Novated Lease – recurrent

A novated lease is an arrangement between the employer, their employee and a lease company for use of a vehicle that the employer pays by using a portion of the employee's salary. An employee forgoes a portion of their future salary to pay the lease amounts payable on the vehicle. The attraction with a novated lease is that the employee can get a brand new car, and use a portion of their pre-tax salary to pay for the vehicle and can include running costs. So, what's the downside? What most people don't realise is that while they may be able to afford the lease payment on the car, there is a balloon payment to be made at the end of the lease. The larger the balloon payment at the end of the lease, the lower the lease payment is throughout the life of the lease. What is a novated lease balloon payment? No matter how much someone pays for the novated lease, there is a balloon payment that needs to be made at the end of the novated lease. The balloon payment helps to make the purchase of a vehicle attractive by being affordable enough for the buyer to buy the vehicle. How is the balloon payment calculated? Calculating the residual payment at the end of the novated lease arrangement is no different to any other lease with a final pay-out figure. However, the ATO has provided a minimum payout figure for any novated lease arrangement (ATO ID 2002/1004), the balloon payment is calculated based on the length of the lease arrangement, and is as follows: Terms of LeaseMinimum Residual Value(Percentage of Cost)1 year65.63%2 years56.25%3 years46.88%4 years37.5%5 years28.13%The minimum residual payment at the end of a novated lease arrangement according to the ATO's guidelines How does the balloon payment work? Therefore, using the ATO table of residual payments above as my guide, if I purchase a vehicle worth $60,000 and decide to have this as a novated lease then the balloon payment at the end of each term according to the length of the term will be as follows: Terms of LeaseBalloon Payment($60,000 Vehicle)1 year$39,3782 years$33,7503 years$28,1284 years$22,5005 years$16,878The balloon payments on a novated lease arrangement where cost of vehicle was $60,000 Do novated leases have balloon payments? Yes. To help the sale of the vehicle all novated lease arrangements will have a balloon payment at the end of the contract. Most people are shown the cheap lease payment to take the car away, not realising the large balloon payment at the end. As mentioned above the ATO has specific guidelines on what the minimum residual value needs to be for the novated lease arrangement. This is to prevent people from salary sacrificing larger lease portions from their pre-tax dollars to pay off their motor vehicle. Do I have to pay the balloon payment? Yes. The novated lease is a contract arranged between an employee and financier. The novated lease makes no difference to the fact that when the balloon payment comes due, it is your responsibility to pay it. Is there any way out of paying the balloon payment? No. As the arrangement between the financier and the employee are a specific type of financial instrument that has a final payout figure as part of its terms, there is no way out of paying the balloon payment. However, there are strategies you can implement at meeting the obligations of this contract, as outlined below (i.e. roll the lease over for another term, or sell the vehicle and pay the difference). Is balloon payment good or bad? A balloon payment is neither good nor bad, it's just the nature of this type of transaction. A balloon payment shouldn't be an issue to anyone if they have the amount already in savings and can meet making the residual payment at any time. It will probably be an issue if you don't have the money at the end of the term, but there are strategies you can choose at the end as discussed below (i.e. roll the lease over for another term, or sell the vehicle and pay the difference). Can you negotiate residual value at end of lease? Yes. The novated lease arrangement is a finance arrangement. If you wanted to negotiate the final payout figure for your vehicle with the financier, then feel free to do so. If you've looked at the strategies above and the financier does not want to roll over the balloon payment to another term, or you find the sale price of the vehicle will not cover the final payment, and you'll have to pay more than what you have saved, then you might want to negotiate a final payout figure. Whatever is arranged, make sure you have confirmation of the final payout figure in writing, before making final payment (don't provide them with any of your bank details). What happens if you can't afford the balloon payment? There are strategies to help minimise the impact of making the balloon payment at the end of the lease term. The most common two approaches for an employee at the end of the novated leasing term are: Option #1 - Roll novated lease over Roll the novated lease into another lease arrangement. This means you'll still have a balloon payment, but it will be a smaller balloon payment at the end of the new lease arrangement than what you've currently got. Option #2 - Sell the vehicle Sell the car, pocket or pay the difference between the cash received from sale of the vehicle and the final balloon payment. If you have a vehicle that is popular and retains its value well, then you might be able to cover the total balloon payout figure. If you struggle to sell the vehicle, you might only have the first option available when the lease term finishes. It can be very difficult to get the price of your car if you're desperate to sell, and you definitely don't want to sell it to the car yard you purchased it from (or the financier) as they will be discounting the sale price of the vehicle heavily. If you're going to do option two you will also have to let the financier know of your intention to sell as you may not be able to transfer the vehicle into the name of the new buyer as the vehicle may not be in your name, or, if the new buyer does an encumbrance search on the vehicle they will discover that there is an encumbrance as your financier would have placed on the vehicle using it as collateral should you have failed to meet the terms of the lease arrangement. Summary The novated lease arrangement is a financial arrangement between the employee and a financier, where the employee's pre-tax salary can be used to make lease payments. At the end of the lease arrangement there will be one final payout and this is known as the balloon payment. This balloon payment is fixed according to the minimums imposed by the ATO, and you will have to meet the obligations of this contract at the end of the term. There are strategies to help minimise the impact of making the balloon payment, such as rolling over the original novated lease into another lease arrangement, or to sell the vehicle. Be careful entering into a novated lease arrangement, as it is very tempting to purchase a high-priced vehicle when the repayments seem low. My personal preference is an associate lease arrangement.