Car buyers gear up for the summer of '53

Just over two and a half million new cars are set to be sold this year, many of them with the "53" registration plate, according to the Society of Motor Manufacturers and Traders. But if you plan to take delivery of a shiny new car next week with the latest number plate, make sure you're not going to regret taking out the finance package you use to pay for it.

Few of us have enough cash saved up to buy a new car outright. In most cases, we rely on some form of finance to foot the bill. In fact, half of all personal loans taken out are for the purposes of buying a new or used car. But while we may spend weeks choosing which car to buy, deliberating over the make, engine size and colour, we don't spend nearly as much time as we should deciding how to finance the purchase.

The AA reveals that half of car buyers (51 per cent) go no further than their own bank when applying for a loan, while just over a quarter (27 per cent) rely on the car dealer for funding. They are certainly the easiest options but in many cases they are also the most expensive.

"These can be the most costly places to arrange car finance," says Neale Phillips, general manager of financial services at the AA. "It's really surprising that people don't seem to spend just a few minutes shopping around for the best deal."

If you are trying to keep costs to a minimum you may be tempted to opt for the dealer's personal contract leasing plan (PCP). But while the monthly payments may be low, you will have to fork out several thousand pounds at the end of the plan if you want to keep the car.

For example, if you buy a new Peugeot 206 1.4 litre GLX (costing £10,700 on the road) through the PCP offered by a Peugeot dealer, you can decide how long you want to take to pay the money back. You might opt for, say, 36 months and put down a deposit of £1,000. A computer then calculates your monthly payments, taking into account the mileage you are likely to do over that period and the value of the car at the end of it.

Allan Bern at Perrys of Milton Keynes, a Peugeot dealer, says that if you were to clock up approximately 6,000 miles a year, the car would be worth around £4,000 after three years. This is subtracted from the initial cost - in this instance £9,700, allowing for the £1,000 deposit - leaving £5,700 to be repaid over the 36-month period. The monthly payment is £158.33; at the end of three years you can either give the car back or buy it outright if you stump up the remaining £4,000.

If you can't afford it do this, you will have to return the car to the dealer, leaving you back at square one again.

If PCP doesn't appeal, the best way to pay for your car is to take out a personal loan. Most dealers will offer you a loan but these have higher annual percentage rates (APRs) than you can get elsewhere.

Loans from Peugeot dealers, for example, have an APR of 15 (see table, right). So the 206 would cost £329.74 a month, or nearly £13,000 over three years, if you put down a £1,000 deposit.

But there is no need to pay a higher APR than 7 - less than half the interest charged by the dealer. The financial services website moneysupermarket.com lists 22 different providers charging an APR of less than 7. The cheapest deal, offered by Northern Rock, is 6.3 per cent; this works out at £295.64 a month for the 206, or a total of £11,643.04 over 36 months if you include the £1,000 deposit.

You would save £1,287.73 by taking out a loan from Northern Rock rather than the Peugeot dealer.

Even if you buy a car via a website such as Jamjar.com you can find cheaper loans than those offered by dealerships or banks. You don't have to buy the car itself from Jamjar.com to apply for a loan, but in this case it might be worth it, as the 206 is on offer for £9,879.

Although its typical APR is 8.9, Jamjar.com has a loan for the 206 with an APR of 6.7 - one of the cheapest deals on the market.

When you take out a personal loan, you will usually be offered payment protection insurance, which is a lucrative sideline for the lender. This optional insurance is certainly not cheap: Jamjar.com charges an extra £34.16 a month in the case of the Peugeot 206, or £1,229.76 over the term of the loan.

While your loan payments are covered if you die - and, with some policies, if you become too ill to work or if you lose your job - such insurance tends to be overpriced compared with other insurance policies. And bear in mind that if you already have life insurance, this may provide a lump sum to cover your debts in the event of your death. In that case, loan payment protection would be an unnecessary extra expense.