Car Loans vs Salary Sacrificing: What's the Difference?

But no matter how exciting it might be, buying a car could prove to be quite expensive. With so much money on the line, it’s important to take some time to consider which method of purchasing a car is the right one for you.

In this article, we’ll compare how buying a car with a car loan works compared to salary sacrificing for one, a.k.a a novated lease.

On this page:

• What is salary sacrificing?
• How does a novated lease work?
• How are novated leases different to car loans?
• Pros and cons of novated leases
• How do you get a novated lease?
• Which option should you choose?

Important note: this article contains information relating to tax, all of which is general in nature. For personal tax advice, speak to a registered tax agent, and visit the ATO for more detailed information on the topics presented.

What is salary sacrificing?

Salary sacrificing, according to the ATO, is an arrangement you make with your employer to forgo part of your salary in return for some benefit of a similar value. For example, some people agree to salary sacrifices for gym memberships, school fees or childcare costs, while some companies might even offer to pay a portion of their employee’s rent out of their pre-tax income.

Salary sacrificing is very common in Australia. Research from Melbourne Institute in 2017 found that 15.9% of employees reported having a salary sacrifice arrangement with their employer!

One of the most common reasons for salary sacrificing is to buy a car. That process is called novated leasing.

How does a novated lease work?

Salary sacrificing with your employer for a car is known as novated leasing. With a novated lease, you agree with a lender to purchase the vehicle and then ‘novate’ the finance agreement to your employer. If they agree, they will then take on the debt and be responsible for all of the agreed repayments in the loan contract.

In return, the repayments will be taken out of your pre-tax income in equal amounts, as well as the running costs and Fringe Benefits Tax (more on this later). So you are sacrificing some of your salary in return for your employer paying for your car, as well as some potential tax benefits to boot. By reducing your pre-tax income, you’re essentially increasing your net disposable income as you’re paying less tax.

How are novated leases different to car loans?

Car loans are different to novated leases in that they just cut out the middle man. Rather than having your employer pay for the loan and deduct it from your salary before it hits your bank account, you pay a lender directly for a loan.

Read more: Car Loan Repayments 101

Car loans don’t have the tax benefits that novated leases do, and you also have to pay your car’s running costs separately. If that’s the case, you may be thinking, why would someone pick a car loan over salary sacrificing?

As we’ll get into below, novated leases have some distinct pros and cons that you need to consider.

What are the benefits of novated leases?

As mentioned, the key benefit of a novated lease is the potential tax benefit of your employer taking the repayments out of your pre-tax income. Say your car loan repayments are $650 a month: normally you’d pay for that with your after-tax income. But with a novated lease, your employer makes the repayment first and reduces your monthly taxable income by $650.

You’re still making the same amount of money technically, but now, you’re paying less tax than you otherwise would if you’d made the repayments out of your own pocket.

Overall, the pros of novated leases include:

• Tax benefits in the form of reduced taxable income (see the ATO or a registered tax agent for more information on the tax implications)
• Potentially better models are available, as you might effectively be paying less for the repayments after tax, and could therefore allocate extra funds to a more expensive car (or you can just save this money)
• Cheaper maintenance if your employer includes a maintenance package where they pay for some of the costs
• It can be easier to switch to newer models or different cars every few years if you prefer
• GST might not apply in some cases, saving money upfront - see the ATO for more information.

What are the negatives of novated leases?

Novated leases are definitely not without their flaws, which could provide some distinct reasons to reconsider getting one depending on your situation. Arguably the biggest might be the lack of flexibility: there can be a lot of restrictions on the type of car you can get and what you can do with it. For example, some leases might restrict you from driving more than a certain number of kilometres each year.

Novated leases can also attract the Fringe Benefits Tax (FBT). This can sound a bit complicated, but essentially the FBT is tax employers have to pay on these pre-tax benefits they provide to employees (unless they’re a non-profit organisation). The employer could choose to pass this tax on to you, eliminating some of those tax benefits we talked about above.

The cons of novated leases can be summarised as follows:

• You have to pay fringe benefits tax (FBT), which is a tax paid by employers on certain benefits they pay to their employees. 
• You don’t own the car, it is being leased to you. This is technically different to a car loan in which ownership is transferred to you and can be sold if need be.  
• The lease can end if you lose your job, meaning you would lose the car and the benefits that came with it. 
• There may be restrictions on what you can do with the car (such as how far you can drive it, what modifications you can make etc). Breaching these restrictions can carry extra costs or terminate the lease entirely.
• Not all employers offer salary sacrificing, and if they do they might choose a lender or dealer for you. There is generally less choice with a novated lease. 
• It can encourage reckless car buying. Getting a car loan once and sticking with that car for ~10 years can still be more financially beneficial than getting a new lease every few years. 
• They can have mandatory balloon payments at the end if you want to own the car, which can be very expensive.
• The interest rates and fees on novated leases can often be higher compared to car loans.

To top it all off, actually applying for a novated lease can be a more complicated process compared to a standard car loan, which we’ll get into below.

How do you get a novated lease?

Getting a novated lease involves quite a few steps and can differ depending on your circumstances, but generally speaking, there are several key steps in the process:

1. Ask your employer for a salary sacrifice package. If they don’t offer one, then you can stop right here! 
2. Your employer will set out the terms of the package. This might include what extra costs they include (like fuel), what limits they place on the lease etc.
3. Apply for the salary sacrificing scheme. This can be a similar stage to applying for car loan pre-approval: you need to go to an outside organisation and complete an application with a lender. You can either find this lender yourself, or your employer may pick one for you. 
4. Set up the lease: Called a lease arrangement or deed of novation, the finance company will arrange with you the details of the lease, such as the duration of the lease, the type of car you want and any limitations that apply.
5. Find the car you want. This is the fun part, as you can now go out and shop for a new car. Bear in mind you may need to abide by any requirements set by the terms of the lease, and you still need to arrange things like car insurance before you can drive away in it. Once you’ve made your decision, let the leasing organisation know. 
6. Start paying. Your employer will start deducting payments from your pre-tax income as soon as the novated lease is set up.

This is a much-simplified version of how applying for a novated lease works, and it’s still a lot to take in. Car loans generally have a much easier application process, as only two or three parties are involved - you, the seller and the lender.

Novated leases on the other hand could involve four or more parties involved at any one time: you, the lender or finance company, your employer and the seller of the car.

Ask your employer for more details about how such an arrangement would work, as each workplace could have different processes.

Which is better overall: car loans or novated leases?

It’s nearly impossible to definitively say whether car loans or novated leases are better than the other because there are so many factors at play. A novated lease being better for one person doesn’t mean it’ll be the better option for another, who might prefer a car loan.

If you’re purely after a short-term money-saving solution, then a novated lease could be the better option if your employer allows one. This is due to the strong tax incentives a novated lease can offer, especially if your car’s running costs like maintenance and insurance are bundled into the package. Novated leases can also suit people with secure employment who like to upgrade their cars more than the average person, and high-income earners in particular stand to benefit from the reduced taxable income.

But there are just as many situations where a car loan could be the preferred option instead. For one, not all places of employment allow salary sacrifices, so they aren’t available to as many people as a standard loan. What’s more, regularly using a novated lease to get a car becomes less financially beneficial the longer you do it.

This is because car loans actually let you take ownership of the car. Instead of just leasing a car and swapping it out every few years, the car becomes yours to do with as you please with a car loan. You can upgrade it, sell it or use it as equity to get another car loan: and once you’ve paid off the loan in full you longer have to make repayments.

One final benefit of car loans against novated leases is their simplicity. There’s no back and forth with another party when applying for a car loan, and you generally have a much greater degree of choice over who you choose to borrow from.

Ultimately, choosing between a car loan and a novated lease will come down to your personal situation. Both might be equally as good for you, but we encourage you to take plenty of time to research your options before deciding.

One of our customer service representatives would be happy to explain to you why a Jacaranda Finance car loan is worth considering.

Consider a Jacaranda Finance car loan

If you’re in the market for a car and don’t like the sound of a novated lease, a car loan with Jacaranda Finance could be the right choice for you. We offer secure and flexible car loans of up to $25,000, with loan terms of up to 48 months and fixed repayments. What’s more, we don’t charge any fees for extra repayments or paying your loan off early, so you can adjust your repayment schedule to your needs.

To apply for a Jacaranda Finance car loan, simply submit an application through our 100% online application process. Our loan assessment platform is one of the quickest in the business: 90% of applicants will receive an instant outcome, and the rest should hear back from us on the same day of submitting an application².

Written by - William Jolly

Content Manager

William is the Content Manager at Jacaranda Finance. He has worked as both a journalist and a media advisor at some of Australia's biggest financial comparison sites such as Canstar, Compare the Market and Savings.com.au, and is passionate about helping Australians find the right money solution for them.

You can get in touch with William via williamj@jacarandafinance.com.au.

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