When it comes to vehicle loans, there are a variety of options available nowadays. We thought we’d put together a ‘Which car loan and how does it work?’ essay that explains the many sorts of car loans available to you and how they work. This will allow you to make a much more informed decision, potentially saving you money and headaches in the process.
Each type of car loan explained
Most car loans are secured. Your car will typically be the security for the loan. If you don’t pay the loan back on time, the lender can repossess your car and sell it. Because the lender has this security, they consider the loan to be lower risk and, as a result, will typically provide a lower interest rate than they would with a personal/unsecured loan. A secured loan is generally only available on vehicles less than five years old, as the lender needs to be confident of its value. You’ll also need to provide details of the vehicle when you purchase so that the value can be verified.
Personal (unsecured) loan
An unsecured loan is a loan without an asset as security for the debt. As a result, you’ll find that the interest rates are higher than a secured loan because lenders will see this type of loan as higher risk. You can use an unsecured loan for a range of purposes such as taking a holiday or making some improvements to your home.
A novated lease is a finance arrangement used with salary packaging. It simply means that your employer pays for your car lease and car running costs out of your salary package through a combination of pre-tax and post-tax salary deductions. If your employer offers salary packaging, you’ll more than likely be able to take advantage of a novated lease.
This involves entering into a financial agreement with both your employer and a finance company, whereby your employer’s payroll department will make your lease repayments directly to the lender, from your pre-tax salary. This is beneficial as it reduces your overall gross (taxable) income, which means you’ll pay less tax when the end of the financial year rolls around.
Keep in mind that if you change jobs or stop working, the responsibility for making the repayments remains with you. You may be able to transfer your lease to your new employer, but you may also have to take over the repayments (no longer pre-tax). When you have a car under a novated lease with your employer, the Federal Government considers it to be a fringe benefit. Fringe benefits tax may then apply. So please check with your accountant for advice.
A finance lease has similar financial characteristics to hire purchase agreements. Finance leases are flexible leases for business that want the freedom to buy at the end of the lease or hand back vehicles or equipment depending on their needs.
The way a finance lease works is that a lender makes the purchase of the vehicle and leases (essentially rents) it to you over the length of the lease. Your business pays monthly instalments, or rental payments, that go towards the car. Once the lease term is up you have the option to purchase the vehicle by paying the final instalment and balloon payment and keep the car, begin a new lease, or pay off the remaining balance or sell the vehicle and use the money to pay off the lender. Businesses that take out a finance lease for a work-related vehicle will be relieved to learn that their payments are also tax deductible.
An operating lease works basically as a rental agreement for your new vehicle between your business and the lender. An operating lease works like a rental agreement in that you only pay for use of the vehicle, and it can free up capital that may otherwise be tied up with asset ownership. Tax benefits may be gained from this type of lease as the rental price is tax deductible where the car is used to generate taxable income. Another benefit is that the car is simply returned at the end of the lease. There are no resale value risks when the lease runs out. Budgeting is easier as you only have to allow for a pre agreed cost – there are no hidden maintenance issues to deal with.
However significant changes have been made to how businesses must account for operating leases. A new accounting standard came into effect on 1 January 2019, and Australian businesses must take heed. Under the changes, operating leases must now be included alongside financial leases on your balance sheet
What’s the difference between a finance lease and an operating lease?
Under a finance lease, the lessee has the option to buy the equipment at the end of the lease, usually with a balloon payment. However, under an operating lease, the lessee may return the equipment to the lessor when the terms of the lease expire, with no further financial obligations.
DISCLAIMER: The information contained in this document is general in nature and should not be relied upon as legal advice. Berra Finance does not warrant the accuracy or completeness of any representations made in the document or that the material is suitable for any purpose. You are responsible for assessing the material and seeking your own legal or financial advice. To the fullest extent permitted by law, Berra Finance excludes all liability for loss or damage (including indirect or consequential loss or damage) which may be incurred in connection with your use of or reliance on the material contained in this document.