Is it better to pay upfront or get a loan when buying a car? Here we look at how to buy a car on finance – from a bank loan to novated lease, or even with a balloon payment.

There’s a well-worn cliché that suggests, next to your house (if you can even afford to buy one of those these days), a car is the biggest purchase of your life, and one that you’ll probably make a couple of times. So, what’s the best way forward?

There are various loan options available and they have their advantages and disadvantages. Some will certainly be better suited than others depending on your circumstances. And don’t forget that once you know what kind of loan you want, it’s important to also make sure you get the best deal on a car loan – something with a low rate and no hidden fees.

Paying cash and buying it outright

There was a time that the only way to buy a car was to pay the whole amount up front. The downside of that was that using ‘rainy day’ money meant that once you’d spent your hard-earned on the car, it was all gone.

Buying outright with money you’ve got in the bank is usually how people purchase second-hand vehicles, or, you use the equity you had in a car when downsizing to totally finance your next purchase and drive away with no more to pay.

On the downside, unless you’re planning to keep that car until it virtually crumbles to dust in your hands, then it might not make real financial sense in buying a car outright with your ‘rainy day’ money.

Getting a bank loan for a car

If you intend to keep the car less than 10 years it’s often worth looking at a personal loan, because you usually won’t have to pay a deposit and there are usually no restrictions on how you use your vehicle (as in, you don’t have set specific mileage, etc). But, which loan though? Well, that’s where it gets complicated.

At the moment interest rates are at all-time lows, but that doesn’t mean a car loan from a bank or finance company will be cheap. As an example, an average car loan for the full price of a new car can range from around 5 to 15 per cent per annum. And that’s another point to watch – ask what the APR is (annual percentage rate) because that’s the amount of interest you will pay on the loan each year. Some companies misleadingly quote x-amount interest but they may be referring only to an equivalent monthly rate.

There may also be additional fees involved in a car loan, including monthly account keeping fees, for example, so always make sure you know what all the costs are, and what you’ll be paying in total.

Can you get out of the loan early by paying any outstanding amount off? Some loan companies make this difficult, and not just dodgy lenders – mainstream lenders can too, so always read the small print and ask those important questions before signing on the dotted line.

Car manufacturer finance loans

Offered through new car dealers, these often appear attractive, offering very low interest rates. But make sure you read the fine print because many depend on you paying a hefty initial deposit. Still, if you are able to do that, some of these loans can be attractive.

Additionally, some car manufacturers are offering a simple form of lease arrangement which starts with you putting a deposit down but includes servicing costs for an agreed period of ownership – usually five years but you can negotiate less too. The initial deposit is up to you, though of course the amount impacts on what the ongoing monthly payments are.

As usual, make sure you are familiar with all aspects of the loan, but for some buyers this type of finance can work well.

Novated lease

Novated leases are an arrangement between yourself, your employer and a car lease or finance company. If your company offers novated car leases it is a form of salary sacrifice which in some circumstances can be very attractive.

For a monthly sum the lease/finance company provides a new car of your choice for a set monthly fee which is taken out of your salary before tax. This has the effect of lowering your taxable income so that you pay less tax.

Depending on your salary if you pick the right price point for your new car, you can end up losing very little in take home pay and have a new car.

Most companies involved in this business buy the car for you and often can negotiate better deals than you can. They can even add on fuel costs as part of the monthly fee (they supply you with a fuel card after you estimate how much you will spend on fuel each month), repairs, servicing, tyre and windscreen replacement. At the end of each year if you’ve gone over and above the agreed mileage then monthly costs going forward are adjusted, but it can be in your favour too if you’ve spent less.

You don’t necessarily have to buy a new car either – novated lease companies usually allow you to opt for a car up to five years old if you want.

If you leave your company you get to keep the car, but if your new company doesn’t allow novated leases it means you either have to buy the car outright or give it back to the lease company, or negotiate a new monthly fee.

Car loans with balloon payments

These are often offered by car dealers and can be attractive on more expensive cars. You pay a deposit, usually at least 10 per cent, and then a regular monthly amount based on the sort of mileage you think you will do and the price of the car. You have a balloon payment at the end. This means that at the end of the term – which is typically five years, but you can arrange less – your car is still worth an agreed amount. At that stage you can pay that amount – the balloon – and keep the car, or give the car back and use that balloon amount as a down payment on another car, and then go through the whole process again.

This finance scheme makes a lot of sense if your company offers a car loan element as part of your salary package. The car loan is an untaxed element of your pay so if you use some or all of that on a lease finance scheme it can work out well. However, there are always tax implications, including fringe benefits tax in some circumstances, so check with your accountant about that.