How has the interest rate on my new car rocketed and why have I hardly paid any of the loan off?

I feel I have been ripped off over a five-year-old car I bought 12 months ago.

The annual statement on the loan shows I have paid £149 per month but the balance left to pay on the original £4,300 loan is still £2,806 when I asked for a settlement figure.

It also says I am paying a whopping 17.7 per cent interest. My understanding with the car dealer was that I was paying around 6 per cent interest.

How do hire purchase companies work out the final figure if I want to pay off the loan early?

Beware: There are fears that sales staff are muddying the true cost of the interest offered, omitting fees and failing properly to explain how the deals work

Linda Mckay, of This is Money, replies: Only last month This is Money wrote a comprehensive piece on new car loans [read more].

It seems you are not alone in being duped by car salesmen into taking out hire purchase agreements that turn out to be extremely expensive.

There are fears that sales staff are muddying the true cost of the interest offered, omitting fees and failing properly to explain how the deals work.

I asked a leading car finance group for consumer advice on how the loans are calculated.

Black Horse replied: Motor vehicle finance is regulated according to the Consumer Credit Act 1974 and settlement figures on loans are calculated using the rules set out in this act.

A car finance agreement will show the amount you borrowed and the charges calculated of the full repayment period.

Under the Consumer Credit Act if you settle your agreement early you are entitled to a rebate of some of the interest charges. The formula used to calculate the rebate is called the ‘Actuarial method’.

Using this formula Black Horse allocate the repayments made to date towards interest due and the reduction of the capital balance.

For example: If you borrow £200 to be repaid in two monthly installments, you will pay the first month’s interest on £200 but for the second month you will pay interest on only £100 - so you pay approximately 2/3 of the total interest in the first month and only 1/3 in the second.

The same principle applies however much is borrowed and however long the agreement.

As your reader progresses through the loan period the interest due each month will reduce as the capital balance reduces; the interest payable on the money borrowed is higher at the start of the agreement when more capital is outstanding than towards the end.

So a greater proportion of your installments will be reducing the capital balance as your reader moves through the loan period.

Linda Mckay adds: Before you commit to any finance agreement on a vehicle always read the small print carefully and consider the paperwork away from the pressure of the garage forecourt - do your sums before signing.