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Novated lease vs. car loan – which one to choose?

Jodie Humphries avatar
Jodie Humphries
- 5 min read
Novated lease vs. car loan – which one to choose?

You’ve finally decided to buy a new car and are exploring the options to fund your purchase. One of the most common ways is to take out a car loan. But there is another option; a novated lease.

You should remember that these are different, even if there may be some similarities. Both require you to make regular payments and give you the opportunity of a balloon or residual value at the end of the term.

Both novated lease and finance can be used to buy a car for personal use. However, if you choose a car loan, you own the vehicle from the first day. On the other hand, if you opt for a novated lease, you acquire ownership once you pay the residual value at the end of the term.

What is a novated lease?

A novated lease is a three-way arrangement between you, your employer, and the lender. It is set up within your income as a component of a salary sacrifice arrangement. A fully maintained novated lease also allows you to include running expenses such as fuel and maintenance within the arrangement.

When you opt for a novated lease, you borrow from the leasing company and pay off the amount over a set period. The payments are made from your salary over the lease period, which is generally between two and five years.

At the end of the novated lease period, there is a residual amount to pay, and there are a few ways in which you can settle it. You can opt for a new lease and exchange your car for a new one. Alternatively, you can extend the lease and refinance the balance. Lastly, you can pay the residual amount and purchase the vehicle outright.

Benefits

  • Decrease your tax liability as your taxable income reduces
  • Lower monthly payments as you pay only for the actual usage and depreciation
  • Most novated lease arrangements include running expenses enabling hassle-free maintenance and costs

Drawbacks

  • You don’t have ownership of the car
  • If you keep the car for a longer period, the total lease cost can be higher
  • No modifications are allowed
  • If you drive more than the agreed kilometres, you may pay extra fees

What is a car loan?

A car loan is a specific type of loan that you can use to buy a new or a used vehicle if you can’t afford to pay for it upfront. There are different types of car loans that can be taken out for buying a new or a used vehicle. The average car loan term is about seven years. ​​During the term, you’ll need to make regular repayments to pay off the lump sum you borrowed (the principal), as well as the interest accrued on it. 

Your car may be used as collateral to secure the loan if you opt for a secured car loan. Even though the interest rate on a secured loan is often lower than an unsecured loan, the lender may repossess the car to recover the loan if you delay or miss repayments. 

Benefits

  • No restrictions on modifications or kilometres driven
  • Ownership of the car remains with you
  • You can sell the car when you want and at whatever price is suitable to you

Drawbacks

  • The monthly payments are usually higher when compared to a lease
  • You’re responsible for the fuel costs and maintenance expenses
  • Your money is tied up in a depreciating asset

How does novated leasing compare to a car loan?

A novated lease can help you save, but you need to compare the pros and cons before deciding. Some of the factors you should consider when choosing between novated leases vs. finance are:

  • Duration for which you will keep the car; generally, the longer you retain the vehicle, the more you’ll save by buying instead of leasing it. This is because a car is a depreciating asset, and its value can reduce by as much as 60 per cent in the first few years.
  • The wear and tear of the car will be lower if you drive less than the agreed distance in the lease. So you may pay higher maintenance costs than necessary.
  • Depending on your total taxable income and the cost of the car, leasing can be a better option as tax savings can be significant over time.
  • You can consider a lease if your employer is ready to set up a salary sacrifice arrangement for buying a car.
  • You can consider a loan if your savings are sufficient for a deposit, and monthly income will cover the repayments.
  • Some leasing companies don’t allow you to choose the car insurance policy, so you may not get the coverage and premium you want.
  • If you lose your job, the novated lease is converted to a regular consumer lease, and the tax deduction and maintenance benefits are lost.

Talk to an independent advisor and calculate your monthly payments before deciding.

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Product database updated 21 May, 2024

This article was reviewed by Personal Finance Editor Mark Bristow before it was published as part of RateCity's Fact Check process.