Mortgage Broking
myeazyassignment
FBPChapter5Slides.pdf
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Chapter 5
Understanding Loan Products
Introduction With all the different features on offer, loan products
become more and more sophisticated.
Mortgage brokers advise their clients on the various features, which may increase the commission or may cause an increase in the loan price.
A mortgage broker should make sure that clients have understood what each particular feature means, how much it would cost, and whether it would benefit or cause detriment to the client.
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Loan Features Mortgage loans involve various features that may be
deal-makers or deal-breakers for a borrower.
Mortgage brokers advise their clients on the various features, which may increase the commission or may cause an increase in the loan price.
A mortgage broker should make sure that clients have understood what each particular feature means, how much it would cost, and whether it would benefit or cause detriment to the client.
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Loan Features…
Extra Repayments
For borrowers, there are certain advantages of making extra repayments towards their mortgage.
Extra repayments will help them pay-off their mortgage more quickly, allowing the borrower to build their equity faster.
Although most companies accommodate borrowers making extra repayments on top of their normal monthly repayment amount, there may be a fee for having this facility.
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Loan Features...
Direct Debit
A direct debit feature means that the lender will automatically draw repayments from the borrower’s nominated account.
It can make paying a mortgage simpler.
As long as there is enough cash in the nominated account, borrowers can make sure that they will never miss a repayment.
Lenders may or may not charge for this facility.
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Loan Features...
Deposit Bond
Used when a buyer wishes to purchase property and needs to put down a deposit, but does not have the ready cash for the deposit, due to money being tied-up in a term deposit.
The deposit bond is the bank or financier’s guarantee that the buyer will pay the deposit monies at settlement, instead of upon signing contracts.
The buyer can avoid breaking fixed-term investments without the need to obtain bridging finance.
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Loan Features...
The process of obtaining such a bond involves: – the applicant completing and signing an application
form; – providing required identification and proof of Australian
residential status, and – providing a copy of the front page of the contract of sale.
An application fee is payable and certain proofs must be provided that funds will be available or that the applicant will have the means to complete the purchase contract.
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Loan Features...
There are two types of deposit bonds: – Finance backed – Equity backed
In the case of equity backed bonds, the applicant will also need to provide details and proofs of their income, assets ownership and debts.
Most banks have a simplified process and offer fast approvals, so once the required documentation and payment is all in order, the bond can be issued quickly after approval
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Loan Features...
Redraw Facility
Probably one of the most widely used loan features in the home loan market.
Allows the borrower to access those funds that have been paid in advance of the loan repayment schedule through extra repayments. – Allows clients to re-borrow any extra
repayments they have made.
From the most basic variable home loans, almost all mortgage products offer this facility.
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Redraw Facility…
Regarding the redraw facility, a mortgage broker should be careful about issues such as:
– there can be a maximum number of redraws allowed per year.
– usually, there is an activation fee which can be up to $300.
– there can be a maximum redraw amount. Usually it is the total amount of additional repayments made, but varies with different products.
– there can be a minimum redraw amount as well, which might be several thousand dollars.
Works best for borrowers who need to redraw against extra repayments infrequently.
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Mortgage related Fees Application Fee
Exit or Early Repayment Fee – Illegal from 1 July 2011 for variable loans
Account Keeping Fee
Switching Fee
Loan re-fix Fee
Break Fee
Discharge Fee
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Other Fees Stamp Duty.
– For property transfer, – For mortgage.
Pest Inspection Fee
Building Inspection Fees – Can cost up to $1,000 depending on the size
of the property.
Real Estate Agent’s Fees
Conveyancing Fees
Searches
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Other Fees…
Building Insurance – Lenders may require borrowers have appropriate
building insurance.
Mortgage protection insurance – This insurance covers loan repayments should a
borrower become sick, injured or redundant and unable to work. It is also called income protection insurance.
– This insurance covers the borrower not the lender.
Council Rates and Strata Fees – The seller is responsible for rates up and until
the day of settlement but the buyer will be responsible from the day after settlement.
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Loan Portability By the virtue of increasing competition between loan
providers, loan portability is offered by many lenders as a handy option.
Loan portability option enables lenders to retain customers while offering them the opportunity to move without having to re-apply for a new loan.
This would be possible if the lender allows a different property to be substituted as security for an existing loan.
There might be a charge when the borrower wants to use this feature.
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Interest-only Loan The Australian practice dictates that the interest-only
period is usually no more than 5-years.
Investors especially demand this type of loan, because they get tax deductions on their interest payments, and therefore only need to pay-off the principal when the property is sold, when they expect to achieve a capital gain.
Best suited to clients who have financial expertise with sound investment abilities and large assets.
A mortgage broker should remind clients they need to evaluate their future ability to pay the higher payments after the interest-only period.
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Interest-only Loan…
A broker is responsible for making clear the pros and cons of interest only loans. The questions brokers should ask include: – What will the client do if their income does not
increase as expected? – What will happen if they lose their job? – What if, for some reason, they have to sell their
home before they’ve paid off the loan? – What if the property value depreciates instead
of appreciating?
Best suited to clients who have financial expertise with sound investment abilities and large assets.
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Performing Loan Calculations
Calculation of interest-only payments: Loan Amount × Annual Interest Rate ÷ Repayment Frequency = Repayment
For a loan of $400,000 borrowed at an interest rate of 5·5% with weekly payments, the payment would be:
($400,000 × 0·055) ÷ 52 = $423.07
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Performing Loan Calculations…
Calculation of principle and interest payments: For a 30-year loan of $100,000, borrowed at an interest
rate of 6%, the monthly re-payment would be?
$100,000 ÷ [1 – (1 + 0·005)–360] 0·005
= $599.55 Using a Financial Calculator: PV = –$100,000 i = 6 ÷ 12 n = 12 × 30
PMT = 599.5505
Variable rate home loan
The main interest rate determinant is the official cash rate set by the Reserve Bank of Australia.
The lender will add-up the credit spread on top of the cash rate, and determine the floating interest rate.
When the Reserve Bank alters the official cash rate, [historically] most variable home loan interest rates change by a similar, if not identical, amount.
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Types of Home Loans
This home loan types usually have the highest repayment flexibility as they generally allow faster repayments and additional lump sum payments.
The norm is that the borrower can pay out their loan without penalty.
These loans generally include an accompanying redraw facility and a 100% offset option.
Early exit penalties applied previously if loan was repaid in full within three to four years, but on 1 July 2011 exit fees became illegal.
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Types of Home Loans…
Types of Home Loans…
Fixed-rate home Loan
A fixed-interest rate applies to this type of loan for a set term which is usually between 1 and 7 years.
Both the interest and principal repayments are fixed for this agreed term, regardless of interest rate changes.
After this fixed period, the variable rate will apply to the loan unless the borrower wants to re-fix the rate by paying the re-fix fee.
Fixed-rate loans eliminate the risk of upward changes in the interest rates so that the borrowers can budget themselves with greater certainty.
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Types of Home Loans…
Capped-rate home loan
Has, as the name suggests, a ‘capped’ interest rate beyond which the required amount cannot rise above, even if variable rates and the Reserve Bank cash rates are well above it.
The interest rate is not allowed to rise, but the borrower will benefit from any falls that may occur as the official interest rate falls.
These loans were more popular around 20 years ago and are re-emerging now.
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Types of Home Loans…
Honeymoon rate loan
Mortgage with a reduced rate of 1–1½ per cent below the standard variable offered for the first six or twelve months of the term of the loan.
The loan is targeted at first-home buyers and is usually available for refinance customers.
These loans are generally fixed during the discount period.
Once the ‘honeymoon’ is over, the interest rate reverts to the higher variable rate.
Types of Home Loans…
Line of Credit loan
Borrowers can draw from a fixed amount at any time to make their personal expenditures.
It is analogous to a credit card with a big limit, but a property acts as security for the loan.
Line of credit loans are sometimes called ‘draw down’.
Effectively, there is a limit set for this loan, but the amount is not accessed all at once.
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Types of Home Loans…
The borrower can draw down the funds as required, up to the set limit.
– the limit can be used at the customer’s discretion.
These loans are interest-only loans, meaning only the interest amount needs to be paid at each monthly payment.
The borrower needs to have self-discipline to ensure that they can pay off the principal as well as the interest.
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Types of Home Loans…
Split and Blended Loans
Blend repayment flexibility with some interest rate security.
– One portion of the repayment is subject to the variable interest rate and the other portion is fixed.
By splitting a loan, a borrower can fix one part and let the other part range with market fluctuations.
Can access variable loan features like redraws and extra payments but have a little bit more certainty around their long-term budget.
Some other split loans have multiple variable portions. 243
Types of Home Loans…
Professional Packages
Designed to attract low-risk and professional borrowers.
Offer a reduced interest rate as well as reduced or even waived fees for other banking products, such as credit cards or financial advice.
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Types of Home Loans…
Construction Loan
Designed to finance construction of residential properties such as houses, town houses, home units, and villas. Before applying for a construction loan the borrower should present the following documents.
– Council-approved plans and specifications for the proposed construction;
– A fixed-price contract from a licensed builder for the construction;
– A copy of builder’s insurance which must be current during construction.
– Valuation of the project. 245
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Types of Home Loans…
Shared Appreciation Mortgage (Equity Finance Mortgage)
Due to the rising property prices, some first-time home buyers may have difficulties in entering into the real estate market, mainly because they lack the initial deposit required to apply for a loan. Shared appreciation mortgages are specifically designed for this type of borrowers.
In an equity finance mortgage, interest and principal repayments will be lower, in exchange for a partial equity remaining with the lender.
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Types of Home Loans…
The funder of equity finance will effectively share in any increase in value over the property.
The amount of capital appreciation the lender receives is double the percentage lent, i.e. equity loan of 10% and lender receives 20% of any capital appreciation.
For instance a borrower is purchasing a property for $240,000.
They have 5% deposit ($12,000), obtain an EFM loan for 20% ($48,000) and seek a standard home loan for the balance $180,000.
The borrower must meet normal lending criteria for the $180,000 and meet repayments on that loan.
Types of Home Loans…
Bridging loan
A bridging loan is a short-term facility, which enables clients who are changing homes to complete the purchase of a new home prior to the original property being sold.
First of all, a mortgage broker should remind the client of the possibility that the client may not get the price for their current home that their agent originally quoted, and there will be many fees, charges and extra costs that come with buying and selling property.
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Types of Home Loans…
Low-doc loan
Especially suitable for self-employed borrowers who may have difficulties in presenting all the financial documents normally required to get a loan.
Borrowers won’t need to provide proof of their income when applying for a low-doc loan.
A low-doc loan borrower must sign a declaration stating the capacity to service the loan and complete an income declaration form along with a standard loan application.
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Types of Home Loans…
Generally to qualify for a traditional mortgage, a self- employed person needs to have been in business for a minimum of 2–3 years and possess full tax returns and financial statements for that period.
These loans generally require a greater deposit than with a traditional loan; 10%–20% deposit is generally required.
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Types of Home Loans…
Generally most of the loan features and loan types available with standard loans are also available with low-doc loans.
The disadvantage of low-doc loans is that the rate is generally higher.
The interest rate is usually reduced after a few years if repayments are on time.
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Types of Home Loans…
No-doc loan
Resemble low-doc loans and are only available for residential property investors and not owner-occupied loans.
These loans will normally only require the applicant to sign an asset and liability statement and also a declaration there won’t be any financial hardship.
Interest rates are quite high for these loans and loan-to-value ratio (LTR) can go up to 65%.
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Types of Home Loans…
100% loans –Also known as ‘no deposit loans’.
With this type of loan, a borrower can apply for the full purchase price without the normal deposit requirements of the traditional lending institutions.
A borrower should have their own funds to cover settlement costs such as stamp duty on purchase, etc.
Generally, lenders require a clean credit history and a strong income to grant a no deposit loan.
This loan is design for people who want to enter the property market but for whatever reason, have not been able to save for a deposit.
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Types of Home Loans…
Vendor Finance
The owner of a property, generally a developer or builder, provides finance to the purchaser.
Especially preferred by some people who have had bad credit history and are having difficulties getting a traditional mortgage loan
It is vital for a mortgage broker to be aware of the potential pitfalls of vendor finance as they have the potential to deprive vulnerable people in some cases.
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Types of Home Loans…
Common characteristics of vendor finance agreements are given below: – legal title remains with the seller – the purchaser usually pays an interest rate of about
2–2.5% higher than the standard home loan – if the seller doesn’t make regular payments on their own
mortgage the financier could sell the property and throw the buyer out
– the buyer may have what is known as an ‘equitable interest’ in the property (to have this equitable interest recognised, the buyer would have to commence expensive legal proceedings and be successful)
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Types of Home Loans…
– the buyer will not obtain any equity in the property until the final payment is made, which may be years into the future
– the buyer is not able to alter, extend or rent the home without the approval of the seller
– the seller may be able to terminate the contract, and not return any moneys to the buyer, when a single payment is missed
– the buyer is not given any of the protection or benefits that come with a residential tenancy (rental) agreement
Vendor financing is also being promoted in many wealth creation schemes.
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Types of Home Loans…
Reverse Mortgage Australia has witnessed a tremendous rise in property
prices in recent years; however, it is a known fact that many retirees have no savings apart from their valuable properties.
Therefore many seniors are left asset-rich but cash- poor on an inadequate pension.
Many senior people have properties, worth many thousands of dollars, but they may not be able to afford a holiday or necessary on- going medical care, or even day-to-day living expenses.
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Types of Home Loans…
A reverse mortgage is one method of alleviating this problem as it allows homeowners to withdraw equity from their home instead of selling it and moving house.
The lender makes payments to the borrower, reducing the equity and increasing the debt.
The equity can be accessed in a lump sum, a steady stream of income over time, an available line of credit, or some combination of these.
A reverse mortgage carries an interest rate. 258
Types of Home Loans…
It is to the borrower’s benefit to ensure the rate of interest is kept as low as possible.
All reverse mortgages from reputable lenders come with a guarantee of no negative equity.
As a condition of the mortgage contract, the property must be maintained to the standard set by the lending institution.
Usually, the amount that can be borrowed varies between 15%–40% of the value of the property. This percentage rises with the age of the borrower. The lowest age allowed is 60 and there is no upper age limit.
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First Home Owners’ Grant Since beginning 1 July 2000, the first home owner’s
grant has now been around for quite a long time.
During the global financial crisis, to attract real estate investments, government introduced a boosted First Home Owners’ Grant (FHOG) Scheme which proposed up to $21,000 of support for first-time home buyers under certain circumstances.
This ended on 31st December, 2009.
The FHOG is non-means tested, which means that provided prospective recipients met all the requirements they could receive the grant.
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First Home Owners’ Grant…
A borrower (the applicant or their partner) can apply for the FHOG under the following rules: – Must be an Australian citizen or permanent resident. – The property must be a recognised house, unit or flat
specifically designed for people to live in. – Must not have purchased in Australia before. – Must apply for the grant within 12 months of settlement
or building completion. – Must buy or build their first home in Australia
(in some places this is restricted to building). – Must occupy the home within 12 months of
settlement or building completion if it is a newly- built home (in some places this is restricted to building).
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First Home Owners’ Grant…
There is a cap on the maximum property price a first home buyer can pay and still be eligible for the grant. The caps vary by state and are as follows: (2017) – New South Wales: up to $750,000 build ($10,000) or
up to $600,000 buy ($10,000) – Victoria: $750,000 ($10,000 grant Metro or $20,000
Regional) – Queensland: $750,000 – South Australia: No limit ($15,000 grant) – Western Australia: up to $750,000 ($15,000 grant) – Northern Territory: No limit ($26,000 grant) – Australian Capital Territory: No limit ($7000 grant) – Tasmania: No limit ($10,000 grant) 262
Stamp Duty Stamp duty is a State Government tax based on the
purchase price of a property.
It is also payable on mortgages in some States.
Each State and Territory have different rules and calculations.
As an incentive for first-home buyers, most States and Territories in Australia offer stamp duty concessions and home purchase assistance to property buyers.
First-time home buyers may be eligible for stamp duty discounts or a rebate.
These will vary from State-to-State and are administered by each State’s respective revenue office.
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Car Finance
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Many finance brokers specialize in one or more specific finance area such as residential loans, reverse mortgages, equity release, equipment leasing, chattel finance, car finance, personal loans, business loans, debtor finance, commercial property finance, etc.
Although car finance is not an area of lending that involves a mortgage, often a mortgage broker will need to be aware of the workings of other types of finance which come into play and affect a client’s financial and bargaining position, when applying for a mortgage.
Car Finance…
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Choosing Car Finance Structure ‒ For most people choosing, finding and driving a new car is
fun whilst arranging car finance can be intimidating. ‒ A finance broker can make this process easier for clients by:
● eliminating the complexities of the process, ● supporting and guiding the client in choosing the correct
finance structure.
Arranging finance for the purchase of a vehicle is a complex task. ‒ Involves thorough research, ‒ Comparison of quotes, ‒ Making loan applications, ‒ Obtaining approval and arranging the workflow.
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There are a number of different ways of financing a vehicle including: ‒ Hire purchase, ‒ Car leasing, ‒ Chattel mortgage, ‒ Novated leasing, ‒ Secured car loans, and ‒ Personal loans.
Each is structured differently from a legal perspective, and each suit different situations. ‒ Clients usually need expert advice to select the
appropriate finance structure.
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The diagram below summarises appropriate finance options for car finance situations:
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Hire Purchase ‒ Operates in an almost identical manner to a retail loan
made on a conditional sale basis.
‒ The credit is restricted and the goods legally remain the property of the loan company until all, or an agreed proportion of the loan, has been repaid.
‒ The key difference is that until transfer of ownership occurs, the borrower is technically hiring the goods, not purchasing them.
‒ With most hire-purchase agreements the option to buy is exercised automatically when the final repayment is made.
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‒ If the borrower decides to terminate the agreement before they have paid all of the instalments the goods remain the property of the lender.
‒ A personal contract purchase is a form of hire-purchase that is partly amortized and partly balloon in nature, and is generally associated with motor finance.
‒ Over the term of the agreement the borrower pays regular instalments covering interest and some of the capital. When the agreement ends a proportion of the original debt remains outstanding.
‒ Enables a consumer to obtain a new car at regular intervals, when one agreement ends, they return the car and take out another agreement for a new one.
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Secured Car Loan ‒ A personal financial product where the financier lends a
customer funds for the purchase of a vehicle, and secures the loan against that vehicle.
‒ The customer takes ownership of the vehicle, and the financier takes an interest in the vehicle as security for the loan. ● Once the contract is completed, the financier lifts their
interest in the vehicle, giving the customer clear title.
Main characteristics of a secured car loan are: ‒ Clients who wish to purchase a late model car
and do not have significant business use of their vehicle or the option of salary packaging via novated lease.
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‒ Can have terms ranging from 24–84 months (two to seven years).
‒ Contracts are flexible; a residual (balloon) can be applied to reduce monthly lease payment.
‒ Can be subject to fixed or variable interest rates. ‒ Borrowers can pay a deposit or offer a trade-in. ‒ As the loan is secured against the vehicle, loans are
subject to lower interest rates. ‒ Generally, interest payments are tax deductible
when the vehicle is used for business purposes. ‒ Tax deductions for depreciation and running costs
can also be claimed on a pro-rata basis.
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Personal Loan ‒ The financier lends the customer funds which can be used
to purchase a car, but does not hold any security over the loan. ● Also known as an unsecured car loan.
‒ The customer takes ownership of the vehicle, and must repay the loan to the financier over the agreed terms.
Main characteristics of a personal loan are: ‒ Higher interest rates compared to car loans as
the financier does not hold the vehicle as security for the loan.
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‒ Suitable for individuals who wish to purchase a car that is outside of the normal lending guidelines (e.g., older model and low value vehicles) or those who do not wish to have a loan secured against their vehicle.
‒ Are subject to less stringent approval guidelines and have flexible contract terms ranging from 24–84 months (two to seven years).
‒ Interest payments, depreciation and running costs can only be claimed as tax deductions on a pro-rata basis according to the percentage of business use.
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Car Lease ‒ A commercial finance product which enables the customer
to have the use of a car or commercial vehicle and the benefits of ownership, while the financier retains actual ownership of the vehicle. ● Also known as a financial lease.
‒ The financier purchases the vehicle on behalf of the customer, who then leases the vehicle back from the financier and pays a fixed monthly lease rental for the term of the lease. ● At the end of the lease, customer has two options:
1. Pay the residual value (final instalment) on the lease and take ownership of the car, or
2. Trade it in or re-finance the residual and continue the lease.
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Main characteristics of a car lease are: ‒ Generally suitable for companies, partnerships, sole traders
and individuals where the leased vehicle is used for business (income producing) purposes.
‒ Fixed interest rate applies to car leases.
‒ Lease payments are fixed.
‒ Certainty of lease payments is an advantage in budgeting.
‒ The usual terms for lease agreements range from 24–60 months (two to five years).
‒ Contracts are flexible; a residual (balloon) can be applied to reduce monthly lease payment.
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‒ When the vehicle is used for business purposes, lease payments are usually tax deductible.
‒ GST contained in the car’s purchase price is claimed back by the financier, only the vehicle’s price exclusive of GST is financed, lowering monthly lease payments.
‒ Businesses can make advance lease payments for tax deduction or cash-flow purposes.
‒ As the lease agreement is secured against the vehicle, lower interest rates apply.
Car leasing has crucial tax implications. ‒ GST is charged on the monthly lease rental and on
the residual value at the end of the lease.
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‒ GST-registered borrower, can claim some or all of the GST contained in the lease rental and the residual value as an input credit on their next Business Activity Statement.
‒ If vehicle is used for business purposes, lease payments can be claimed as a tax deduction up to the depreciation limit. ● The maximum asset value that is allowed by the Australian
Tax Office when depreciating a motor vehicle.
● 2016–2017 financial year this value stands at $64,132 and $75,526 for fuel-efficient cars.
‒ All interest charges on the lease are also tax deductible.
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Commercial Hire Purchase (CHP) ‒ A commercial finance product where the customer hires the
vehicle from the financier for a fixed monthly repayment over a set period of time.
‒ The financier agrees to purchase the car on behalf of the customer, and then hire it back to them over a set period of time.
‒ Effectively, the borrower possesses the use of the vehicle for the term of the contract but is not the owner of the vehicle.
‒ At the end of the contract term when total price of the vehicle (minus any residual) and the interest charges have been paid in full, the customer takes ownership of the vehicle.
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Main characteristics of commercial hire purchase are: ‒ Usual terms range from 24–60 months (two to five years).
‒ Lease contracts are flexible; a residual (balloon) can be applied in order to reduce monthly payment.
‒ Fixed interest applies, making monthly payments fixed and certain therefore costs are known in advance.
‒ As the lease contract is secured against the vehicle, lower interest rates apply.
‒ The transfer of title to the customer for the vehicle is completed when the finance provider receives the last rental.
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‒ GST is not charged on the monthly repayment or on the balloon (final instalment) amount.
‒ Companies or sole traders using the accrual method for accounting can claim the GST as a lump sum on their next Business Activity Statement, whereas companies or sole traders using the cash method for accounting can claim the GST evenly over the term of the agreement.
‒ Where the hirer is registered for GST, they can apply Input Tax Credits to claim some or all of the GST contained in the purchase price of the vehicle.
CHP agreements work best for business entities (companies, partnerships and sole traders) that account for GST on an accruals basis.
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Chattel Mortgage ‒ The financier advances funds to the customer to purchase a
vehicle, and the customer takes ownership of the vehicle (chattel) at the time of purchase.
‒ The financier then takes a mortgage over the vehicle as security for the loan, usually by registering a fixed and floating charge with ASIC.
Main characteristics of chattel mortgages are: ‒ Contract terms are flexible ranging from 24–60
months (two to five years). ‒ Fixed interest rate applies to chattel mortgage
finance; monthly payments are fixed.
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‒ Title of the vehicle automatically passes to customer and the finance company takes a mortgage over the vehicle.
‒ As the loan is secured against the vehicle, lower interest rates apply.
‒ Is a very flexible finance option, in that, the customer has the ability to either finance the full purchase price or alternatively, include an upfront deposit or trade-in to reduce rental commitment.
‒ A residual payment may also be placed at the end of the term to reduce monthly payments.
‒ Where the vehicle is used for business purposes, tax deductions can be claimed for depreciation (up to the depreciation limit), running costs and interest paid.
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‒ Once the contract is completed, the mortgage is removed giving the customer clear title to the vehicle.
‒ GST is charged in the purchase price of the vehicle but not the monthly rental or the contract balloon (final instalment).
‒ Suitable for those companies, partnerships and sole traders who use the cash method of accounting (they record business income and expenses when they pay or collect cash) as it allows them to claim the GST in the vehicle’s price up-front.
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Novated Lease (Salary Packaging a Vehicle) ‒ A tripartite agreement between employer, employee and a
financier where the employee leases a car from financier and employer agrees to take on the employee’s obligations under lease, paying monthly lease rentals from employee’s pre-tax income. ● Also known as ‘salary packaging a vehicle’.
‒ Combines many features of more traditional forms of vehicle finance to deliver some attractive benefits for both employers and employees. ● Popular form of vehicle financing over recent years.
‒ Can have significant advantages for both employees and employers.
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‒ Enables employers to provide a significant financial benefit to employees at little or no cost to the business. ● If the employee ceases to be employed, or the lease agreement
ends, the employee retains the vehicle but all obligations assumed by the employer under the novation agreement revert back to the employee.
‒ Vehicles salary packaged through a novated lease attract Fringe Benefits Tax (FBT). ● FBT is treated concessionally for vehicles.
‒ May be a tax-effective way for an employee to purchase a vehicle.
‒ There are two main types of novated lease: 1. Non-maintained novated lease (also known as
finance-only novated leases), where just the vehicle is leased.
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2. Fully-maintained novated lease. ‒ The vehicle and its running costs are wrapped-up into
the lease, and. ‒ The residual-value risk is assumed by the lessor.
‒ It is up to the employer whether to offer fully-maintained or finance only novated leases. ● Some employers offer both whereas some do not offer
novated lease to their employees at all. ‒ May be a tax-effective way for an employee to
purchase a vehicle.
‒ Fully-maintained novated leases and fully- maintained novated operating leases are normally managed by third-party lease management company.
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Non-maintained (Finance only) Novated Lease ‒ A three-way agreement between an employer, employee and
leasing company whereby the employee enters into a car lease with the financier and the employer agrees to take on the employee’s obligations under the lease agreement.
‒ The employer pays the monthly lease rentals on behalf of the employee. ● By way of salary sacrifice.
‒ Provides the vehicle for the employee to use as part of their salary packaging arrangement.
‒ If employment ceases for any reason, or the lease agreement is finalised, the novation ceases and the obligations assumed by the employer revert back to the employee.
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Main characteristics of finance only novated lease are: ‒ Reduce the income tax the employee has to pay. ‒ Under a non-maintained novated lease employees can
choose the car that best suits their needs, control the car, including care and maintenance, take the vehicle and lease with them if they change jobs.
‒ Non-maintained novated lease is a tax-effective arrangement and may best suit individuals on higher marginal income tax.
‒ As the lease payments are made out of pre-tax income, the arrangement reduces the final income tax liability payable by the employee.
‒ The employee retains any equity built-up in vehicle and benefits from all the other benefits of car finance.
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‒ There is no residual risk for the employer. If the employee quits the job, the novation ceases revert back to the employee. Also, when the novation ceases, employer does not have to deal with the excess vehicle.
‒ Employers can provide a more attractive remuneration package via novated lease and therefore attract the employees they need.
‒ Allow reduced administration time and costs compared to company-owned cars.
‒ Reduce on-costs such as Payroll Tax and WorkCover premiums.
‒ Under a salary packaging arrangement all finance and operating costs for the vehicle are known as a ‘related benefit’ and are GST- and income tax-exempt.
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Fully-maintained Novated Lease ‒ A method of salary packaging a car and its operating costs,
under which an employee leases a car and the employer agrees to take on the employee’s obligations under the lease, paying the monthly lease rentals and operating expenses from the employee’s pre-tax income. ● Distinct from a non-maintained novated lease where only
the lease rentals are deducted from the employee’s pre-tax income.
‒ Suits any employee who wants to include a motor vehicle and its operating expenses as part of salary package. ● Provided employee drives a reasonably high number
of kilometres each year which ensures savings from FBT liability.
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Some examples of the types of operating expenses that can be packaged are: ‒ Lease rental (repayments). ‒ Fuel and oil. ‒ Service and maintenance. ‒ Registration. ‒ Tyres. ‒ Comprehensive insurance. ‒ Other types of insurance – e.g., tyre and rim,
gap and more. ‒ Accident management. ‒ Operating Costs and Fringe Benefits Tax reporting.
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When the vehicle requires fuel or maintenance, the employee pays for these with a fuel card.
The main characteristics of a fully-maintained novated lease are: ‒ Provides similar benefits to a non-maintained novated lease. ‒ Reduces the income tax the employee has to pay further
because operating expenses are also deducted from the employee’ pre-tax income.
‒ An estimated amount is deducted from the employee’s salary each pay cycle to cover lease and operating costs of vehicle, and FBT payable.
‒ Amount deducted for operating expenses are reviewed regularly.
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‒ A third-party lease management company usually becomes involved to help the lessee with maintenance and administrative tasks. These services may include: • Accident Management. • Account Management. • Roadside Assistance. • Car Maintenance. • Automatic registration renewal.
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Goods and Services Tax implications of Novated Lease. ‒ GST is payable on the sale on most new and used vehicles
where the seller is registered for GST (e.g., a dealership). ‒ The financier pays the full amount of the sale price of the
vehicle to the supplier, who then passes the GST on to the Australian Tax Office.
‒ The financier claims the GST component they have paid to the supplier back from the ATO (to a maximum of $6,866.00 for 2016–2017 Financial Year [1/11 of LCT limit]). ● This refund is known as an Input Tax Credit (ITC).
‒ In addition to the GST on the sale price of the vehicle, GST is payable on lease and operating costs. ● These are refunded back to the employee as the
employer claims an Input Tax, making it exclusive of GST.
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GST will only become payable if: ‒ the employee cancels the salary packaging or novation and
continues to pay the lease payments by themselves.
‒ the lease is terminated early (GST is payable on the payout amount).
‒ the lease reaches maturity and the residual falls due (GST is payable on the residual and is the responsibility of the employee).
The net effect is that the employee can save up to $5,774.00 on the price of vehicle and benefit further from the operating costs being exclusive of GST (under a Fully-maintained Novated Lease).
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Fringe Benefit Tax implications of Novated Lease. ‒ The employee agrees to salary sacrifice a portion of his/her
salary in return for the benefit of a car equal to that amount.
‒ The lease payments, FBT amount and running costs of the vehicle are deducted from the employee’s pre-tax earnings, and PAYG income tax is calculated on reduced salary. ● This can effectively increase the employee’s net
disposable income as less tax needs to be paid.
‒ The amount of FBT is now based on a flat rate regardless of kilometres travelled. ● Running costs can be offset through employee
contributions using the Employee Contribution Method (ECM).
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FBT is usually calculated using the Statutory Formula method. ‒ This method calculates the FBT payable each year by
applying a statutory percentage to the vehicle’s FBT Base Value (the purchase price minus government charges). ● This is multiplied by the number of days that the vehicle is
available to the employee, grossed-up by a factor (normally 2.0647) and then multiplied by the FBT Rate (currently 47%).
‒ Under the statutory formula, there is no distinction made between business and private use therefore this method is particularly attractive for employees who have little or no business use.
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Statutory Formula percentages are:
Motor Vehicle Stamp Duty
Stamp duty is collected by the State Governments on transactions including registering a motor vehicle or transferring its registration.
Stamp duty that applies to a vehicle of choice varies from State-to-State. ‒ Usually determined by the dutiable value of the vehicle:
List price including options GST and the luxury car tax (LCT) if applicable
Exemptions and concessions exist for specific vehicle circumstances and vehicle purposes.
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Luxury Car Tax
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First introduced on 1 July, 2000 in conjunction with the removal of sales tax and the introduction of the Goods and Services Tax (GST).
Applies to any car that meets certain criteria, not just luxury cars.
Car dealers always include the Luxury Car Tax (LCT) amount in their quoted prices.
Luxury Car Tax (LCT) is applicable to most new and demonstrator cars where total price exceeds the LCT threshold. ‒ $67,525/$75,526 (fuel-efficient) for 2019/20 (incl. GST) .
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From a typical car buyer’s point of view, LCT (33%) is payable when: ‒ the vehicle is purchased from a dealership; and
‒ the vehicle is less than two years old (the age of a car is measured from the build date for locally built cars, or the compliance date for imported cars) and;
‒ the vehicle’s price (including GST, excluding government charges such as stamp duty, registration & CTP) exceeds the Luxury Car Tax threshold.
LCT is effectively only payable on new cars and used demonstrator vehicles less than 2-years-old.
