Car leases vs loans
Trying to decide between a lease and a loan is a common problem people face when considering purchasing a new car. The summary below looks at advantages and disadvantages associated with both leases and loans.
A lease is a long term agreement to finance the use of a car for a fixed period of time. At the end of the term you will not own the car. Generally, there are 2 main types of car leases: a financial lease and a novated lease.
With a financial lease a residual value for the car is set upfront to reflect the vehicle's value at the end of the agreement. At the end of the term you have no option or right to purchase the vehicle however most financiers will consider an offer for the set residual value. Under a financial lease you will be responsible for maintaining the vehicle.
The second type of lease is a novated lease. As an employer you can allow your employees to salary package to a novated lease. Your business will lease the motor vehicle on behalf of your employee, with the responsibility for the lease lying with the employee.
Under this type of arrangement the lease payments will be made from your employee’s pre-tax income. Salary sacrificing the payments reduces their taxable income, which in turn reduces the income tax they pay. If they were to cease employment with your company, the employee will retain the vehicle and all obligations assumed by the employer will revert back to the employee.
Vehicles salary packaged through a novated lease attract Fringe Benefit Tax (FBT). The amount of FBT you'll get charged for the car will depend on its cost price under the statutory formula method or its operating costs under the operating cost method.
There are 2 main types of novated leases:
- Novated finance lease: where just the vehicle is leased
- Fully maintained novated lease: the vehicle and its running costs are included in the lease and the residual value risk is assumed by the lessor.
Advantages of leasing
Preserve your cash flow. You are able to acquire a new car without making the initial cash outlay. Compared to a loan arrangement to purchase the same car, a lease usually requires no down payment.
Lower payments. As you are paying for a portion of the cars full value leasing payments are usually lower than loan repayments.
Help employees. When using a salary packaged novated lease the payments are made using the employees pre-tax income reducing their taxable income which in turn reduces the tax they pay.
Increase flexibility. A lease allows you to update the motor vehicle you are leasing every few years.
Maintenance. Depending on the type of lease the maintenance and running costs of the car are included in the lease.
Disadvantages of leasing
Lack of ownership. With a lease you do not actually own the asset, which will prevent you from making any modifications to the vehicle throughout the duration of the lease. At the end of the lease you will have to return the vehicle to the lessor or be required to pay the residual still owing.
Fringe Benefit Tax. The amount of FBT you'll get charged for the car will depend on its cost price under the statutory formula method or its operating costs under the operating cost method.
Residual value. This value is set by lessor when the lease is established. If at the end of the lease the car is worth less than the predetermined value you will still have to pay the agreed residual value. You will also have to pay GST on the residual value if you decide to purchase the car when the lease ends.
Long term legal obligation. Repudiating a lease agreement prior to the end of the lease term can incur significant termination costs
A loan is used to finance the purchase of a new car. Business loans, or personal car loans, can be used to finance the purchase of a new car. When buying a car using a loan you are paying for the entire cost of the car in addition to the interest rate determined by the lender. Loans can be secured or unsecured. With a secured loan, you offer an asset, such as the car you are purchasing as security for the loan. If you are unable to make the repayments, the lender has the right to repossess and sell your asset.
The term of a car or personal loan can vary but are generally between 12 months and 5 years. Unlike a lease, at the end of the term and once the loan has been repaid you will own the vehicle.
Advantages of loans
Ownership. You will have the discretion to make any modifications to the vehicle throughout the duration of the loan. At the end of the loan term you will own the car.
Optional Balloon Payment. You may be able to structure your payments to reduce your ongoing loan repayments by paying a residual or balloon payment at the end of the finance term.
Disadvantage of loans
Higher repayments. As you are paying to purchase the entire car, loan repayments can be higher than leasing payments
When deciding on how to finance your new car, you should consider what is important to you and what is best for your personal situation. You are encouraged to seek professional accounting advice for further information on which option may be best for you.
The articles represent the views of the authors and not necessarily that of the Bank. You should seek independent professional advice before acting on any matters set out in the articles.