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Novated Lease Pros & Cons

If you’re in the market for a new car, a novated lease could be an option for you. If you’ve never heard of the ‘novated lease’ term (or you have and you don’t  understand what’s involved with one), then this article is for you.

We’ll explain everything you need to know to work out if novated leasing is the right car financing option for you.

 

What is a novated lease?

A novated lease is a three-way agreement between you, your employer and a finance company. When you take out a novated lease, your employer pays your car payments out of your salary and sends them directly to your finance company.

 

How does novated leasing work?

Novated leasing is an example of a salary packaging arrangement. Not all employers offer salary packaging options, but many do. Most of those that do will offer novated leasing as an option.

Salary packaging is also known as ‘salary sacrificing’. Instead of getting paid your full salary, you sacrifice part of your salary to receive  another benefit. The use of a new car is the benefit you receive when you take out a novated lease.

Novated lease terms generally range from one to five years.

 

What happens at the end of a novated lease?

At the end of the lease term, you usually have four options:

1) hand the car back to the finance company and take out another novated lease on another car.

2) pay for the residual value of the car to own it outright. The residual value is the pre-agreed value of the vehicle at the end of the lease.

3) renew the lease.

4) hand the car back to the finance company and walk away. If you do, you’ll obviously need to get a new car some other way.

Your options depend on the type of novated lease that you have.

 

Types of novated leases

There are two main types of novated leases:

  • a novated finance lease.

You are responsible for paying the agreed residual value at the end of a novated finance lease.

 

2) a novated operating lease.

You have no responsibilities at the end of a novated operating lease other than to hand the car back to the finance company.

Novated operating leases can be either fully maintained or not.

A fully maintained novated operating lease includes the vehicle’s running costs (like petrol, insurance, rego and servicing) as part of the regular payments.

There may be a restriction on the maximum number of kilometres you can travel in any one year with a fully maintained novated lease. You should check the terms and conditions before you take one out and make sure that it will cover your driving needs.

A non-maintained novated operating lease doesn’t include the vehicle’s running costs in the regular payments. You must pay for these costs separately out of your own pocket.

 

Are novated leases a good idea?

Novated leases are a good idea when the pros outweigh the cons.  We’ll now look at the pros and cons in turn.

 

Advantages of novated leases

There are many benefits of a novated lease, including:

 

  • tax benefits.

Your lease payments are taken out of your salary before tax. You then receive less salary, so you pay less tax.

Because of incremental income tax rates, the higher your annual income, the more tax you’ll save paying your vehicle out of pre-tax income.

 

  • you can bundle your vehicle running costs into your regular payments.

You usually receive a fuel card and your finance company will take care of any servicing, insurance and rego payments.  (Beware these can occasionally be through the lease provider’s preferred partners, who may pay the leasing company ‘kickbacks’ which the client ultimately pays for).

 

  • you can potentially get access to a cheaper, GST-free car.

Finance companies who offer novated leasing tend to buy vehicles in bulk. That means they can usually get them at cheaper prices. They can also claim back the GST they pay. That means they can potentially pass both of those cost savings on to you by charging a cheaper price than you could buy the same car for yourself.

 

  • one regular payment can take care of all your vehicle costs.

This will be the case if you take out a fully maintained operating lease.

 

  • you can use a novated lease vehicle for private use.

Just because you pay for your novated lease via your employer, it doesn’t mean you have to use the vehicle for work purposes. You can use it for a combination of work and private purposes, or purely for one or the other if you want. The choice is yours.

 

Disadvantages of novated leases

While there can be many benefits of taking out a novated lease, it’s also important to understand some of the potential downsides, including:

 

  • Hidden Costs outweighing the tax savings

Unlike consumer loan contracts, leasing companies are not required to disclose the final interest rate charged to the customer, or the costs of insurances.  Often high commissions are applied to the loan unbeknownst to the customer, which offset the tax savings.  You can see our article on novated lease cost.

 

  • fringe benefits tax (FBT).

Employers who participate in novated lease agreements are liable to pay fringe benefits tax (FBT). Although your employer is responsible for paying FBT if you take out a novated lease, they may pass some or all of the cost back to you in the form of an even further reduced salary.

The current FBT rate in Australia is 47% of the taxable value of the benefit provided. The taxable value is usually about 20% of the vehicles’ value. So if you get a $40,000 vehicle on a novated lease, the taxable value each year would be approximately $8,000, and the FBT payable would be $3,760 (47%).

You will also get a reportable fringe benefit for the value of your car listed on your annual payment summary from your employer. This benefit can affect your eligibility for other government benefits. It’s added onto your taxable income for any income eligibility tests.

 

  • When you change jobs, the savings are likely to cease

You can change jobs and keep your lease, but important to understand that unless your new employer is happy to take on the leasing company as a salary sacrifice partner (most have one or two leasing companies they will work with), you’ll be responsible for making all your novated lease payments AFTER tax.  You’ll be paying more tax because your payments will be coming out of your after-tax salary, not your pre-tax salary like it does when an employer pays on your behalf.

 

  • you don’t own the car.

The finance company does for the entire lease term. If you take out a car loan on the other hand, you own the vehicle straight away, even though you still have to make all your repayments.

 

  • your tax affairs become a little more complicated.

Any salary sacrificing arrangement will make your personal tax affairs a little more complicated. You might need to get the help of a tax agent to help you lodge your tax return.

 

  • lease costs can be just as (or more) expensive than taking out a car loan.

Once you add up all the leasing costs (including leasing company monthly admin fees), it may be cheaper to take out a secured car loan even though they don’t have the same tax savings. A secured loan has a lower interest rate because you provide the vehicle as security for the lender, and interest rates are competitive and fully disclosed.

You still own the vehicle when you take out a secured loan, but the lender can repossess it and sell it if you don’t make your repayments. They will take any money owing on the vehicle from the sale price and give you what’s left over.

 

  • you can’t make any modifications to a novated lease vehicle.

You can make any modifications you want if you buy a car by taking out a loan or paying cash upfront.

 

Are novated leases good value?

Novated leases can be good value if the tax savings outweigh the leasing company’s commissions and monthly fees, compared to just getting a standard car loan which doesn’t offer tax savings but is competitively priced.  The convenience of having a new car that you can easily upgrade can also be appealing to buyers.

 

Should I get a novated lease?

There’s no yes or no answer to this question. It depends on your individual circumstances and whether the pros outweigh the cons.  As a rule of thumb, the more expensive the car and the more kilometres you do per annum, the more attractive a lease becomes over other forms of finance.

 

Other novated lease FAQS

Can you get a novated lease on a used car?

Yes, it’s possible. But most lenders will have restrictions on the age of the vehicle that you can finance using a novated lease.

 

How is a novated lease residual value calculated?

The Australian Taxation Office publishes depreciation guidelines that novated leasing companies use to calculate the residual values of vehicles.

 

What is the employee contribution method?

This is a way to reduce FBT on a novated lease vehicle if your employer wants to pass some or all of it onto you by reducing your salary. Instead of you making all of your lease payments out of your pre-tax salary, some of it comes out of your after-tax salary to reduce the FBT.

But it’s important to understand that you won’t save as much personal income tax if you use this strategy to reduce FBT.

 

Can I sell a novated lease vehicle to pay the residual value and make a profit?

Yes, as long as you use part of the sales money to pay the residual value,  you are free to sell it. Any profit you make is tax-free.

 

The bottom line

If your employer offers novated leasing as a salary packaging option, it’s worthwhile considering it along with your other finance options like a car loan.

Choose the option that’s best for your situation. If you’re unsure, you should talk to a car finance broker for advice.

You can read more about novated leases here.

 

How we can help

If you need finance to buy a new or used car, talk to our expert brokers at Auto Car Loans. We’ll take the time to help you find you a great deal from our panel of over 50 Australian lenders.

Don’t get talked into car dealer finance at a car yard or you’ll end up paying more. We work for car buyers, not dealers of lenders.

Like to find out more? Simply call 1300 301 051 during business hours to speak with one of our licensed brokers. We’d be happy to answer any questions you have.

Helpful links: Novated lease good or bad? Why are novated leases bad?

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