Novated Leasing Explained
What is a novated lease?
Find out how novated leasing works in Australia and how it's different to the other main car finance options.
Like everything else, the cost of paying for a car in Australia has risen steeply. Savvy motorists looking for ways to save can consider a novated lease. If you’re eligible, it can work out to be a lot cheaper than other ways of paying for your car. Understanding how a novated lease works is the first step on the journey.
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What is a novated lease?
A novated lease is a way of financing a car directly from your salary. Payments on the car and running costs are made by your employer from your salary before tax is deducted, meaning you don’t pay income tax on that money. This saves you money compared to paying for a car using your after-tax salary.
A novated lease involves an agreement between you, your employer and a lease provider who sets up and manages the lease. While a novated lease is linked to your employer, you can use the car entirely for your personal use, with no minimum or maximum mileage limits.
Novated leasing is only offered by certain employers but it’s becoming more and more popular as a benefit to help employees save on their car costs.
How does a novated lease work?
A novated lease works similarly to other car finance options, but there are some key differences that make it more cost-effective. Here’s what happens if you take out a novated lease:
- Through a novated lease company, you enter an agreement to purchase your vehicle of choice (it can be new or used), with finance provided by a lender.
- The vehicle is owned by the lender during the finance term (usually 1-5 years), but you have full and unrestricted use of it.
- The novated lease provider instructs your employer to deduct the finance payments from your pre-tax salary.
- Your vehicle running costs (fuel/electricity, registration, servicing, insurance etc) can also be deducted from your pre-tax salary.
- At the end of the lease term, you can pay off the residual value of the car to own it outright (we'll explain this further below), or you can extend the novated lease term.
How do you get a novated lease?
The first step is usually to check with your employer if they offer novated leasing. If they do, you can apply for a quote from a novated lease provider based on the car you're looking to buy.
The novated lease provider then usually takes care of the rest (e.g. setting up the vehicle finance and the payments via your employer).
Even if your employer does not currently offer novated leasing, it's worth asking if they would be willing to facilitate it. There generally is no cost and little admin involved for the employer.
What are the tax savings on novated lease?
The main benefit of a novated lease compared to a car loan is that it enables you to save on tax. In fact, there are a few different tax savings at various stages of your novated lease. Here’s an overview of how it works:
GST saving on purchase price
Because a novated lease means buying a vehicle through your employer, there is a GST saving on the purchase price of the vehicle. Straight away this means a 10% saving on the up-front cost of the vehicle (up to a maximum saving $5,885).
Income tax savings
Paying for your car and its running costs using your pre-tax salary means you do not pay income tax on that portion of your income. This can add up to thousands of dollars in savings during your novated lease term.
GST saving on car running costs
There is also a GST saving on the car running costs funded through your novated lease. This is a further 10% saving on costs like fuel, registration, insurance and car maintenance.
What about fringe benefits tax (FBT)?
Like most other employee benefits, novated leases are subject to fringe benefits tax. This is a tax employers who offer novated leasing need to pay based on the value of the benefit provided to the employee. However, novated leases are generally set up so that part of the payments are made using after-tax contributions to offset the fringe benefits tax and ensure there is no cost to your employer. If you buy an eligible electric or plug-in hybrid electric vehicle, your novated lease will be exempt from FBT.
What is the residual value of a novated lease?
The residual value of a novated lease is the final payment required to pay off the vehicle and own it outright. It is sometimes called the ‘balloon payment’.
The residual amount is set at the start of the lease, based on the estimated value of the vehicle at the end of the lease. It's calculated as a percentage of the vehicle’s purchase price, with the minimum residual value percentage allowed set by the Australian Taxation Office (ATO).
What happens at the end of the novated lease?
At the end of the novated lease term when the residual payment is due, you have a few options:
- Make the residual payment (using after-tax money) and keep the car
- Make the residual payment, trade in the vehicle and start a new novated lease with a new car
- Renew your novated lease with the same car for a further term
Other question you might have about novated leasing:
What types of novated lease are there?
There are two main types of novated lease available in Australia:
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Fully-maintained novated lease where the pre-tax lease payments cover the payments on the vehicle itself and its runnings costs.
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Non-maintained novated lease which means the lease payments only contribute towards paying off the car, with no running costs included.
What kind of car can I get with a novated lease?
It’s generally possible to get a novated lease for any new or used vehicle. There are only a few restrictions to be aware of:
- It must be a passenger vehicle
- The vehicle’s capacity must be less than 1,000kg (meaning the vast majority of cars are eligible)
- For a used car, generally it must be less than 15 years old at the end of the lease term.
What are the fees on a novated lease?
The main fees that apply to a novated lease are:
- Finance fees charged by the lender (e.g. loan establishment fees)
- Lease admin fee charged by the lease company to set up and manage the lease (these are included your pre-tax lease payment
Who owns the car with a novated lease?
During the lease term, the lender providing the finance owns the car but gives you unrestricted use of it. Once you make the residual payment, you take full ownership of the vehicle, meaning you can keep the car with no further payments, or trade it in.
What happens if I move jobs?
If you move employer during your novated lease, the novated lease moves with you. If your new employer offers novated leasing as a benefit, you can simply continue the same arrangement with them. If they don’t (or if you need to take time out from work) you can make the lease payments using your own funds via a bank transfer.
What are the main benefits of a novated lease?
The main benefits of a novated lease include:
- GST saving on the vehicle purchase price
- Novated lease companies can also often get a bulk discount on the vehicle's purchase price with the dealer
- Income tax savings because the lease payments and car running costs come from your pre-tax salary
- You don’t need to budget for ongoing car-related costs as these will come straight out of your salary
- Because the arrangement is made through an employer, it can be easier to get approval for a novated lease for people with issues in their credit history, compared to a bad credit car loan.
Are there any disadvantages to a novated lease?
Some of the potential drawbacks of a novated lease include:
- It’s only available through participating employers
- The residual payment required to pay off the car is usually substantial
- If you stop working for a period and are not earning an income (e.g. parental leave) the lease payments will still need to be made but you will not enjoy the same tax savings on those payments
