Novated Leasing vs Traditional Car Loans: Which is Better?

While a novated lease might sound like the best option on paper, as with all large financial decisions, it’s essential that you’re aware of how the concept works, as well as the advantages and potential disadvantages of novated leases, so you’re best prepared to make an informed decision. 

That’s exactly what we’re going to do today, as we break down the concept of novated leases, how they work, and compare it to the process of a traditional car loan to see which is the better of the two options when shopping around for your next car. 

What Is a Novated Lease? 

A novated lease, otherwise known as salary sacrificing or packaging, is an agreement struck between you, your employer and a lender that helps you step into a new or used vehicle with the potential of significant savings for both you and your employer. 

Simply put, your employer is committing to paying the lease for the vehicle and its running costs, where they take contributions from both your annual pre- and post-tax salary, which can help to reduce the tax that you’ll pay on your annual income. This means you can put your pre-tax salary to more use, and save yourself money in the process. 

Quite simply, it’s a tax-effective means of leasing the vehicle of your choice for a long period of time, with the ownership costs of the vehicle bundled into a single payment that is deducted from your pre-tax salary. This new or used vehicle doesn’t have to be used only for work or business purposes, either- you’re free to use it for all your personal needs. 

How Does a Novated Lease Work? 

The name ‘novated’ stems from the transfer of payments that would typically be paid by you, to your employer. These payments are transferred - or novated - on your behalf to your employer for the duration of the lease’s terms. Your employer agrees to factor-in and deduct these lease and ownership payments from their payroll, which helps to reduce your overall taxable income figure, and adds to the potential savings.

A novated lease usually runs for a period of one to five years, and at the end of that period, you’re given the option to trade that vehicle of a new model - resigning a new novated lease agreement - or you’re able to pay the remainder of the lease agreement, transfer ownership to yourself and keep the vehicle; this is nicknamed paying your ‘balloon payment’.  

Novated Lease Advantages 

The major advantages of novated lease agreements centre on the fact that, compared to typical vehicle financing, you’re able to pay for the lease and all the requisite running and ownership costs with your pre-taxable salary, which stands to benefit you immensely come tax-time; the lower your income, the less tax you will pay to the ATO. 

While novated lease agreements differ from lender-to-lender, a general guideline on the advantages of this type of lease includes: 

Lowering your pre-taxable income

Paying the novated lease from your pre-taxable income effectively lowers the amount of tax you’ll pay at tax-time, as your taxable income is reduced

Eliminate GST entirely

You’re not technically the one purchasing a new vehicle, which means you won’t have to pay GST on a novated lease, saving you thousands on even the cheapest cars on the market

Package registration and insurance into pre-taxable income

Paying for expensive items like insurance and registration each year with your pre-taxable income is significantly more advantageous than what’s left in your paycheck after paying tax 

Vehicle can be used exclusively for personal activities

A novated lease agreement typically states that you’re more than welcome to use the vehicle for personal activities, rather than exclusively for business

Novated Lease Disadvantages 

The main disadvantage of novated leases is the simple fact that your employer is technically leasing the vehicle, while you’re paying your employer back with your pre-taxable income. This means that you are not officially the owner of that vehicle, so you’re unable to claim it as an asset for financial reasons or make any modifications. 

This also means that in the event of losing your job, the lease is transferred to you personally, and you’re responsible for making payments with post-tax salary; forgoing the previous pre-tax reductions on your novated lease.

The major considerations of novated leases include: 

Lack of personal ownership

The vehicle belongs to your employer, rather than yourself, in spite of the fact that you’re paying the entirety of the loan

Restrictions on kilometres

Vehicles purchased via novated leases are often bundled with restrictions on how many kilometres they can be driven per year 

Loss of job leaves you personally responsible for payments

Perhaps the most significant downside of a novated lease is that upon leaving your position, you’re still technically ‘on the hook’ for the payments, regardless of your employment status once you’ve left

Cancellation fees

Novated leases often include significant administration and service fees, with early cancellation fees for a novated lease remaining a sticking point for those leaving their employer  

Interest rates and fees 

Do You Own the Car at the End of a Novated Lease? 

You do not own the vehicle at the end of a novated lease, unless you’ve elected to pay the amount withstanding. 

At the conclusion of a novated lease, you are given three options. You can either trade the vehicle in and opt to lease another vehicle entirely, extend the lease on the existing vehicle, or choose to keep the car at the end of the novated lease period. This means that it is possible to own the car at the end of the lease, however, you are required to pay the residual value of that loan, otherwise known as the ‘balloon’ payment. 

Is a Novated Lease Better Than Buying Outright? 

Overall, there are immense benefits of a novated lease when it comes to reducing the amount of tax you’ll pay each year, however there are a number of things to be mindful of. You do not own the vehicle, and you’re also effectively tied to that employer, so if you feel as though staying in that position for a number of years isn’t a reasonable option for you, a novated lease would not be the sensible decision.

These leases often incur significant administration and service fees, on top of the interest that you’re paying on the loan itself, which means that purchasing a vehicle via a novated lease is a more expensive process than simply purchasing the vehicle outright. 

What Are the Benefits of a Traditional Car Loan?

One of the major benefits of a traditional car loan comes down to the simple fact that from the outset, you are the owner of that vehicle, and so long as you’re paying off the debt and the required interest, you can do whatever you want with the vehicle - because it’s yours. Compared with a novated lease, where there are often restrictions on kilometres in the contract, supplemented by any restrictions your employer puts on the vehicle, a car loan offers far more flexibility than something like a novated lease. 

This also means that you can even sell the vehicle to help pay off any debts remaining, although we’d encourage you to contact your lender before taking this avenue. 

Opting for a car loan also means that you’ve got more flexibility, options and competitive pricing to compare when shopping around for your car loan, due to the added competitive nature of the car loan segment compared to the novated leasing segment. This means you personally benefit from choices of secured or unsecured loans with variable and fixed interest rates that you have more control over, compared to something like a novated lease. 

What are the Downsides of a Car Loan? 

One of the most significant downsides of a traditional car loan is the higher repayments that these loans can incur, compared to a novated lease. This is because the lender recognises that you’re paying off the entirety of the vehicle, rather than paying your employer for the pleasure of driving it. This freedom does come at a cost, however, it’s important to remember the restrictions on vehicles implicated in a novated lease that a typical car loan is removed from. 

It’s also important to remember that your money is tied into a depreciating asset, which becomes less valuable over time, and also requires investments into servicing and other running costs. 

Higher repayments

Since you’re the owner of the car, rather than paying off your employer for its use, repayments on car loans are typically higher than a novated lease, but they do offer unlimited flexibility and driving freedom compared to the alternative 

Depreciation

Your money is tied up in a depreciating asset

Covering ownership and running costs

Paying for servicing and registration comes from your pocket more directly

Is a Traditional Car Loan Better Than a Novated Lease? 

It’s widely believed that a traditional car loan is the most sensible option over a novated lease, but of course, this remains dependent on your financial situation. However, due to the simple fact that you own the vehicle from the moment you sign a traditional car loan, they are widely believed to be the best option for those purchasing a new car over the three-way agreement struck for a novated lease. 

Imagine, for example, you’ve spent a sizable chunk of your income paying off your share of a novated lease, only to lose your job. In this situation, not only have you paid the lion’s share of the vehicle’s repayments, you’re also left out of any material ownership of the vehicle, because it is technically your employer’s vehicle, and not yours. This is one of the major reasons that people opt for a car loan rather than a novated lease, because they can’t stand the thought of paying a huge portion of a vehicle’s price and running costs only to have it ripped away from them because their employer, rather than them personally own the vehicle. 

While the repayment schedule and interest terms often result in a traditional car loan becoming the more expensive of the two options, the added flexibility and guaranteed ownership of the vehicle are two massive positives when it comes to opting for a car loan over a novated lease.