Car loan vs novated lease: which is better?

If you're getting a new car and you're an employee, there's a good chance someone has mentioned a novated lease. It sounds appealing: pay for your car out of your pre-tax salary and save on tax. But a traditional car loan is simpler and more flexible, and for many people it works out just as well or better. The right choice depends on your income, your employer, how long you plan to keep the car and how settled your job is.

This guide explains how each option works, where the real differences lie, and the questions worth asking before you commit.

How a car loan works

A car loan is money you borrow from a lender to buy a vehicle, repaid in regular instalments over a set term, usually somewhere between one and seven years. You own the car from day one, and the loan is entirely between you and the lender. Your employer has nothing to do with it.

Most car loans are secured, meaning the car itself is security for the loan. Because the lender can repossess the car if repayments stop, secured loans are often priced lower than unsecured personal loans. You can also choose to include a balloon payment to lower your regular repayments, although that leaves a lump sum owing at the end.

You make repayments from your after-tax pay. Running costs like fuel, rego, insurance, servicing and tyres are paid separately, by you, as they come up.

How a novated lease works

A novated lease is a three-way agreement between you, your employer and a lease provider. The lease provider funds the car, and your employer deducts the lease payments (and usually the running costs) from your salary before paying you. You drive the car as if it were your own.

The appeal is that some or all of those payments come out of your pre-tax salary, which can reduce your taxable income. Running costs are typically bundled into the same deduction, so fuel, insurance, servicing, rego and tyres are budgeted into one regular amount.

There are a few moving parts to understand:

• Fringe benefits tax (FBT). A car provided through salary packaging is generally a fringe benefit. Many lease arrangements use an employee contribution from your post-tax pay to reduce or eliminate FBT, which offsets part of the tax benefit.
• Electric vehicles. Some eligible electric and low emission vehicles may qualify for an FBT exemption, which can make a novated lease noticeably more attractive for those cars. The rules have conditions and can change, so confirm eligibility with your accountant or the lease provider.
• Residual value. At the end of the lease there is a residual, a lump sum based on ATO guidelines and the length of the lease. You can pay it out and keep the car, refinance it, or trade the car in.
• Fees and bundled costs. Lease providers charge management and other fees, and bundled running costs are estimates. Ask for a full written breakdown.

Side-by-side comparison

A simple example

Imagine two people each buying a $45,000 car.

Sam takes out a secured car loan of $40,000 after putting down a $5,000 deposit. Sam's repayments come out of after-tax income, and Sam pays running costs as they arise. If Sam changes jobs or decides to sell the car in two years, nothing about the loan changes, except that Sam may need to pay it out from the sale proceeds.

Alex, on a similar salary, takes a novated lease through an employer that offers salary packaging. Alex's lease and running costs come out of pre-tax pay, so Alex's take-home pay drops by less than the full cost of the car. But at the end of the lease Alex owes a residual, and if Alex leaves the job, the lease will usually revert to Alex personally, with payments coming from after-tax income unless the new employer agrees to take it on.

Neither is automatically the winner. The overall cost depends on the interest charged, fees, how FBT is handled, residual or balloon amounts, and Alex's personal tax position. Comparing the total cost over the full term, not just the weekly figure, gives the clearest picture.

When a car loan might suit you better

• Your employer doesn't offer salary packaging, or you're self-employed. If you use the vehicle mainly for business, look at business vehicle finance, such as a chattel mortgage.
• You're on a lower income, where the tax savings from salary packaging may be smaller.
• Your job is new, casual or contract, and you'd rather not tie your car to your employer.
• You're buying an older used car, which some lease providers restrict.
• You value simplicity and want to manage running costs yourself.
• You want the freedom to sell, modify or pay the car off early on your own terms.

When a novated lease might suit you better

• Your employer offers salary packaging and you're in a stable, permanent role.
• You're on a higher income, so reducing your taxable income may have a bigger effect.
• You're considering an eligible electric vehicle that may qualify for an FBT exemption.
• You drive a fair amount and like having running costs budgeted into one regular payment.
• You tend to upgrade your car every few years anyway.

Questions to ask before deciding

1. What is the total cost over the term? Ask for the full figure including interest, fees, the residual or balloon, and running costs, for both options.
2. How is FBT being handled? Understand whether employee contributions are being used and what that means for your take-home pay.
3. What happens if I leave my job? Get the answer in writing before you sign.
4. What are the end-of-term options? Know how the residual will be paid and whether refinancing it is possible.
5. Am I comparing like with like? A lease quote that includes running costs will look very different to a loan repayment that doesn't.

Because the tax side of a novated lease depends on your personal situation, it's worth running the numbers past your accountant before signing anything.

Getting a car loan quote to compare

Even if you're leaning towards a novated lease, a car loan quote gives you a useful benchmark. You can use our repayment calculators to estimate repayments with and without a balloon, then see how that stacks up against the lease figure.

If you'd like help, The Finance Club can connect you with a specialist broker from our partner network who can explain the car loan options that may be available to you and help you understand the total cost. Getting pre-approval before you shop can also help you negotiate with confidence. When you're ready, you can start an enquiry in a few minutes.

This article is general information only and does not take into account your objectives, financial situation or needs. Speak to your broker, and your accountant where tax is involved, before making a decision.