Car loan vs novated lease

By: James Massie-Taylor, Stephanie Sims, Stephanie Toutountzis

The COVID-19 pandemic brought about unprecedented times for car manufacturers, car dealers and consumers. By and large, this was a result of significant demand, extended wait times for cars and a substantial increase in the cost of both new and used cars, which has thrown the market equilibrium out of whack.

The general supply and demand issues, coupled with interest rate rises means that consumers need to give serious consideration to their preferred means of purchasing a car. Broadly, this will depend on each individual’s circumstances however, there are typically three avenues to consider. Leasing, loaning or buying a car with cash.

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Leasing a car

There are typically two types of leases, the first being a standard lease where you effectively ‘rent’ the car. You never take ownership of the car and the car is typically maintained by the leasing company where all maintenance costs, registration, roadside assistance and insurance costs are built into your recurring lease fee whether this be weekly, fortnightly or monthly.

Opting for a lease arrangement of this nature provides flexibility in terms of upgrading, which is often seen to be an advantage.

The second type of lease is a novated lease.

What is a novated lease?

An employee may enter into a lease arrangement with a finance company for a car and then enter into a three-way agreement with their employer and the finance company whereby:

• The employer takes on the obligations of the lessee;
• The terms of the agreement provide that if the employee ceases employment, the novated arrangement ceases and obligations under the original lease will revert to the employee;
• The employee has the risk for the residual value (balloon payment); and
• Under a novated lease, a combination of pre and post-tax amounts are taken from the employee’s pay to cover the lease costs (and sometimes also running costs), as well as negating any resulting fringe benefits tax (FBT).

What are the benefits of a novated lease?

The main benefits of a novated lease rest with the employee.

Under this arrangement employees can typically access fleet pricing discounts through lease providers, as well as personal income tax savings.

More specifically, by virtue of using pre-tax salary to pay the car lease costs, employees are left with a higher disposal income. Employees can also choose to include the car’s running costs in the novated lease arrangement, such as servicing, fuel, insurance etc., which further increases their tax savings.

When utilising a novated lease, because the employer takes on the obligations of the lessee, the GST can be claimed (by the employer). Therefore, the employee is only having to pay the GST-free lease amount, resulting in instant savings.

There are generally no restrictions on what car the employee can choose – not only in terms of make, model and colour, but also whether it’s a new or used car.

Further, novated leases are transferrable between employers, so there is no need to cancel the arrangement if an individual decides to change jobs partway through a lease term (so long as the new employer accepts the arrangement).

In addition, employers are generally no worse off by allowing employees to use novated leases. Any FBT that arises from the employee’s use of the vehicle is covered by the employee via payroll deductions, and employers can use it as part of their employee attraction and retention strategy.

How do you enter into a novated lease?

There are many salary packaging / novated lease providers in the market which offer similar services. The main difference being the ongoing administration costs which are typically built into the payroll deductions.

It is worth checking whether the employer is agreeable to the arrangement in the first instance, and whether they use a particular provider.

Employer considerations

From an employer’s perspective, there are a few important considerations such as the Luxury Car Tax (LCT) limit. Where a car on a novated lease exceeds this limit, the novated lease arrangement is automatically broken and reverts to a company loan, which means that the business can only claim the interest and depreciation on the vehicle (as opposed to the full repayment) and must make an adjustment to the company tax that is payable. Further, the amount of GST credits available is also capped to the LCT limit resulting in a lost GST benefit.

Employees choosing to enter into a novated lease on a luxury car should engage early with their employer to understand the cost to the business that will be typically passed back to the employee.

Weighing up the benefits of a novated lease

The amount of savings achieved by using this arrangement can vary significantly from person to person and can depend on a number of factors. When considering a novated lease, most of the providers have online calculators where a person can input all of their details including salary, car value, loan terms etc. and the calculator will show weekly/monthly/annual tax savings under a novated lease arrangement compared to a normal lease.

As with all loans, it’s worth noting the employee does not own the car until all payments are made (including the balloon payment) and, in addition to administration fees, some providers place some restrictions on the car’s use such as number of kilometres that can be travelled in a year.

In times where car prices are at an all-time high, when looking to buy a car it is certainly worth exploring a novated lease to try and save some money where possible, however, employees should weigh up the pros and cons of a novated lease before entering into the arrangement to determine what best suits their needs.

Comparing a car loan to a car lease

When comparing a traditional loan to a novated lease, it’s important to be mindful of all additional charges that arise as well as interest. Typically, these can comprise of monthly account maintenance, administration and other charges. In addition, consideration should be given to your annual vehicle expenditure such as registration, insurance, fuel and repairs to ensure the comparison between leasing and loaning is being compared like for like.

When choosing the car financing that’s best for you, the first consideration is whether you will seek a fixed or variable interest rate loan. The pros and cons of each will largely depend on personal circumstances.

A fixed rate loan will lock the rate for either the entire loan period or a specified period. The benefit of this is it provides the borrower with certainty over repayments for the entire loan term.

A variable loan will move with the market meaning there is no certainty over the repayments and the rate can increase or decrease without warning, which is important given the market at present and the current predictions. This makes it harder to budget repayments and other related costs over the period of the loan.

It is important to be aware of the structure of the finance as it’s common for lesser repayments to be made over a fixed period with a balloon payment due at the end of that fixed period. This requires future planning to ensure you have funds for the balloon payment to be made at the end of the fixed period. This concept is sometimes perceived to be an advantage where you can sell your vehicle at the end of that fixed term and use the sale proceeds to cover the balloon payment, and upgrade after that period.

When you purchase a vehicle that will be used, in part, for business operations, consideration should be given to what portion of the interest and other costs, such as depreciation, may be deductible for tax purposes.

The benefits of paying cash for a car

Purchasing a car with cash means you’re not subject to ongoing fees that are typically charged over the life of a loan, which is the obvious advantage. However, personal preference may be to outlay cash for part of the purchase and finance the other part to effectively spread the outlay over a number of years.

Payment in cash ultimately depends on personal circumstances at the time of purchase. Consideration needs to be given to cash flow. Purchasing wholly in cash means you are tying up your personal cash flow but spreading your cash flow over a known period (by way of loan or lease) means you are incurring a cost to do so.

Last updated: July 2022