings accounts with them.

Interest rates at credit unions generally are lower than at other loan sources. If you are a member of a credit union or can join one in order to get a loan, it may pay to shop there.

Another option is to obtain a car loan through a finance company. For people whose credit rating is less than perfect, working with a finance company, either directly or through the dealer, often makes it easier to secure a loan.

The greater the risk to the finance provider, the more interest you pay. The shorter the car loan, the less interest you pay. And if your circumstances are unsettled, consider an insurance policy to cover your repayments if something goes wrong. Some institutions will insist on this safety net but it adds to the cost.

The interest rate is a big factor but because there are several ways of calculating this, the final amount you end up paying at the end of the car loan is the most important figure. You should shop around for the best finance deal just like you would any other consumer product. Some used car dealers will offer special finance rates as an incentive.

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As the name implies, you borrow the money for personal use based on whether you are a good credit risk but some financiers will now monitor the purpose of the finance... how the funds are being used. Depending on your assets and personal circumstances, the amount you borrow and the terms are usually negotiable. Watch for hidden costs like establishment fees.

Buyers with equity in property often establish a line of credit for a pre-arranged loan amount that you can draw on at an interest rate lower than most other loans. You may need to choose between a fixed or variable rate. The down side of a variable rate is that if interest rates soar, your repayments will rise and you could end up in financial strife. That may place your property at risk. The upside is that you pay interest only on the loan amount that you draw down which drops to zero as soon as the money is returned to the account. This can suit buyers who only need access to a loan at certain times of the year.

Unlike personal loans, you don't actually own the vehicle purchased with hire purchase finance until the final repayment has been made, meaning that any missed payments could see you losing your car. For buyers with no credit history or assets, hire purchase is often the only way of breaking the poverty trap of pumping endless funds into a worn-out vehicle.

As long as you're sure you can afford the repayments, hire purchase schemes offer reasonable value, explaining their continued strength in the face of newer finance alternatives. Shop around for the best finance deal.

Leases vary but the principle is the same. A finance institution funds the difference between the purchase price of the vehicle at the start of the lease and its projected residual value at the end. Monthly repayments vary according to the agreed interest rate, length of lease period and the projected residual value. The payments cover the interest and projected depreciation but not the value of the vehicle. At the end, you might choose to purchase it outright for the agreed residual value or you can re-lease it.

What happens if the residual value is higher than what the car is worth? You may have to pay the difference to get out of the lease. Leases are usually structured to provide tax relief and may not be suitable for buyers where this does not apply. Leasing terms and conditions are highly competitive so shop around.

Regardless of their source, all loans can be compared by their Annualised Percentage Rates (APR) to determine their relative cost. While lenders may compute interest charges on instalment loans by various methods, the APR adjusts the actual rates to reflect the loan's true cost per year. As long as the APRs are the same, the costs of any loans you are considering also are the same.

Most financial arrangements are structured so that payments cover mainly interest for the first year or two. If you have to sell the car early, the sale price may not cover the car loan or lease because the car's value will have dropped faster than the amount owing. Extra money will usually be required to break a financial arrangement in the first two years. If a seller invites you to take over the book or pay the balance of a lease or loan, check it out carefully.