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Guide to financing your car

Planning to buy a car but cash is a bit tight? Here's some advice to guide you through a potentially expensive decision.

-Buy second hand. New car depreciation is costly

-Don't over commit

-Check out the small print (especially if you are in the risk category of borrower)

-Don't put a car on the mortgage

-Get pre-approved finance but let the dealer think you will be paying cash

-Pay on time

David McLister is the AA's CEO of Driver and Vehicle Licencing has a 30-year banking background and is the organisation's finance expert. "You shouldn't over-extend yourself to buy an asset that depreciates as much as a car does," he says. "Borrowing for a new car is a costly luxury because of that massive depreciation. I have a two-and-a-half year old Audi wagon that's dropped $37,000 in 28 months. Holy hell. But we do it."

The risk is that you take your loan out - and as soon as you drive the car off the lot it's worth less than you've committed to pay. Thus, buying a used car makes sense. A year-old car has already taken its biggest depreciation hit. "If you can live with a car that may not be brand new, but could be the current model, it makes more sense to borrow," McLister says.

Given the financial size of a car purchase it's common for people to borrow whether it's new or used. And there are many institutions happy to lend money - banks and credit unions, building societies and finance companies are ever increasing. Most dealers offer finance options as well. It's best to research all options in the financial market and for the best deal on interest rates.

What are the benefits of pre-approved finance?

Experts we spoke to differed, but it does have one advantage. You know the money you can afford, so you don't waste time looking at cars that are out of your reach. And it gives you the buying power of a cash buyer. The dealer doesn't care where the money comes from - as long as it comes.

Still, the AA advises you don't tell a salesperson you have pre-approved finance; instead say you're a cash buyer. Otherwise the salesperson will know you're a good credit risk and may offer you a better finance deal. That seems like a reason to trumpet your good fortune to the skies, but it can backfire. Dealers often get commission on insurance and finance deals; they may offer a finance 'deal' or a 'free' warranty but not budge on the price.

Whereas a cash buyer has bargaining power. McLister: "things aren't always what they seem. If they drop two percent off finance they take it back somewhere. They don't give you as much on the trade. They're selling a car with a margin, the finance with a commission - they've got several income streams to work with."

Of course, you shouldn't feel disadvantaged by having a loan. McLister: "the unfortunate scenario is that many people are intimidated by having to borrow money, (and) they feel they're at a disadvantage if they have to borrow. They aren't. We'll get the money if it's via them or a finance company."

Is there any situation in which it's better to pay cash? McLister says not. "If you've got savings to buy a car we'd encourage you to invest the saving and use finance. Invest smartly and the amount you earn can offset the interest on the car. Because the interest on investment compounds, but interest on the car doesn't."

Gather Information

It's very much a case of buyer beware. Gather information, look at alternatives, and make a good call about the reputation of the lender. McLister: "it's a minefield and most people are financially illiterate. There's nothing wrong with borrowing as long as you have discipline and a dedicated repayment plan. Those are the guys that get ahead."

Don't over-commit

Again, don't be tempted to over-commit even if you're absolutely sure an expected pay rise will come through. Most finance managers aren't sharks. Their job is to organise a deal that works for everyone.

A balloon payment is a deposit at the end of the term. It can be 35 to 40 percent of the total cost, and it allows you to keep the monthly payment down. Calculating the right balloon amount is a black art.

"We have to be conservative enough to be sure the car is still worth more than the balloon payment at the end of the term," says McLister. Get it wrong, and the punter has the depreciated car - and still owes more than it's worth.

"Generally we trade them out of it and keep them in a new car. Say three years down the track the car's worth 20 and the balloon's 15, they've got five grand equity and could put that into a new car. Or refinance the 15 and keep the car. Or just pay it off in one lump.

"Vehicle financing is very functional in the way it can be varied and structured to suit different scenarios. If you've got someone in a seasonal job - say they're a shearer - you can have higher payments in the summer, and lower payments in the winter when their work has shut down.

Should I put my car on the Mortgage?

Avoid adding your car loan to your mortgage. Banks may not offer that flexibility, but it can be worth asking. McLister says the AA have competitive loan rates from 10.95%, but those with homes - compare it to loans from as little as 5.95% they could be paying for their mortgage.

A $15,000 advance may only add $75 per month (*based on 5.95%) to the mortgage payment, which looks tempting. But don't forget a car loan is usually paid off in three years. You're paying the mortgage for 15 or 20. Do the sums - loan institutions like Westpac, BNZ or Kiwibank include loan calculators on the net. McLister: "Pump in a $15,000 loan for 15 years, or 20 years or 10 years, push the button and you'll see the total repayments and interest, and it shows you the fallacy that most people fall into."

People opting for the mortgage route often compound the problem. Kiwis turn their cars over in three or five years, and another 20 grand is required.

Will I qualify for finance?

The company financing you is taking a risk. The safer its risk, the smaller your deposit and the more flexible the terms. The greater the risk, the more the lender will want to protect itself - so the more you'll pay.

The usual requirement is a full driver's licence and few companies will consider a person who has been made bankrupt.

You may find someone that accepts learner licences and no-deposit deals: what sweetens their risk is the interest they charge - 30 percent isn't unknown. A responsible lender requires a full licence. Expect to pay 25 percent minimum as a deposit. If you've got an excellent credit rating, lots of assets and a stable history you may get a 100 percent loan.

Lenders will do a credit check and ask for background details and even employer or landlord references. If you're a home owner, or you've been at your address or in your job for three years or more, you're seen as pretty stable and a lower deposit will be more likely.

Final tip

Don't impulse buy. Research your options. Snap decisions may backfire both with the car and the finance you organised too hurriedly.

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