Novated lease residual value: What is it and how is it calculated?

A novated lease is a popular way for employees in Australia to finance a car. It’s become even more popular in recent years as electric vehicle incentives have boosted the potential savings and overall appeal. But the novated lease residual value is one aspect that can confuse people and in some cases put them off entirely.

Once you understand how it works, the novated lease residual value is usually a relatively simple aspect of your agreement.

If you’re considering a novated lease, it’s important to be aware of what the residual value on your vehicle will be. It will affect your ongoing novated lease payments and the final cost of the car.

The residual value on a novated lease is the one-off lump sum amount you need to pay to own the vehicle at the end of the lease. It’s sometimes called the novated lease ‘balloon payment’ because it’s an inflated amount compared to the regular lease payments.

The novated lease residual value is essentially an estimate of the value of the vehicle at the end of the lease.

Unlike the ongoing novated lease payments, the residual value balloon payment must be paid for using your after-tax salary.

Novated lease residual values are designed to offset some of the significant tax savings that a novated lease offers. For this reason, all novated leases have a residual payment.

Your ongoing novated lease payments are made using your pre-tax salary, meaning you save on income tax. However, the residual balloon amount must be paid using after-tax money. In other words, you’ll need to use your savings, as opposed to a direct payment from your salary.

The residual value on a novated lease is different to the optional balloon payment often available with car loans. A car loan balloon payment is generally more flexible and is set at a level you agree with the finance company.

However, the overall effect is similar: the residual payment (or balloon payment) will lower your regular payment amount, but will mean you have a large one-off amount to pay at the end of your lease or loan term.

The novated lease residual value is calculated at the start of your lease by your novated lease provider. The calculation is based on minimum rates set by the Australian Taxation Office (ATO).

The residual amount takes into account the likely value of the vehicle at the end of the lease based on depreciation and other factors.

The residual value on your novated lease will be a percentage of the purchase price of the vehicle you are leasing. The residual amount also depends on the length of the novated lease. The shorter the novated lease, the higher the residual value of the lease will be. This is simply because the car will have retained more of its value than it would have with a longer lease.

It can also be possible to set the residual value on a novated lease at a different level to the ATO’s minimum. For example, if the driver will do very high mileage using the car, a lower residual may be allowed. This is because the car would theoretically be worth less at the end of the lease than the same model of car with lower mileage.

The novated lease company facilitating the agreement will be able to advise on whether a different residual level is possible in your situation.

The residual value on a novated lease affects your costs in two ways:

• It determines how much you will need to pay using your after-tax salary at the end of the novated lease to own the car outright.
• It also affects how much your regular pre-tax novated lease payment will be. That’s because the regular novated lease payments are based on the purchase price of the car (minus the residual value) plus car running costs.

At the end of the novated lease term, you have the option to buy the car. If you choose to do this, you will need to pay the residual value.

Once you own the car, you can then either hang onto it, or trade it in and start another novated lease with a different vehicle.

If you trade in your vehicle and the sale price you get for it is higher than the residual amount you paid, this is effectively a tax-free profit.

The other option when the novated lease residual amount falls due is to extend the lease on your current car by starting a new novated lease agreement.

In this scenario, the new lease would be based on the residual amount from the initial lease. In other words, you are effectively refinancing the residual amount.

This new lease would also have a residual amount to be paid at the end. But this would be significantly lower than the residual on the initial novated lease agreement. The regular payments would also be reduced, compared to the initial lease.