Should I refinance or pay my novated lease balloon payment?
Understanding what to do at the end of your novated lease.
Key takeaways
- A novated lease is a form of salary sacrifice where you lease a car through pre-tax salary payments.
- The ATO only allows you to pay off a certain percentage of the car you're leasing, so when the lease ends, there's an extra amount for you to deal with - that's the residual.
- You can choose to pay the residual in full with a balloon payment, take out another lease to continue using the car or take out a loan to repay.
Residual value in car financing
While often discussed in the context of novated leasing, residual value is a foundational concept across almost all types of car financing. In simple terms, the residual value is the estimated worth of the vehicle at the end of the finance term. Rather than paying off the car's full value over the life of the loan or lease, a portion is set aside to be paid at the end. This structure is designed to align your payments with the expected market value of the car once your contract concludes.
Balloon payments vs depreciation
It is important to distinguish between the mechanic of depreciation and the structure of a balloon payment. Depreciation is the actual loss in a car's market value over time due to wear, tear and age. A balloon payment, on the other hand, is a predetermined lump sum that you agree to pay at the end of a loan term. While the balloon payment is typically calculated to reflect the car's depreciated value (its residual value), they are not the same thing. Depreciation happens naturally, whereas a balloon payment is a financial choice that determines how much of the principal you defer until the end of the agreement.
What happens at the end of a novated lease?
Put simply, at the end of your novated lease, you need to pay the residual value.
What is the residual value?
The Australian Taxation Office (ATO) says that the cost of a car lease must only cover a certain portion of the estimated value of the car at the end of the lease. The longer the lease, the lower the residual value.
The ATO uses these percentages to determine the minimum residual values:
| Term of lease | Percentage of cost |
|---|---|
| Year 1 | 65.63% |
| Year 2 | 56.25% |
| Year 3 | 46.88% |
| Year 4 | 37.50% |
| Year 5 | 28.13% |
It's confusing, so let's throw in an example.
If I were to take out a novated lease for the next 4 years for a $30,000 car, the residual value of the car would be worked out as 37.50% of $30,000.
That means the residual value is $11,250 - that's the amount you would need to pay at the end of your lease.
How residual value dictates monthly repayments
The residual value plays a critical role in determining your monthly cash flow. Choosing a higher residual value (or balloon payment) significantly reduces your regular monthly repayments because you are servicing a smaller portion of the total debt during the term. Conversely, a lower residual value means you pay more each month but owe less at the end. This allows borrowers to choose between lower ongoing costs or a smaller final bill, depending on their personal budget and financial strategy.
Residual value beyond novated leases
Residual values are not exclusive to novated leases. They are a common feature in commercial hire purchase agreements, chattel mortgages and certain consumer car loans. In these broad-spectrum finance products, the balloon payment serves the same purpose of lowering the monthly commitment. However, unlike novated leases, where the ATO sets strict minimum residual percentages, other car loan products may offer more flexibility in setting the balloon amount based on the lender's policies and the vehicle's expected longevity.
What options do you have at the end of your novated lease?
1. Making a balloon payment
If you've got the money saved, you could pay the residual value outright. The shorter your novated lease was and the more expensive the car, the higher that balloon payment would be.
- You'd own the car once you've made that payment.
- It's an expensive cost to bear
2. Start a new lease
You could opt to extend your lease and keep hold of the car a little longer while taking advantage of all the tax benefits.
- Continue on the tax benefits train
- You still don't technically own the car so you can't modify or damage it
3. 'Refinance' with a personal loan
If you don't have the money but you still want to own the car, you might be able to take out a personal loan to pay for the residual. You'd then be making repayments to the loan instead using your post-tax salary.
- You'd own the car without the upfront expense
- You're no longer receiving tax benefits and you're paying towards a big loan
4. Sell the car to pay the residual
You could sell the car and use the money to pay for the residual. If you sell it for above the residual, you get to keep the profit! But you'd still need to make up the rest of the cost if you sold it below the residual value.
- You could pay for the residual and keep some profit
- You could still end up owing money and you won't have a car
Comparing residual value across car loan products
When looking at residual options, the type of loan you choose matters. Secured car loans often allow for balloon payments because the vehicle acts as collateral, giving the lender more confidence that the residual value will be covered. Unsecured personal loans, however, rarely feature a residual value or balloon payment structure because there is no asset for the lender to claim if the final lump sum cannot be paid. Therefore, if your goal is to use a residual value to lower your repayments, you will typically need to look at secured finance options.
Questions to ask yourself:
How much is your balloon payment? The amount you have to refinance will affect whether it’s worth refinancing or not.
How long are you planning to keep your vehicle for? The length of time you’re planning to keep your car also needs to be thought about. You should consider the age of the vehicle, the amount of the balloon payment and whether it can be repaid in that time.
Are you happy with your current vehicle? If you take out another lease, you will be able to get a new vehicle. However, you may want to keep your current vehicle. This is another factor to consider.
Our expert says
"If you can't pay off the residual amount with your own savings, be wary of using a personal loan. This should only be an option in circumstances where you really need to end the lease and don't have the money saved up. This is because of the amount of interest you'll end up paying and the post-tax payments. If you have the option to extend or start a new lease this may be better for you. You won't be paying interest and you'll get the income tax benefits. But remember that there'll be another residual amount to pay at the end of this lease period."
Make use of the tools available to you
When deciding whether or not to refinance, you can use finder.com.au’s tools to help make a better informed decision.
Compare personal loans. Compare rates and fees and read through reviews from banks and other lenders to see if refinancing will be worth it.
Novated lease calculator. You can use the novated lease calculator on this page to find out the overall costs of your lease.
Use a personal loan calculator. Calculators including borrowing power, comparison and repayment are available on this page to help you find out the costs of different personal loans.
Deciding whether or not to refinance your novated lease balloon payment doesn’t have to be a complicated decision. With the right tools at your fingertips, you can make the right choice for your needs.
Compare refinancing options now
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I had a novated lease over 5 years that has just finished. At the end of the lease I was reimbursed $12,000, which my pay office taxed. Is the reimbursed amount part of my taxable income for the Year?
Hi Loraine,
Thank you for getting in touch with Finder.
The reimbursed amount should not be part of your taxable income since you’ve mentioned that your office has been taxed for the novated lease. You may want to review ATO’s guide on types of income you need to declare.
In addition, ATO’s full or split full novation guide will help you know more about GST and vehicles purchased under novated leases.
I hope this helps.
Have a great day!
Cheers,
Jeni