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When you’re looking to buy a car, one of the biggest decisions you’ll face is how to finance it. In Australia, two popular options are a novated lease and a traditional car loan. Each has its advantages, depending on your financial situation, employment, and personal preferences.
In this blog post, we’ll explore the key differences between novated leases and car loans and help you decide which option might be best for your next vehicle purchase.
What is a Novated Lease?
A novated lease is a three-way financial agreement between an employee, their employer, and a leasing company. Essentially, the car lease payments, as well as other running costs like fuel and maintenance, are deducted directly from the employee’s pre-tax salary through salary packaging.
This arrangement can lead to significant tax savings, as the employee’s taxable income is reduced by the amount of the lease payments and running costs.
How Does a Novated Lease Work?
- Employer Involvement: Your employer takes responsibility for the lease payments on your behalf.
- Tax Benefits: Payments are deducted from your pre-tax salary, reducing your taxable income and lowering the amount of tax you pay.
- Bundled Expenses: Many novated leases include fuel, insurance, registration, and maintenance in one payment, making it easier to budget.
- End of Lease: At the end of the lease term, you can choose to buy the car for its residual value, extend the lease, or return the car.
What is a Car Loan?
A car loan is a more traditional form of financing where you borrow money from a bank or lender to purchase a vehicle. You own the car outright from day one, but you repay the loan in fixed monthly installments, which include interest, over a set period (usually 3 to 5 years).
How Does a Car Loan Work?
- Ownership: You take full ownership of the vehicle once you purchase it, though the lender may hold an interest in the car until the loan is fully repaid.
- Interest Payments: You repay the loan with interest over time, with monthly payments based on the loan’s principal and interest rate.
- Flexibility: Once the loan is paid off, you own the car outright without further financial commitments.
Key Differences Between a Novated Lease and a Car Loan
1. Tax Savings
One of the main benefits of a novated lease is the tax advantage. Since lease payments and running costs are deducted from your pre-tax salary, your taxable income is reduced, which can result in paying less tax overall. This makes novated leasing particularly attractive for those in higher income brackets.
With a car loan, you do not receive any tax benefits. You repay the loan using post-tax income, and interest on the loan is not tax-deductible unless the vehicle is used for business purposes. Also, with a car loan none of your running costs are deductible and you pay for all of this with your post tax income.
Which is better for tax savings?
If you’re looking for tax advantages, a novated lease is the clear winner. However, this benefit is only available to employees who have access to salary packaging through their employer.
2. Ownership
With a car loan, you own the car from the moment you purchase it. Once the loan is repaid, the vehicle is entirely yours, and you’re free to keep it for as long as you want or sell it at any time.
A novated lease operates differently. While you’re essentially “renting” the car during the lease term, you don’t own it. At the end of the lease, you can choose to buy the car for its residual value, extend the lease, or sell the vehicle and lease a new one.
Which is better for ownership?
If owning your car outright is important to you, a car loan is the better option. However, if you prefer flexibility and longer-term savings a novated lease can be more appealing. A non-maintained novated lease for instance can end up being cheaper than car financing. Ask your consultant to crunch the numbers for you and see how it stacks up.
3. Upfront Costs
A novated lease typically requires no upfront payment. You can drive away in your new car without making a deposit as the entire cost of the lease is deducted from your salary over time.
With a car loan, many lenders may require a deposit—often around 10-20% of the car’s purchase price. This upfront cost can make a car loan less appealing if you don’t have significant savings.
Which is better for upfront costs?
A novated lease is better for those who want to avoid a large upfront payment. With a car loan, you’ll likely need to make a down payment, which could impact your budget.
4. Running Costs and Maintenance
A novated lease often bundles all of the car’s running costs like fuel, insurance, servicing, registration and maintenance into one regular payment. This simplifies budgeting and ensures that there are no unexpected expenses during the lease term. All of these running costs are GST exempt and come out of your pre-tax salary!
In contrast, with a car loan, you are responsible for all running costs, which can fluctuate and may result in large, unexpected bills.
Which is better for managing costs?
A novated lease is ideal for drivers who prefer bundled, predictable payments. However, with a car loan, you have more control over when and how you handle maintenance and other costs. Over the long term the running costs usually come out cheaper with a novated lease.
5. Flexibility
With a novated lease, you have the option to upgrade to a new vehicle every few years. Once your lease term ends, you can sell the vehicle, re-lease the vehicle, buy the vehicle outright or lease a brand-new car. This makes it easy to drive the latest models without the hassle of selling or trading in a vehicle.
A car loan locks you into ownership of the vehicle and all the risks associated with that.
Which is better for flexibility?
A novated lease offers more flexibility in terms of upgrading your vehicle. A car loan is better if you want long-term ownership without the need to replace your car regularly.
6. Interest Rates and Total Cost
Interest rates for car loans can vary depending on the lender and your credit score. With a car loan, you’ll be paying interest on the full amount borrowed, which increases the total cost of owning the car over time.
With a novated lease, the payments are generally structured to cover depreciation, running costs, and interest. The total cost of a novated lease may be higher than the cost of owning a car outright, but the tax savings can offset this and you end up saving more money in the long term.
Which is better for interest rates?
Interest rates can vary for both options, but with a novated lease, the tax savings may outweigh the interest charges. A car loan may result in slightly lower overall interest payments, but you won’t benefit from any tax deductions.
Which Option is Best for You?
The decision between a novated lease and a car loan depends on your financial priorities and personal preferences. If you’re looking for flexibility, tax savings and simplified running costs, a novated lease might be the best option—particularly if you like upgrading your vehicle every few years.
However, if you value full ownership and don’t mind managing running costs yourself, a car loan may be a better choice, especially if you plan to keep the car long-term.
Conclusion: Novated Lease vs Car Loan
Both novated leases and car loans have their advantages. A novated lease can offer significant tax savings and flexibility, while a car loan provides ownership from day one with no ties to your employer. To make the right decision, consider your financial goals, employment situation and how long you plan to keep the vehicle.
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