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What is a car lease?

Similar to renting a place to live, a car lease is a contracted agreement under which you pay a fixed monthly payment (or, a rental fee) to a lender, for the use of a car over a set period of time.

How does a car lease work?

Here’s how car leasing works:

  1. You choose a car.
  2. A financing company buys it on your behalf.
  3. You lease the car from them for a set monthly fee over a predetermined period of time, generally between two and five years.
  4. When your contract ends, the financing company will maintain ownership of the car. At this point you may have the option to either extend the lease or purchase the vehicle by way of a balloon payment.

Is a car lease tax deductible?

If you’re leasing a car for work purposes, you may be able to claim some tax deductions, including the lease payments. The amount you can claim may depend on if you are an employee or a sole trader, and what percentage of your driving is done for business use.

As tax rules may be updated, it’s best to contact the ATO or a tax accountant to confirm how much you can claim as tax deductions from your car lease.  

How is a car lease different from a car loan?

Car leases are essentially rental agreements. However, unlike holiday car rentals, car leases can last between two and five years. A short car lease term requires higher monthly payments, but you’ll be able to move to a new lease and upgrade to a new model sooner.

The monthly payment for a long term lease is typically lower than the monthly repayment to buy the car outright, which is why long term car leases can be appealing. However, other regular expenses attached to a leased car can be more expensive, particularly insurance, which can often be an expensive policy chosen by the dealer.

Unlike owning a car, leases come with a number of restrictions on use, including maintenance and alterations. Plus, you only possess the car temporarily - you will never own it.

Car loans, on the other hand, involve borrowing a principal amount to cover the cost of buying the car. You then pay back this amount plus interest and any fees and charges over an agreed loan term. Car loans can be secured or unsecured, with the borrower deciding whether they would like to use collateral against the loan to reduce the risk to the lender. By doing this, you may be able to get a lower interest rate, so many borrowers choose secured car loans.

Car leases, however, are usually secured by the car itself as you do not own the vehicle outright. This is why if you get a car lease, you will typically have much cheaper repayments than those under a car loan.

Insider tip

Don’t forget that while car leasing repayments may be cheaper than loan repayments, you are not building any equity in the car you are leasing, and you will not own the car outright. If you decide you want to buy the car, your lease repayments do not count toward the price of the vehicle.

Is it better to lease a car or get a loan?

The right decision for you will always depend on your own financial situation. When you’re comparing car loans and car leases to work out if leasing a car is worth it, you should consider a number of factors including your income, employment status and whether you're willing to pay for a car that you won't own.

Compare the pros and cons of a car lease 
  • Repayments: A leased car may have cheaper repayments than if you took out a car loan. This is useful if you are an undisciplined saver. Leases also often have lower interest rates than car loans.
  • Budgeting: You know what the repayments will be each month, as these will have been agreed with the lender, and they are often cheaper than car loan repayments.
  • Package deals: Many lease packages come with maintenance, repairs and insurance included. If the repairs are mechanical faults, not consumer driven faults, the car’s owner, not you, needs to pay for them.
  • Potential ownership: You may be able to own the car outright at the end of the lease period, or enter into another arrangement with the finance company.
  • Latest models: You can switch your car every few years to upgrade to a new vehicle without having to take on the full depreciation costs of the previous model.
  • Early exit fees: Leaving a lease early means you have to pay out the remaining lease payments and the residual value of the car.
  • More expensive: Multiple car leases for the one car are often more expensive than getting a car loan to buy that car outright.
  • No alterations: With car leases, you cannot improve or alter the car as you do not own it.
  • Driving restrictions: Many leases have restrictions on how many kilometres you can drive and how much wear and tear the car endures.
  • Additional costs: Add-ons like insurance are chosen by the dealer and can be very expensive and not be the best option for your situation. Breaching restrictions on driving or alterations or wear and tear will attract extra costs.

What is a novated car lease? 

A novated lease is an arrangement between an employee, their employer and a lender, in which the employee takes out a lease and the employer makes the repayments to the lender on the employee's behalf, out of their pre-tax income.

What are the steps involved in a novated lease?

  1. You choose your car with your employer and supplier, and organise a car lease
  2. Your employer makes lease payments on your behalf, deducting them from your salary prior to you being paid, and prior to being taxed
  3. Your taxable income is reduced, so you pay less tax or get a bigger refund at tax time.

Before you apply, make sure you look at all the factors so you can make the best financial decision for you.

What is the difference between a fully maintained novated lease and a non-maintained lease?

A fully maintained novated car lease is a salary packaging option under which the car lease repayments and general running costs are collectively paid to the lender by the employer, out of the employee's pre-tax income.

These running costs often include anything from servicing, registration, insurance and even fuel, depending on the individual agreement. A fully maintained novated lease can save the lessee the hassle of budgeting for lump sum running costs, and instead enjoy the convenience of having regular monthly instalments paid on their behalf alongside the lease repayments.

Under a non-maintained lease, only the car lease repayments are made from the employees pre-tax income, meaning running costs are an additional expense that the lessee will be responsible for.

What are the benefits of a novated lease?

For consumers

  • As your car lease repayments are paid directly out of your pre-tax income, novated leasing can help you to effectively reduce your taxable income.
  • If you choose a fully maintained lease, your running costs will also come out of your pre-tax income, further reducing your taxable income.
  • A fully maintained lease will also provide you with the convenience of not having to budget separately for, and manage, things like insurance and registration.

For businesses

  • As a business owner or sole trader, your car lease repayments will typically be tax deductible if the car is leased for business use.
  • If your business needs change and a different car would be better suited, you won't have the hassle of selling the car and buying a new one.
  • Once the lease agreement has ended, you can simply choose the most suitable car for a new lease.

What are the disadvantages of a novated car lease?

  • If you were to lose your job, or your business, while you had a novated car lease, the lease would become a consumer lease, meaning you will lose the benefits of tax deductions.
  • Fully maintained car leases do not allow you to choose your own insurance, so you may be stuck paying for an expensive car insurance policy, and this will carry on regardless of whether you lose your job and the lease changes to a consumer lease.  
  • If you damage the vehicle or drive more than the stipulated kilometres during your lease, you'll have to pay excess charges when the lease term ends.

What documentation do you need to supply for a novated lease?

The documentation needed to secure a novated car lease differs slightly from the documentation required for a standard lease. This is mainly because this is not a consumer lease, but a lease that involves an employee, employer and supplier agreement. As there are tax deductions that benefit the lease, you’ll need:

  • Signed copy of your lease quote (signed by both you and your employer)  
  • Completed novated lease application  
  • Your insurance declaration form
  • Privacy and consent declaration
  • A copy of your driver’s license
  • A copy of your most recent pay slip
  • A copy of your rates notice or rental agreement which indicates where you live

How do I apply for a car lease?

If you do not want to own the car outright, and have decided that a car finance lease is the best option for you, the next step is to apply for the car lease of your choosing.

Ahead of submitting your application, it’s important to gather the necessary documentation, to reduce your chance of rejection. Being rejected from a credit application can have a negative impact on your credit rating, so for your benefit, it’s best to be prepared.

Proof of Identity

If you’re getting a car lease, you will need to prove that you are who you say you are. The following identity documents can help you with this:

  • Driver's license, passport or proof of age card
  • Birth certificate or citizenship certificate
  • Proof of Australian residency
  • Medicare or credit card
  • Concession or pension card
  • Utility bills or bank statements

Proof of Income

To prove to the lender that you can meet your car lease repayments, you can provide income documents including:

  • Pay slips if you are a full time, part time or casual employee
  • Previous years’ tax returns / notice of assessment if you are self-employed
  • Rental income receipts (if you currently own a rental property)
  • A letter from your employer can help your application
  • Bank statements, usually at least three months
  • Superannuation statements, especially if you receive income from your super fund
  • Any other document that shows you receive regular income

Can I get a low-doc car lease?

If you're a business owner or sole trader and your business is in its early stages, you might not have a lot of documentation. Some financiers will consider low-doc applications in these instances, and instead look at other areas of your business to determine whether you are in a suitable position to meet repayments on a lease.

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Can you buy your car after leasing it?

In a typical car lease, you won’t be automatically offered the option to buy your car at the end of the lease. You may instead need to choose between renewing the lease or returning the car.

However, a novated lease may offer the option to purchase the car at the end of the lease, provided you can make the final residual value or balloon payment, which may be expensive. Alternatively, you may be able to refinance this residual value and start a new lease.

Can you return a leased car?

Like many other rental agreements, you’ll be able to return your car at the end of its lease. Returning a car before this time may also be possible, though there may be terms and conditions involved when breaking a lease early.

How to use a broker for a car lease

A car lease can affect your lifestyle and your finances, so it’s important to be confident that you’re making a choice that will suit your needs. Getting professional help can be useful, which is where a broker comes in.

Much like how a mortgage broker can look at your personal financial situation and recommend home loans that may be right for you, a car finance broker is an expert in car leasing and car loans, and can help you select a finance option that suits your needs. Simply contact a car finance broker in your local area to start benefiting from their local knowledge.

Find a broker to assist you

What is a car lease?

A car lease, also known as an asset lease or finance lease, is an arrangement by which a finance company buys a car on your behalf. You get to borrow the car in return for making regular payments to the financier. At the end of the lease, you can either buy the car or hand it back. 

What is an asset lease?

An asset lease, also known as a finance lease or car lease, is an arrangement by which a finance company buys a car on your behalf. You get to borrow the car in return for making regular payments to the financier. At the end of the lease, you can either buy the car or hand it back.

What is a finance lease?

A finance lease, also known as an asset lease or car lease, is an arrangement by which a finance company buys a car on your behalf. You get to borrow the car in return for making regular payments to the financier. At the end of the lease, you can either buy the car or hand it back. 

What is a novated lease?

A novated lease is a car lease that is ‘novated’, or transferred from one party to another. Novated leases are often used when companies provide a car as part of a salary package. The employer signs for the lease and makes the lease payments, but the employee assumes the responsibility of looking after the car. While most car leases involve two parties, novated leases involve three – employer, employee and financier.

What is an operating lease?

An operating lease is an arrangement by which a company leases a car from a vehicle fleet supplier for a set period. It’s a bit like a long-term car rental in that the company gains access to the car but the supplier retains ownership. Companies like operating leases because they are tax-deductible and because they save the company from having to make a large upfront payment to buy a car.

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