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How does a Novated Lease work?
A novated lease is a three way agreement (novation agreement) between an employer, employee and lessor (normally a bank or finance company), under which the employee leases a vehicle and the employer agrees to take on the employee’s obligations under the lease. The employer makes the lease payments (rentals) on behalf of the employee, deducting them from the employee’s pre-tax income. This is also known as salary packaging.
There is a residual value (balloon payment) at the end of the lease. This is an amount that is offset until the end of the term which has the effect of reducing your regular lease payments. The minimum residual value that you can set is a pre-determined percentage of the original amount financed which is set by the ATO. At the end of the lease term you can decide to pay the amount and keep the asset, re-finance the amount and start a new lease agreement or you can sell / trade in the asset and if the amount you get is greater than the residual value than you can use this equity towards a new asset or simply retain it. Under a fully maintained novated lease you can also include provision for the vehicle’s operating expenses, such as fuel, oil, scheduled servicing, repairs, tyres, registration and insurance within your payment so that these costs are also deducted from your pre-tax income.
The amount financed is GST exclusive. GST is charged on the lease payment and the residual value at the end of the lease. Subject to your employer’s GST status and salary packaging policy they may claim back the GST associated with the vehicle’s operating expenses and pass those credits on to you and reduce the amount that they deduct from your salary.
If an employer provides an employee with a benefit as part of their employment, the benefit may be subject to Fringe Benefits Tax (FBT). Once the estimated Fringe Benefits Tax liability is calculated the cost is deducted from the employee’s salary package, along with the vehicle’s operating expenses.*
If the employee leaves their employment the lease obligations revert back to them but can be transferred to a new employer if they offer salary packaging.
Who does a Novated Lease suit?
Novated leases are commonly used by employees to lease vehicles that they use for personal or business use.
Before you buy or lease a second-hand asset you can check to see if the owner has ‘clear title’ or if there is a registered interest in it by doing a PPSR (Personal Property Securities Register) check to protect yourself against potential repossession.
The Personal Property Securities Register is the register where details of security interests in personal property can be registered and searched. The Australian Financial Security Authority (AFSA) is the Australian Government agency responsible for administering the PPSR. You can visit their website at www.ppsr.gov.au .
For used cars you can also arrange checks through other service providers to see whether the asset has ever been an insurance write-off or stolen and if the vehicle has suffered from flood or water damage.
The Key Factors
Finding the best novated lease for you will depend on your individual circumstances but the main factors to consider are:
Interest Rate – The rate of interest plays a large part in determining your repayment amount. The higher the interest rate the higher the repayment amount. But you need to be aware that the interest rate isn’t the only factor that will effect the total cost of your lease.
Fixed and Variable Rates – The interest rate is usually fixed, meaning that it will remain the same for the life of the lease, but it can also be variable. If the interest rate is variable this means that it can change during the time that you have the lease. Variable rates can be linked to the rate of interest that the lender is paying for its money in the same way that a lot of home loans are. So generally speaking if you have a variable rate and the Reserve Bank increases interest rates your interest rate and repayment amount will increase. If the interest rate is fixed you know exactly how much your lease payments are going to be for as long as you have the lease and you can budget around them accordingly.
Fees – Most banks and finance companies will allow you to include various fees within your novated lease. Usual fees include, establishment fees, which are one off amounts charged by the lessor (bank, finance company) for accepting and setting up your lease and account as well as ongoing fees such as account keeping or service / maintenance fees. Make sure that you are aware of all the fees associated with your lease and make sure that they are included within the repayment amount that you are quoted.
Lease Term – Lessors have minimum and maximum periods for repaying the novated lease. Depending on the age of the vehicle the minimum lease term is usually 1 year with the maximum usually being 5 years (less for some assets and older second-hand assets). The term of the lease is another significant factor in determining what your repayment amount will be. The shorter the term the higher the lease payment, and the longer the term the lower the lease payment. But remember the longer the term the more interest you will be charged and the more you will pay back in total.
Deposit – You do not pay a deposit on a novated lease but you may be able to pay advance payments (rentals) which will reduce your regular lease payment.
Total Amount Payable – This is the total amount that you pay back to the lessor for your lease.
Additional Repayments and Early Termination – Generally leases operate over fixed terms at fixed lease payments and you are unable to make additional repayments into your lease. If making extra payments and paying off your finance early is important to you then make sure to check that your finance allows you to do this and any costs associated with doing this are acceptable to you.
Minimum and Maximum Lease Amounts – Normally the lowest lease amount available from mainstream lenders is $5,000 or $10,000. The maximum varies from lender to lender but $100,000 to $150,000 is the most that many lessors will provide for a lease agreement.
Residual Value (Balloon Payment) – A residual value amount, often referred to as a balloon payment, is applied to the lease. This is an amount of the lease that is offset until the end of the lease term which has the effect of reducing your regular repayments. Be aware that whilst you do not make principal repayments on the residual value amount you will be charged interest on it. At the end of the lease term you can decide to pay the amount and keep the vehicle, re-finance the amount and start a new lease agreement or you can sell / trade in the vehicle and if the amount you get is greater than the residual value than you can use this equity towards a new vehicle or simply retain it.
Lower Interest Rate – By using the vehicle that you’re buying as collateral the lender has increased security and as a result can offer you a lower rate of interest, which means lower repayments for you.
Lower Repayments – By financing the GST exclusive price and including a residual value (balloon payment) at the end of your novated lease this reduces your repayment.
Potential Tax Benefits* – As novated lease payments are deducted from your pre-tax income there is the potential to benefit from income tax savings. You can benefit from savings on GST that would you would normally incur on vehicle expenses.
Low Deposit – Novated leases are set up with minimal deposits / advance payments so you can potentially get the vehicle that you want for a minimal initial outlay.
Inclusions – You can potentially include things like government fees, insurance premiums and accessories as part of your lease, so one repayment covers all of your costs.
Budgeting – You can opt to include all scheduled servicing and maintenance costs, such as repairs, registration renewal and tyres in your lease, which can assist you to budget costs more effectively.
Choice – Using a novated lease to salary package your car can give you more choice compared to a company car arrangement.
Employer Benefits – For employers novated leasing gives them a potentially cost effective alternative to operating a fleet of company cars and can potentially provide an effective increase in employee’s salaries with minimal cost to the business.
Costs – Any type of borrowing is going to cost you money and a lease agreement is no different. But don’t forget using your own money comes with its own costs too. Just think of the return that you could you get if you invested the funds in your business or interest that you would generate if you invested the money. You just need to make sure that you do your research and get the best the lease for you.
Security – Although using your vehicle as security can help to get you a lower interest rate it also means that if you don’t make your agreed payments you risk the vehicle being repossessed.
Asset Only – With a novated lease the amount that you finance can only be used for the purpose of leasing the vehicle. You can’t split the funds and use part for the vehicle and part for something else.
Fees – If you opt for a fully maintained novated lease then there can be additional fees to pay for the administration of the maintenance costs.
Lease Obligations – If you change employers you must take over the lease obligations and they can only be transferred to a new employer if they offer salary packaging.
Employer Arrangements – If your employer offers salary packaging they may have an arrangement in place with a preferred salary packaging provider which may mean that you have to go through them and cannot make your own arrangements.
Things to Consider
Payment Frequency – Most lenders will give you the option of making weekly, fortnightly or monthly repayments. Choose the frequency that suits you and your employer best.
Your Current and Future Circumstances – Think about what your requirements are right now but also your plans for the future. For example, if you’re planning to start a family and your household income is going to reduce whilst you have your novated lease, ask yourself if the repayments / salary deductions would still be affordable for you. You may need to consider a lease over a longer term to reduce your repayment. If you expect that your income will increase during the time that you’re paying your novated lease off be aware that a novated lease generally does not offer much flexibility to make additional payments.
Rate for Risk – Some lenders use a system whereby they determine the interest rate that they offer to you based on their analysis of your profile. This includes your credit history, employment history and residential status, as well as what vehicle you are buying. The better they deem your profile to be the lower the rate you will get.
LoanPlace.com.au is here to help you make sense of it all by providing you with information resources and connecting you with experienced professionals who will search their lenders to find the latest deals so that you get 3 Free Quotes to evaluate and compare.
*We strongly recommend that you consult your accountant or tax advisor to confirm the tax benefits available to you prior to entering into any finance agreement. The information provided is for product description purposes and is not intended to be used as taxation, financial or legal advice.