Novated Finance Lease

What is a novated finance lease?

In the coming articles I am going to describe the 3 different types of novated lease. These are as follows:

• novated finance lease
• fully maintained novated lease
• fully maintained novated operating lease

So what is a novated finance lease? Under this type of agreement, you will get full use of the car and in return you agree to make a certain number of payments at an agreed rate for an agreed period. At the end of the period you pay the remainder and end up owning the car. As with all of these situations, payments are deducted from you pay and made the the financier by your employer. It has the usual benefit of using pre-tax dollars.

In some ways this is just like normal finance you would obtain to purchase a vehicle, except that your employer is making the payments on your behalf.

There are a number of things to consider here.

The Amount Financed:

This is effectively the amount you're "borrowing". This will be determined by the purchase price of the car.

The Interest Rate:

This is the rate at which you'll be obtaining the finance. Interest is normally calculated and charged as part of the monthly payment.

The Term Of The Finance:

This is the period over which you will be making payments under the lease.

The Residual Value:

This is the amount you will need to pay to the financier at the end of the lease. It is agreed at the beginning and is meant to be an approximation of the market value of the car at the end of the term.

Risks of a Novated Finance Lease.

The main risk attached to this arrangement is the residual value. Because the actual value of the vehicle is not known at the start of the agreement, there is a risk that the actual resale value of the car is less than the residual amount the lessor is required to pay when the time arrives. This means the lessor is carrying the valuation risk under this type of lease.

Despite this fact, many car leasing companies offer a novated finance lease as part of their product line.

What Is A Novated Lease?

First things first - lets define novated lease.

Before we get too far into this, I guess the first thing we need to do is answer the question "What is a novated lease?".

This was the first question I asked. I heard everybody talking about salary sacrifice, salary packaging and novated leasing, but I didn't know much about it. I knew there we meant to be tax advantages for the employee and figured there must have been something in it for the employer, or else they would want to play the game.

This arrangement seems to be a distinctly Australian concept. In my research I found that in other countries it refers to the situation where a car lease is transferred from one party to another. And this is what the term means in places like the UK and the US.

Novated Lease - Australia:

So coming back to what it means in a Australia, here is what I found out. A novated lease is an agreement (called a novation agreement) between 3 parties. These parties are:

1. You (the employee)
2. The car finance company (or lease company) and
3. Your employer

In a nutshell the way it works is as follows. You (the employee) enter into an agreement to lease a car from a lease company. Your employer than agrees to take over the responsibility for making payments under the lease. These payments are normally made out of the employee's pre-tax salary (hence the term salary sacrifice).

Upon cessation of employment, the responsibility for the lease falls back on the employee (you).

There are 3 different forms of novated lease:

• Finance
• Fully maintained
• Fully maintained operating
  

I will describe the details of each of these in a separate article.

Under the right circumstances, this arrangement should benefit all parties. That's what makes this such a popular deal - it's a win-win-win situation. I will write more about the specific benefits in my next post - Novated Lease Benefits.