In this article we look at:
What is a car lease?
A car lease allows you to ‘borrow’ or ‘rent’ a vehicle from a car dealer or car finance provider for an agreed period of time while making regular fixed repayments. At the end of the lease period, you may have the option to extend the lease on the same car, trade it in for a new model, or pay the residual value of the car (often referred to as a balloon payment) to own it outright.
Keep in mind that like most forms of borrowing, there are typically credit checks and application criteria you will need to meet when applying to lease a vehicle.
Types of car leases
There are generally three different types of car leasing options available in Australia:
Novated lease
A novated lease (also known as ‘salary sacrificing’ a car) is a three-way agreement between you, your employer and a finance company, whereby your employer agrees to make lease repayments for a car to the finance company using your pre-tax salary. If your employer agrees, you can then take out the lease with the finance company (which may be chosen by your employer) and your employer will be responsible for making the lease repayments directly on your behalf. The deductions made from your pre-tax salary also generally cover operational costs such as maintenance, fuel and insurance.
At the end of the novated lease period, you can generally decide whether to keep the car and pay the residual value (balloon payment), take out a new lease with a new car, extend your current lease, or sell your leased car and use the money from the sale to pay the residual value.
When you make repayments on a vehicle through your pre-tax salary, those repayments can reduce your taxable income and potentially lower the amount of tax you are required to pay each year, according to ASIC’s Moneysmart. However, there may be fringe benefits tax (FBT) implications for your employer if you receive a car through salary sacrificing. While it is your employer who is liable to pay FBT, depending on your agreement it may choose to reduce your salary by the amount of FBT it has to pay, the Australian Taxation Office (ATO) says on its website.
Finance lease
This type of car lease is used primarily by businesses, whereby a finance provider or lender purchases a vehicle and leases it to a company for a fixed period in return for regular repayments. At the end of the lease term, the company may pay the residual value of the car to own it outright, or renew the lease for a newer model.
Operating lease
An operating lease works similarly to a finance lease, except the company does not pay the residual value of the car at the end of the lease period, and instead hands the car back to the finance provider. An operating lease often has a shorter term with the opportunity to upgrade more regularly.
Pros and cons of a car lease
Before leasing a vehicle, it’s important to first understand the potential advantages and disadvantages involved. These may include:
Pros of a car lease
- No large upfront payment
With a lease, you don’t need to pay a large upfront cost to start using the vehicle, like you would if you bought it outright or paid a deposit on a car loan.
- Opportunity to drive latest models
Under a lease, you will typically have the option to trade in your vehicle at the end of the lease period for a newer or different model, without having to go to the effort of selling your old car.
- Consolidated repayments
Many car lease agreements combine the purchase price of the vehicle (as well as any finance costs such as fees and interest) and running expenses (such as maintenance, registration and car insurance) into a single regular repayment. These repayments may be either paid by your employer (under a finance or operating lease) or taken out of your pre-tax salary (under a novated lease). This means you or your employer don’t have to come up with a large upfront payment for the vehicle or juggle multiple car bills at different times throughout the year, which could make it easier to budget.
- Tax benefits for novated leases
If you take out a novated lease, the repayments made through your pre-tax salary could reduce your taxable income, according to the ATO. The ATO also says that as an employee with a novated lease, you can avoid paying GST on the purchase price of the vehicle (which is factored into your lease repayments) because it is considered part of your remuneration.
Cons of a car lease
- You don’t own the car and can’t modify it
With a car lease you will not legally own the vehicle, and therefore can’t use it as an asset to secure a loan. On top of this, you typically are unable to make any modifications to the vehicle (such as tinting the windows or adding roof racks), unless you get approval from the finance provider and potentially from your employer.
- Mileage restrictions
Many finance providers have restrictions on how many kilometres you can drive the car over a certain period. If you do not follow these restrictions, you may be charged extra fees.
- Administration fees and other charges may apply
Some car leases come with administration fees that are calculated into your repayments. You may also incur hefty fines if you terminate the lease contract prematurely. The interest rate you pay on your car lease may also be higher than those offered through a normal car loan, according to carsguide.
- Large residual value at end of lease
Under most lease agreements you are required to pay the residual value of the car at the end of the lease, unless you renew it or trade in the car for a new model. Depending on your lease term and the original cost of the car, the residual value you must pay may be significant. This may be covered by the sale of your car at the end of the lease, or alternatively you will be required to pay it if you choose to keep the car and do not enter another lease agreement.
Pros and cons of buying a car
If you are thinking of buying a car outright or using a car loan to secure your new wheels instead of a lease, there are some potential benefits and disadvantages to consider. These may include:
Pros of buying a car
- You own the car
Owning a car outright means you are able to use it as an asset for other borrowing or financial purposes. If you do buy the car with a car loan, then its title will be in your name, although the lender will still hold an ‘interest’ in the car while the debt is outstanding. Once you’ve fully paid off the loan, then the vehicle will be solely yours.
- No limitations on modifications or mileage
When you buy a car and own it outright, you can modify it and use it as you please (so long as you comply with the laws in your state or territory and potentially your insurer’s requirements) and will not have any mileage limitations to worry about.
- More choice
When choosing to purchase a vehicle, you may have more options in choosing the car make and model than you would through a leasing company or your employer. Similarly, if you choose to take out a car loan, you have the opportunity to compare loans to find a competitive rate, which you may not have the option to do if leasing.
- Potentially cheaper
If you’re looking to take ownership of a car, buying it outright is generally the cheapest option overall, as you won’t be required to pay any interest.
Cons of buying a car
- Higher initial costs
If you buy a car upfront, you will need to outlay a lot of money to pay the dealer or private seller. If you have a car loan, you may also have high monthly payments to consider.
- Multiple bills to pay for upkeep
When you buy a car and own it outright, you will be responsible for paying the costs to keep the car running and maintained, as well as the costs of car insurance.
- Depreciation
As your car ages, it will depreciate in value and may become harder to resell later down the road, compared to a car lease where you can typically choose to upgrade at the end of the contract.
- No model upgrades
You are unable to upgrade or change your mind about the model once you’ve bought a car, unless you sell your current vehicle and purchase a new one. With a car lease, on the other hand, you can often choose an upgraded model once the end of your current lease comes around.
Leasing vs buying a car: Some final considerations
The decision as to whether to buy or lease a car will ultimately come down to your individual needs and budget. While leasing a vehicle may provide convenience and the opportunity to use a car without spending a lot of cash upfront, the repayments and residual value you pay may end up costing you more in the long run than if you purchased the vehicle outright. This depends on your situation, including potential tax implications when it comes to a novated lease, so it could be a good idea to speak with a financial advisor or other qualified professional to help you crunch the numbers.
It is important to weigh up your options carefully and examine your lifestyle and financial situation to determine the right way to go. If you do decide to enter into a lease agreement, it’s important to understand your contract, and calculate whether you can afford the repayments coming out of your pre-tax salary (for a novated lease), plus the payment of the residual amount at the end of the lease.
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