Introduction: What are novated leases?

Novated leases are a popular option for Australian employees looking to acquire a new car through their pre-tax income. The appeal lies in the potential tax savings on vehicle payments and running costs. However, as the lease term concludes, many drivers face a critical decision with significant and lasting financial implications. At this juncture, you typically have three options: extend your existing lease, trade the car in for a new one after paying out the residual value, or pay the residual value and take outright ownership of the vehicle. While paying the residual and owning the car was once a commonly perceived benefit, the evolving Australian automotive landscape increasingly suggests it’s a gamble that’s no longer profitable for many.

What is the residual value in a novated lease?

The residual value, often referred to as a “balloon payment,” is the predetermined estimated worth of the vehicle at the end of the novated lease term. This figure is set at the commencement of the lease and is a percentage of the car’s original purchase price. The Australian Taxation Office (ATO) provides guidelines for these minimum residual values, which vary depending on the lease duration to account for depreciation.

Here are the common minimum residual values set by the ATO:

• 12 Month Lease – 65.63%
• 24 Month Lease – 56.25%
• 36 Month Lease – 46.88%
• 48 Month Lease – 37.5%
• 60 Month Lease – 28.13%

These percentages are designed to reflect a conservative estimate of the car’s market value at the lease’s conclusion, ensuring that the asset isn’t fully paid off, thus preserving the tax benefits throughout the lease term.

Why paying the residual value to own your novated lease car is a bad idea:

The notion of owning your car outright after a few years of salary sacrifice payments might seem like a great option. However, several factors in the current Australian market make this a financially risky proposition.

Negative Equity Risk: Car is worth less than the residual value

One of the most significant risks is entering a state of “negative equity,” where the market value of your car at the end of the lease is less than the residual value you’re obligated to pay. The Australian new car market is currently experiencing significant shifts. The Federal Chamber of Automotive Industries (FCAI) reported that while May 2025 sales were slightly down compared to the previous year, the market remains resilient with strong competition. However, this competition, coupled with an influx of new brands, particularly from China, is expected to intensify. Cox Automotive Australia (CAA) 2025 New Market Forecast predicted a cooling of total sales for 2025 against the 2024 record, with increased likelihood of discounting due to excess supply. This buyer’s market for new cars can directly impact the resale value of existing vehicles.

Analysts have consistently predicted a weakening in the used car market in the coming years. The Australian Automotive Dealer Association (AADA) and AutoGrab’s Automotive Insights Report for April 2025 highlighted a seasonal softening in the used car market, with sales volumes dropping. While certain segments like quality 3-5 year old used cars might still be sought after due to past supply chain disruptions, the general sentiment points towards a buyer’s market for pre-loved vehicles in 2025. This makes it increasingly difficult to accurately assess what your car will be worth in three years, posing a substantial negative equity risk if you plan to own and then resell.

Sharp obsolescence curve: Increasing ownership and maintenance costs

Beyond the initial lump sum, taking ownership of a novated leased car means forfeiting the key benefits of salary sacrificing. During the lease term, many of your running costs, such as servicing, insurance, and registration, are typically bundled into your pre-tax payments, offering significant tax advantages. Once you pay the residual value, these benefits cease.

According to the Australian Automobile Association’s Transport Affordability Index released in December 2024 service, tyres, registration, maintenance, CTP and insurance can cost more than $6,400 a year or $533/ week. As the car ages, maintenance and service costs invariably increase. A car that was relatively new and under warranty at the start of your lease will, by the end of a typical three-year term, be entering a phase where more significant repairs and upkeep may be required. A vehicle reaching its fifth or sixth year of life will likely incur even higher service charges, potential part replacements, and increased insurance premiums as it’s no longer considered “new.” These accumulating costs, no longer offset by pre-tax contributions, can quickly become a financial drain, making the car a burden rather than a cost-effective asset.

Opportunity cost of locked-up capital: The looming lump sum residual

Most novated lease terms in Australia are for three to five years, meaning that at the end of this period, you’re looking at paying almost 50% of the car’s original value. For a car initially valued at $60,000, this would mean a lump sum payment of approximately $27,000 (based on the 36-month residual of 46.88%) to take ownership. This does not include the 10% GST that you need to pay on the residual value. This significant amount of capital, if not carefully considered, represents a considerable opportunity cost. Opportunity cost, as defined by Investopedia, is the desirable benefit someone foregoes by choosing one alternative over another – in this case, the potential growth or strategic use of a significant sum of money.

Imagine having $29,700 readily available. This money could be strategically invested, potentially yielding returns, used as a substantial down payment on a mortgage, or simply to bolster your savings for future financial security. Instead, it’s tied up in a depreciating asset. Furthermore, if you don’t have the lump sum readily available, you might be forced to apply for additional finance, such as a personal loan, to cover the residual. This not only adds interest costs but also pushes you further into debt, negating any perceived financial benefits of owning the car outright.

Unlock flexibility and freedom with a car subscription

In light of the risks associated with novated lease residuals, a compelling alternative to novated leases emerging in the Australian market is car subscriptions. This model offers a modern, flexible approach to car access that bypasses the traditional ownership pitfalls.

A car subscription with Karmo fundamentally changes your financial landscape by providing fixed, transparent weekly payments. This means you avoid the uncertainty of depreciation costs and, crucially, the looming lump sum residual payment. Services, insurance, and registration are typically bundled into the weekly fee, simplifying your car expenses and providing predictable budgeting. Beyond financial simplicity, car subscriptions offer unparalleled flexibility and freedom.

You can drive a car of your choice without worrying about its depreciation, as that risk is borne by the subscription provider. Many services also allow you to swap and upgrade your vehicle every few months, providing the ability to match your car to your lifestyle or needs without the hassle of selling and buying. This means no large upfront costs, no lump sum payments, and your capital is not locked up in a depreciating asset. As the automotive market continues to evolve rapidly, particularly with the acceleration of electric vehicle technology and changing consumer preferences, the agility offered by car subscriptions provides a strong counter-argument to the traditional, and increasingly risky, novated lease residual gamble.