Leasing vs Buying a Car-Working out What’s Best for You

Leasing vs Buying a Car - The Pay Calculator

 

It’s one of the most common decisions a car buyer can face – and one of the least understood. What’s actually the benefit of leasing a car? We know there’s some sort of ‘saving’ – all of the online lease calculators show us that – but what exactly are we saving?

Leasing a car is essentially a finance option that lets you have use of a car for a defined period of time. At the end of this lease term, you hand the car back – or sometimes you can buy the car outright, known as a balloon payment. There are a few different types of leases, but we’ll just be talking about novated lease agreements.

Novated leases

A novated lease is one of the most common lease options available and involves entering into a lease agreement between an employee, an employer, and the financier. The employer agrees to make the lease payments on behalf of the employee as long as they remain employed by the company. If the employee no longer works for the company, the payment obligations shift to the employee.

The benefit is that a portion of the payments can be made out of pre-tax earnings, which results in tax savings. And this is where it all gets confusing for many people – exactly how much will you save by entering into a novated lease agreement?

What’s in a novated lease?

A novated lease agreement generally contains the following components:

  • Finance – this is the loan component including interest that you pay to the finance company.
  • Ongoing costs – these costs are estimated based on the amount of kilometres you are expected to drive, and covers things such as fuel, car servicing, tyres, insurance etc.
  • Pre-tax payment – the salary-sacrificed portion of your pay that gets paid before tax. This is where the tax savings come from with a novated lease.
  • Post-tax payment – There’s a portion of the lease payments that are typically made out of your post-tax income. This is done to avoid having to pay Fringe Benefits Tax (you can read more about FBT here).
  • Saving – most novated lease companies will calculate a saving, and it’s important to note that this is usually the difference between what your payments under the exact same lease agreement would be if you were paying the pre-tax component out of your post-tax pay. So essentially it’s the tax savings you get – not any other comparison.

The information that’s typically provided is good and lets you know where your lease money is going, however it doesn’t give you any idea if you’re actually better off just buying a car outright. Let’s run through some examples and show you how you can do some quick checks to see what’s better for you.

Note that the following examples and results are only estimates based on a series of generic inputs. The examples are only intended as a guide to illustrate the impact on total costs that various components of a typical lease agreement can have and should not be used as the basis for any decisions you make regarding purchasing a car – leased or otherwise.

Doing your Research

These examples will show the net difference in cost for novated leasing versus buying a car outright and selling it at the end of the lease term. This is calculated for a number of different incomes and annual kilometres travelled, and is simply the output from a leading online lease calculator.

Example 1

Car cost: $26,490

Lease term: 3 years

Assumptions:

  • Ongoing costs associated with buying the car outright have been based on the ongoing costs estimated as per the lease agreement, without the admin fee and carbon emissions offset. The registration fee has also been adjusted.
  • The sale price of the same car three years later has been assumed to be $16,490. It’s assumed that at the end of the three years, the car will be sold.

The following table shows the total cost over three years for leasing versus buying the car outright then selling three years later.

Leasing a Car Comparison Table 1

Example 2

Car cost: $62,400

Lease term: 3 years

Assumptions:

  • Ongoing costs associated with buying the car outright have been based on the ongoing costs estimated as per the lease agreement, without the admin fee and carbon emissions offset. The registration fee has also been adjusted.
  • The sale price of the same car three years later has been assumed to be $38,844.

Leasing a Car Comparison Table 2

Results

As we can see from the results of both examples, the three key factors that impact the costs and overall savings:

  • Income – as your income increases, you will enter into a higher tax bracket. If the pre-tax component comes out of a higher tax bracket, then you will save more in tax. Note that the savings occur incrementally as you reach new tax brackets – for example there’s a saving when going from $80k income to $100k, however no difference when going from $100k to $150k.
  • Annual kilometres – as kilometres increase, your ongoing costs will also increase due to fuel, tyres etc. This increase will be the same whether or not you are leasing; however, if you are leasing, the pre-tax component you pay will also increase, meaning you get some of this money back in the form of additional tax savings. This tax saving isn’t applicable when you buy the car outright, therefore in a lease versus buy scenario, as kilometres increase the benefit of buying outright diminishes. Eventually, you would reach a point where the interest you have to pay as part of the finance component of the lease is completely offset by the tax savings, and it would be more beneficial to lease compared to buying. Note that in Australia, motorists drive on average around 15,500 km per year.
  • Cost of the car – as the cost of the car increases, the finance component of the lease will increase to cover the payments for the car. The ongoing costs also increase, but only slightly (insurance might be more expensive for example). As a result, the more expensive the car, the higher portion of the total cost is for finance – which means more interest. The interest costs will always be higher than the tax saving you receive for paying that interest out of your pre-tax salary. Therefore when compared to buying the car outright, as the cost of the car goes up the benefit of buying that car outright instead of leasing also increases.

Based on these results, it seems that most of the time buying the car outright is the best way to go, purely on a dollars basis. To really get the best advantage of a novated lease agreement you need to:

  • Earn a high income, so you benefit from tax savings at a higher marginal tax rate.
  • Travel a lot of kilometres per year.
  • Buy as cheap a car as you can.

All of this said, there are benefits of leasing that haven’t been mentioned yet:

  • No need for capital – if you were to buy a car outright, you would need to have money available to do so. Depending on the car and your circumstances, this might not be possible, so although over the lease term you might pay more if you lease, it allows you to purchase a car that you couldn’t otherwise buy. However, this leads to another potential issue with leasing a car – it allows people to drive cars they practically can’t afford; they still end up paying for it, only over a longer period of time.
  • Opportunity cost of buying – if you outlay money for a car, what else could you have done with that money? Could you have invested it or spent it on other things you wanted to buy? There would probably be a number of different things you could use that money for that would yield some sort of financial or emotional benefit. The above calculations don’t take this into account – only you can decide what’s important.
  • No need to sell the car – at the end of the lease term you can either pay the balloon payment and buy the car, or get a new car on a new lease agreement. In the above examples, we haven’t taken into account the costs and effort involved in selling the car.

All of these factors are important to consider, and might justify for you entering into a novated lease agreement even if the overall cost is higher. If you are unsure, always seek the advice of a professional financial adviser.

The key message is this: do your research, understand all of the aspects, and make a decision based on your circumstances and what you value the most.

 

Subscribe for more!