Unlike other car leasing arrangements, a novated lease involves an employee and their employer, in addition to the financier. The employee uses and maintains the car while the employer deducts the lease payments from the employer’s salary to repay the financier.
According to the Australian Taxation Office (ATO) rules, the last such repayment is called the residual value or balloon payment and is calculated as a percentage of the lease amount. If the terms of the novated lease do not specify a balloon payment, the lease may not be considered legitimate. However, employees can refinance the novated lease as an alternative to making the balloon payment.
How does refinancing a novated lease affect the balloon payment?
Typically, employees who’ve arranged novated leases with their employer have several options when the lease term is about to expire. They can pay the residual value and take ownership of the car, which can have tax implications. Also, the residual value can be a significant percentage of the lease value. For this reason, the standard course of action involves renegotiating the lease to cover this residual value. The new lease will also be novated, but it’ll have a lower residual value. Note that the employer should agree to refinance the novated lease.
Employees can also choose to trade in the leased vehicle for a newer one, in which case the balloon payment can become part of the new lease arrangement. Alternatively, employees can sell the car to cover the residual value and make fresh arrangements to lease a different car. Calculating the residual value factors in the car’s depreciation over the lease term and, as a result, the balloon payment may equal the market value of the vehicle at that time. However, if the market value is lower, the employee will have to pay the difference between the residual value and the market value.
What are the advantages and disadvantages of a balloon payment in a novated lease?
While the balloon payment depends on the lease amount and term, it is usually larger than other lease repayments. Therefore, not having a balloon payment could mean having to make higher repayments over the lease term and potentially lower the employee’s take-home income.
On the other hand, depending on the size of the balloon payment, finding the funds may not be easy for the employee. Even if they can afford the novated lease’s balloon payment, their salary would be more heavily impacted at the time the balloon payment is due.
Without making the balloon payment, the employee can neither own the car nor sell it and even arranging for a trade would depend on the financier agreeing to it. One workaround for employees is checking if they can choose a novated operating lease instead of a novated finance lease, which gives them the option of returning the car at the end of the lease instead of worrying about the balloon payment.
Employees may also want to calculate the long-term impact, in terms of both taxes saved and potential balloon payments, before choosing a novated lease over a car loan.