How novated leases affect police officers ability to get a home loan
Love them or hate them there is no doubt that the novated lease is a popular “product” when it comes to police officers. In its simplest form, the novated lease packages the cost of a motor vehicle into a single payment that accounts for the real financial cost of the vehicle as well as the vehicles full running cost. That payment is paid in part from pre-tax income and in part from post-tax income.
The attraction for the product is in part the simplicity of having all the costs effectively pre-paid and in part the tax advantage. Today I would like to talk about how the lease affects officers seeking a home loan but I will share a few brief comment on the product in general. Firstly, the upfront cost of the vehicle must be aggressively negotiated in the same way you would with any other type of finance. Paying sticker price for the vehicle is not ever a great idea. Further, the additional cost of paying sticker are magnified inside the lease when you factor in the time cost of money and the interest rate. Secondly, the rate on the lease and fees need to be examined and aggressively negotiated. In short, it will always be better to buy well and pay a lower rate and then package that product.
In November 2015 we had a week in the office where 4 out of 8 applications that came in had at least one applicant with a novated lease. I started to make some calls to really get to the bottom of how the products work and why people are attracted to them. The first call I made was to a Sydney based commercial brokerage who specialises in business equipment finance and executive vehicle finance. I explained how police officers are paid and gave examples of the leases. I then called a similar brokerage in Victoria known to be an industry leader in equipment finance. The both said the same thing. That is, that these leases make the most sense when the employer is effectively paying for them as a bonus over and above salary. When the are self-funded, the way police do it, the principles still work but the make less sense.
The real concern is how having the novated lease affects the customer’s ability to borrow. With over 30 lenders on panel getting to a summary of how banks treat the novated lease is not easy. However an examination of how the majors do it gets us to the core of the issue.
Combination of pre-tax salary sacrifice and post-tax contribution basis
With the major banks, the pre-tax salary sacrificed component is to be excluded from income & servicing as it represents the amount the employer pays directly to the novated lease.
The post-tax contribution must be included as a commitment as commitment or liability.
Policy Example:
The total package (gross) = $100,000
Cash component (gross) = $90,000
Salary sacrifice (novated lease) = $10,000
Customer also has a post-tax contribution (novated lease) of $10,000
In the above example, the $10,000 salary sacrifice is excluded from income and the $10,000 post-tax contribution is included as a commitment as it is the contribution/deduction from the customer’s pay (to cover the difference between what the employer pays directly to the novated lease and the actual novated lease commitment). Only the cash component of $90,000 can be used for servicing or the affordability calculation.
This simply means that the pre-tax amount is excluded from your usable income and the post-tax part is counted as a loan or liability. Immediately you can see the effect this will have on your ability to borrow.
This is how the major banks assume the lease works primarily because this is the type of customer they were designed for. That is someone who in the example above gets paid $90,000 in cash and $10,000 in car allowance as part of the package.
However, let’s have a look how they are structured for police.
Police Real World Novated Lease Example:
The total package (gross) = $100,000
Cash component (gross) = $100,000
Salary sacrifice (novated lease) = $10,000
Customer also has a post-tax contribution (novated lease) of $10,000
In the example above, Police Real Novated Lease, you see that the total package is the same as the cash component. This recognises that the officers pay is determined by the award independent of the vehicle. The vehicle agreement is at will and nothing to do with the employer. The employers only involvement is to arrange the deductions pre and post tax.
The ability of the police officer to get a home loan is reduced because the method banks use to determine affordability does not account for the fact that the vehicles running costs have already been paid for.
A Real World Solution for Police
We actively petition lenders for changes in credit policy when those policies disadvantage our customers. As you can imagine we get mixed results. Some lenders listen and offer case by case exceptions while some react how you would image, like banks.
In an ideal world, we would simply skip those banks and look at others. However, often the reason we seek concessions is that everything about the scenario points us to this lender except for one particular piece of the puzzle being the novated lease.
Add backs make the difference
The banks who get it let us use add back to account for the benefits to the customer.
We have 2 types of add backs. Top line add-backs and tax-free add backs.
Top line add-backs are a concession the lender lets us use the offset the lease cost. An example would be a $5,000 increase in income that is input into the lender’s calculator. In this case, the officers on an income of $90,000 would be allowed to use $95,000 of gross income. We would then deducted the cost of the lease pre-tax and post-tax.
Tax-free add-backs have a much greater impact. We have various lenders who allow us to add back, for example, $7,500 to income to account for the cost of the lease. Being tax-free income it has a greater dollar for dollar impact on capacity.
Final word on novated leases and home loans for police officers
Providing solutions for customers with novated leases is something we have had to become very good at. Customers fall into two camps. Those who tell us they love the novated lease and those who would never take out another one. This makes perfect sense as for the right customer the product works. However, when it comes to home loans it is factually a little harder to get the home loan you want with the lease. If you are thinking of getting a home loan and a novated lease simply ca the novated lease after your home loan is secured.
