The debate over buying or renting a house is hotly contested, but is there an argument between buying or leasing cars?
- How does leasing a car work?
- Types of car leases
- Pros and cons of car leases
- Pros and cons of car loans
- Leasing vs financing a car: what to remember
- Leasing a car with bad credit
How does leasing a car work?
Aside from a car loan or cash, an alternative method for Australians to pay for a car is with a car lease, which essentially involves ‘borrowing’ a vehicle and regularly paying for its use over a set period – typically two to five years.
Like renting a house, leasing a car does not grant you ownership rights over it and there may even be some restrictions around its use. But while a leased car is not technically yours, it still largely serves its purpose.
Types of car leases
A novated car lease is an arrangement between three parties – an employee, their employer and a finance company – where the employer agrees to make car lease payments to the finance company from the employee’s pre-tax salary (salary sacrificing), which reduces the employee’s taxable income.
This type of activity will attract fringe benefits tax though, which is payable by the employer. The car does not have to be used by the employee for work – it can be 100% for personal use, so most employees are eligible for a novated lease if they have their employer’s approval. The lease can be packaged up to include operating costs (fuel, maintenance, insurance etc.).
At the end of the lease, the employee could either keep the car after paying a balloon payment, sell/trade-in the car and lease another car, or extend the lease on the same car.
Cars used by businesses can be paid for through a finance lease where the vehicle is bought by a finance company and rented out to the lessee over a lease period. At the end of this period, the lessee is obligated to either purchase the car from the finance company by paying the residual value or lease the car again.
Operating leases are like a finance lease, except the lessee is not responsible for the residual value at the end of the lease – the car is simply handed back to the finance company. Some businesses with a high turnover of vehicles use operating leases to reduce administration costs.
So if you’re thinking of buying a car with a car loan, is it worth considering a car lease instead? A look at some of the pros and cons of both options could help provide a better idea of what’s more suited to you.
Leasing vs buying a car with a car loan: pros & cons
Car Lease Pros and Cons
- Cheaper recurring payments: Compared to a monthly car loan repayment, a monthly lease payment is often cheaper. This lower cash demand can free up money for other needs.
- Drive the latest models: With leasing, it’s easy to switch to a new car every few years, allowing you to have some of the latest car safety and technology features.
- Easy maintenance: Many car leases come with a maintenance package, with maintenance costs included in the regular lease payments.
- Tax benefits: Leasing a car for commercial purposes or under a novated lease arrangement can generate significant tax savings for some. For more info about this, talk to a registered tax agent.
- You do not own the car: Since you don’t own it, you cannot claim the car as one of your assets for other financial purposes.
- You cannot make modifications: You cannot alter a leased car’s design or performance.
- Driving restrictions: Many leases have restrictions on how many kilometres you can drive the car over the set period and how much wear and tear it endures. Breaching these will attract extra costs.
- High long-term cost: When you do the total calculations, continually using car leases is often more expensive over the long-term (such as five two-year leases over ten years) than simply buying a car with a car loan and sticking with that same car for a decade.
Car Loan Pros and Cons
- You own the vehicle: Buying a car with a car loan makes you the owner of the vehicle, so the car becomes an asset in your name for as long as you like. With each loan repayment, you’re increasing your equity in it. After the loan is paid off, you own it outright.
- You can do what you want with it: As the owner of the vehicle, you’re free to drive it as much as you like, wherever you like or modify it however you want.
- You can sell the car: The car will have resale value which you can recover. Since you cannot sell a leased car, lease money is irredeemable.
- Power to compare: There are many providers of car loans in Australia offering secured or unsecured car loans at fixed or variable interest rates. Car loan customers have the power to shop around to find a good value product with the right features for them.
For reference, these are some of the lowest-rate fixed-interest car loans available in Australia for new cars:
|Company||Advertised rate||Comparison rate*||Monthly repayments|
|Car Loan (New)||4.89%||5.44%||$376||More details|
|Car Loan (Up to 2 years old)||5.49%||5.84%||$382||More details|
|New Car Loan||5.49%||5.87%||$382||More details|
|Discounted Personal Loan (Car Loan)||5.64%||5.99%||$383||More details|
|New Car Loan Fixed||6.45%||6.66%||$391||More details|
|Secured Car Loan Fixed||6.99% (up to 9.49%)||8.05% (up to 10.53%)||$396 (up to $420)||More details|
|Ad rate||Comp rate*||Repayments|
|Car Loan (New)|
|Car Loan (Up to 2 years old)|
|New Car Loan|
|Discounted Personal Loan (Car Loan)|
|New Car Loan Fixed|
|Secured Car Loan|
|6.99% (up to 9.49%)||8.05% (up to 10.53%)||$396 (up to $420)|
*Data accurate as at 1 November 2019. Rates based on a loan of $20,000 for a five-year loan term. Products sorted by advertised rate, then by company name (A-Z). View disclaimer.
- Higher recurring payments: Since you’re paying off the total cost of the car (instead of merely paying for its use), car loan repayments are usually higher than lease payments.
- Repair bills: As the car gets older, more expensive repairs will need to be done.
- Selling hassle: If you want to get a new car, you’ll have to deal with the hassle of selling the car or trading it in.
- Depreciation: Cars usually significantly depreciate in value, particularly in the first couple of years. As the car’s owner, you’ll have more money tied up in this depreciating asset.
Leasing vs financing a car: what to remember
- When leasing a new car, you’re essentially paying for the vehicle’s depreciation, with the car’s value falling by as much as 60% in the first few years. By repeatedly taking out a lease on a new car at the end of each lease term, you’re basically always paying the top price.
- Generally, the longer you’re going to hold the car, the more you’ll save by buying it instead of leasing it.
- Beware of agreeing to a lease if you’re not sure you can commit to it over the entire term. Leaving a lease early will see you having to pay the remaining lease and the residual value.
- Like a car loan, car leases require a credit check. If you have a bad credit rating, you may be denied a car lease.
- If you’re driving a car significantly less than what the car lease permits (the maximum mileage), you’ll be doing an unnecessary favour for the finance company when you trade it in at the end of the lease. You’ll have paid for wear and tear that you didn’t even cause.
- Many car leases do not allow you to choose your own insurance, so you may be stuck paying for a poor value car insurance policy.
- If you were to lose your job while under a novated lease, the lease will become a consumer lease, meaning you will lose the benefits of tax deductions or a maintenance package.
- A novated lease is paid with your pre-tax salary so, depending on a range of factors such as your salary and the cost of the car, it can make your dollar go further and reduce your tax payable, making it cheaper to lease the car instead of buying one with a car loan.
- It can be risky to rely on tax benefits, since government regulations can change. With Australia’s car manufacturing industry close to extinction, the Government may soon consider winding back the tax benefits of car leasing because there might not be an industry to support anymore.
How to lease a car with bad credit
In some cases, you can lease a car with bad credit in Australia – it will just depend on what your credit score actually is and how generous the dealer is. You might have to put up with higher lease payments & fees or more unfavourable terms, however. When leasing a car through a novated lease arrangement, many finance companies will overlook a bad credit rating, since they’re receiving the payments through your employer.
Car Lease vs Car Loan Case studies
Kendall is an auto tech fan who prefers leases
Kendall is obsessed with cars and loves driving the latest in-car tech. She enjoys driving a flashy new car every couple of years and gets bored driving the same car for any longer than that, so she prefers to pay for cars through a novated lease.
Kendall believes that driving a nice car every day keeps her happy in life, because it helps her enjoy the long commutes to and from work (45 mins each way), plus she saves on tax.
Kendall understands it might be cheaper for her to buy one car and hold it for several more years, but she believes the joie de vivre (enjoyment of life) she gets from leasing new cars is worth the extra cost.
Shinji chooses a car loan to buy his dream car
Shinji has fallen in love with a particular new car on the market. He doesn’t have the cash to buy the car outright but he knows he could either buy it with a car loan or pay for it with a novated lease.
He understands a novated lease might save him money, but doesn’t think he’ll stay with his current employer for much longer and he’s not sure if a future employer will agree to a novated lease arrangement.
Also, since it’s his dream car, Shinji wants to be its owner so that he can have the freedom to drive it as much as he wants and modify it with a new sound system, metallic wrap, hydraulics and underglow neon lights.
Savings.com.au’s two cents
The biggest saving opportunity with a car lease often comes from the tax benefit you can leverage by paying for it with your pre-tax income. The risk here of course is that a change of employer could mean that you lose this ‘pay-with-pre-tax-salary’ capability and your benefit could disappear overnight. Without this tax-driven benefit, you’re more than likely better off buying the car with a car loan, particularly if you plan to own the car for a longer period of time (eg. more than 5-6 years). Cars are an asset class that do generally depreciate quite quickly at the front end of ownership.
However this rate of depreciation can come down substantially in the ‘middle’ years of ownership from year five to year eight which means the that if you do own the car (after having paid off your car loan), these years can provide you with very cost effective motoring through slowing depreciation, even after taking into account the higher maintenance costs that come with cars as they age.
Regardless of your decision, if you are considering a lease for what you believe will be tax benefit purposes, it is always wise to consult a registered tax agent such as an accountant for their professional advice on the matter.
The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:
- The big four banks are: ANZ, CBA, NAB and Westpac
- The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in 2018. They are (in descending order): Credit Union Australia, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
- The larger non-bank lenders are those who (in 2019) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.
In the interests of full disclosure, Savings.com.au and loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.
*Comparison rate includes both the interest rate and the fees and charges relating to a loan, combined into a single percentage figure. The interest rate per annum is based on a loan credit of $150,000 and a loan term of 25 years.