A three-way between you, your employer and your car financier might sound risqué – but it’s not quite as exciting as the name suggests.
This little agreement, aka a novated lease, does have its perks though. And like any financial decision, it’s important you’re aware of the potential pitfalls (as well as the benefits) of agreeing to something without doing your homework first.
In this blog, we’ll pull back the sheets and explain what a novated lease is, and whether it’s all it’s cracked up to be.
Before we get into things, we’d like to remind you that while we do our best to give you the correct info, we can only provide basic information. We can’t tailor it to your exact circumstances. We recommend you check with your accountant and/or financial advisor before making any decisions.
What is a Novated Lease and How Does It Work?
A novated lease occurs when you incorporate a car into your salary package as part of a salary sacrifice arrangement. You may also have the opportunity to incorporate the vehicle’s ongoing costs (eg fuel, car insurance, services, etc). If so, this is usually referred to as a ‘fully maintained novated lease’.
For the purposes of this article, we will simply refer to this opportunity as a ‘novated lease’.
As mentioned earlier, three parties are involved in the leasing of this car, which will be new or near new:
- Your leasing company (aka financier)
- Your employer
You can choose to buy a used car with your novated lease (usually no more than a couple of years old) or a brand-spankin’ new one.
When you lease, you’re essentially ‘borrowing’ the car from the leasing company and paying it off over time. They can often purchase the car with a ‘fleet discount’ from the seller, which is usually a car dealer. You agree to make payments from your salary to cover the expected vehicle depreciation and wear and tear over the life of the lease (most commonly between two and five years).
At the end of that lease period you are usually left with an amount left owing on the car. You can choose to pay this off in a number of ways, which are detailed below.
What Discounts and Savings Apply to Novated Leases?
Buying cars is a core part of a leasing company’s business. It’s what they do. If bought from a dealer, the car can be purchased as an operational expense and the GST on it claimed back – which means an opportunity to pass on those savings to you.
Given this financier buys lots of cars, they’re usually able to negotiate a ‘fleet discount’ = more savings.
Your leasing company does all the paperwork (niiiice) and organises with your employer to deduct the repayments and car operating costs out of your pre-tax salary on your behalf. This is how your taxable income is reduced.
A novated lease can mean significant tax savings. Cha-ching!
In the process, your employer also benefits from discounts to Fringe Benefits Tax (FTB) too. So, it’s a win-win.
More buying capacity and less tax
The discounted purchase cost means you get better buying power. This might mean you choose to buy a more expensive car for less than what you would through a regular car loan. Is it time for that fully-electric Audi?
Importantly, you save precious dollars on tax because your taxable income is reduced by the total of the lease payments you make over the financial year. Yes!
What about at the end of the lease?
- Start a new lease by trading your current car for a new model.
- Extend your lease by refinancing the residual balance and keep the same car.
- End your novated lease by paying out the residual in full (buying the car outright).
What you decide to do will depend on your circumstances. We’ll explain.
So… Is it Cheaper to Buy or Lease a Car?
While this might all seem like rainbows and unicorns, there are pitfalls to be wary of. And, depending on your situation – like how much you travel and how long you intend on keeping your car – a regular ol’ car loan can be more economical over the long term.
Feeling bamboozled by all the info? Keep on reading.
Novated Lease Explained: The Pros and Cons
If, like us, you love the sound of reducing your taxable income, taking the hassle out of car repayments, then you’ll be interested to learn these are just some of the pros. What are the others?
The pros of a novated car lease
- Budget friendly monthly payments: Your leasing payments don’t cover the total car cost. Instead you’re paying for the use of their car and the cost of depreciation while it’s on lease, so monthly payments are cheaper. This is why you have a residual balance at the end of the lease.
- Hassle free maintenance and car costs: Because the cost for these (e.g. services, fuel, repairs, insurance, etc) is bundled into the lease agreement and paid for you, without you having to do a thing.
- Update your car often: Be the envy of your friends and family with a new (or near new) car.
- Yummy tax benefits: Get more money in your hot little hands by reducing your taxable income and therefore tax payable each year.
Now let’s get some balance and take a look at the negatives of a novated lease.
The cons of a novated car lease
- You don’t own the car: You’re technically borrowing it over the term of the lease, so it’s not classed as an asset.
- Potential limited choice of car: Depending on your financier and its relationships with different manufacturers, you may be limited to the available cars they offer.
- You can’t modify the car: If you’re a rev head, you might find this disappointing. Leasing companies don’t like you modifying their car.
- Driving restrictions: When you negotiate your lease, you agree on the total number of kilometres travelled each year (and the expected wear and tear it endures). Go over and you might be slogged extra fees.
- High long-term costs: While the initial and monthly payments are more affordable, the total cost of the lease is often higher – particularly if you keep your car for a longer period.
Car loans: The Pros and Cons
Of course, the alternative to leasing your car is paying for it in cash or applying for finance to cover the purchase cost. You can apply for car finance a few ways:
- Through the dealership directly
- Shop around yourself, and apply direct with a lending institution
- Use a broker to help you find the best interest rate and loan terms
Beware of higher interest rates, inflexible terms and a potential lack of support offered by dealership car finance. It pays to get quotes from various institutions. If in doubt, Money Smart has some great tips on what to consider when applying for car finance.
However, a loan is the way to go if you’re wanting to own your car from the get- and don’t have the cash to pay for it straight up.
The pros of car loans
- You own your car: A traditional car finance agreement secures the loan against your car. Meaning you own the car and it is classed as your asset.
- You have full choice and control: You can choose any car and loan to suit your circumstances.
- You can modify your car: Because the car is yours, you can make any changes to it you want to.
- Drive it as much as you want: Road trip anyone? There are no restrictions on driving your car as much or as little as you like.
- Sell when it suits you: You have absolute freedom about when you sell and for how much. You can’t sell a leased car until you fully own it so the money you pay towards your lease is irredeemable until then.
There are some potential pitfalls to car loans too. Let’s go through them.
The cons of car loans
- Higher monthly payments: A car loan pays off the total cost of the car (instead of its use while you lease it).
- Maintenance and running costs are your responsibility: Not only are you fully responsible for the payment of these costs, they come out post tax. So, you pay more tax and have to budget for maintenance, rego, insurance and so on, out of your higher income than you would if you leased.
- Selling can be a hassle: Without the buying power of a leasing company – you’re left to trade or sell your existing car, and if you’re not leasing the next one, you’ll pay market price for it too.
- Depreciation: New cars depreciate by as much as 60% in the first few years of their life. As the owner, it’s your money tied up in this depreciating asset.
Get the figures
Almost every leasing company in Australia has an online novated lease calculator available for you to do some research. And likewise – you can compare hundreds of car loans and interest rates, plus find out expected payments online too.
As with everything finance-related, there are lots of fiscal factors to compare before signing on the dotted line. These include:
- The length of time you intend to keep your car
- How flexible you need to be with its use, distance travelled and when you might need to sell
- The amount of your taxable income
- The expected benefits from reducing your taxable income
- Your available savings and monthly cash-flow
- How much you use the car for work
- Your employer’s willingness to salary sacrifice your payments
- Your usual wear and tear on the car
TIP: If you’re considering a lease, we recommend you check to make sure your financier is passing on the GST and fleet discounts properly. It’s also important to know what the administration fees and car lease interest rates are. Otherwise, you might be paying more than you should – despite the tax savings.
Sadly, not everyone is above board. Plus, it’s well known that financiers often get kickbacks for recommending services. If their accompanying comprehensive car insurance quote feels too high, get your own quotes (we can help with that!).
In the same way we can help you get the best discount on your insurance, sometimes it’s worth getting a quote from the most competitive lease and car loan deals and comparing them side-by-side. Your final step is to get your financial advisor to go through it with you.
Our verdict? Do your research homework, then calculate and compare the sums. If you gather all the right info, you’re sure to come out on top – no matter what you decide.
Over to You – Car Loan and Novated Lease Explained
Have you had a novated lease explained to you? Ever taken one out? What was your experience like? Let us know in the comments below.