Bypass the credit jam and drive loan costs down

This week, new cars will roll off forecourts up and down the country as the 58 registration is introduced. And despite endless warnings about the dire effects of the credit crunch, much of this spending will be financed through credit.

But the financial information site Moneyfacts.co.uk has found that failing to shop around for the best deal on a car, home improvement or wedding loan could cost you 14 per cent more than it should – a mistake that could leave you thousands out of pocket. And if you really do have to borrow money, your funding options are getting increasingly expensive. As a result, it may be worth looking at more unusual ways to get your hands on the cash.

USwitch.com, a price comparison site, says that a loan of £8,000 spread over four years will cost you £317 more in interest than it did 12 months ago. And it's worse for smaller loans. To borrow £1,000, you will now pay an average of just under 20 per cent APR, a jump of almost 3.5 percentage points in a year. What's more, borrowing criteria are getting stricter as lenders try to reduce the risk of bad debt. Almost 1.4 million people, according to banking industry estimates, have been refused an unsecured personal loan since the credit crunch kicked in a year ago.

Borrowing large amounts on a credit card is often the most expensive way of financing a big purchase. And your chances of moving balances to a zero per cent rate are getting smaller as lenders continue to rein in their risk in this arena too. Since the credit crunch started, the average interest rate on balance transfers has risen from 15.11 per cent to 16.49 per cent now.

But that's not stopping us borrowing. Credit card lending is growing by an average of £179m every three months. If you really want to go down the plastic borrowing route, the best standard interest rates include Barclays' Simplicity at 6.8 per cent APR, or Capital One's "One low rate with cashback" at 8.5 per cent.

Or you can secure your borrowing on your home. The interest rates may be a little lower, but in the current economic climate, David Kuo of financial advice website Fool.co.uk says they are worth avoiding. "If you secure your loan on your property, you only have to miss one repayment and you put your home in jeopardy," he warns. "Lending criteria is tight now, but it is worth looking for an unsecured loan because the company won't be able to take your house off you if you run into trouble."

But you don't have to go to a traditional lender to borrow. Zopa (uk.zopa.com) is a "social lending" network of private individuals lending and borrowing money. Borrower members state how much they need and why, and then bid for the loans offered. To reduce the risk, the borrower's credit rating is made available to lending members, who are liable for only £50 per loan. The borrower sources the whole loan from a number of lenders.

"We look at the credit scores of people looking to borrow," a spokesperson says. "Lenders make an offer detailing the duration, amount and rate of the loan, and borrowers snap up the ones they like the look of." Zopa earns money by charging borrowers a £94.25 transaction fee and lenders a 1 per cent annual servicing fee.

"This is a much more personal way of getting a great deal," Mr Kuo adds. "It's safe and you can often get better interest rates than you could hope for elsewhere."

If the loan is specifically for that new motor, there are endless dealer finance packages available. These seem easy to set up when you buy the car, and you may get a few discounted perks if you take the dealer's package. But these are very rarely the cheapest deals, and because new cars rapidly depreciate in value, you could quickly find you are paying around 10 per cent interest on something that is not worth anywhere near what you paid for it. In effect, you could be signing up to the car equivalent of negative equity.

One solution is a personal contract purchase, Mr Kuo suggests. "This is a loan arrangement where you buy the car but the dealer takes it back after a period of time. So you only borrow the difference between the new value of the car, and what it will be worth at the end of the period."

A £10,000 car, for example, may be worth £6,000 three years on, so the buyer borrows only £4,000. "The interest rates are usually around 8 or 9 per cent, less than the 10 per cent or more you would pay for straightforward dealer finance," says Mr Kuo, "and you are paying that on a much smaller debt." You will have to stick to a specific mileage, have full insurance and maintain a full service history, though.