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Why are novated lease effective interest rates sky high — yet may still work

One of the most common objections to novated leasing goes something like this:

“Why would I take a novated lease at 10–12% interest
when I can get a car loan at 6%?”

At face value, this sounds like a decisive argument. In reality, it isn’t.

The “interest rate” on a novated lease is not directly comparable to a standard car loan interest rate.

And no — you also can’t “convert” a novated lease rate into a post-tax equivalent and treat that as a valid comparison. That calculation is conceptually wrong, because the tax treatment does not apply neatly to the interest component.

Interest rate is not the cost of a novated lease

The core mistake is treating the novated lease interest rate as if it were directly comparable to:

  • a standard car loan interest rate, or
  • a mortgage interest rate.

A novated lease is not a simple loan.

It is a bundled financial arrangement that combines:

  • financing,
  • tax treatments (both income tax and GST),
  • salary packaging mechanics,
  • and running cost management.

The quoted interest rate applies only to one component of that structure, namely the financing component.

Focusing on the rate in isolation is like judging a restaurant solely by the price of dessert.

Why novated lease effective interest rates are higher than prevailing car loan interest rates

The simplest answer is:

because they can.

Novated leases (particularly the FBT-exempt variety) often generate such large overall savings that financiers and novated lease providers can extract a substantial margin from the arrangement while still leaving the employee with a positive net outcome.

An additional factor is market structure. For historical and administrative reasons, many large corporations and public-sector employers have established near-exclusive salary-packaging arrangements with a single provider. Within such a quasi-monopolistic setting, there is little competitive pressure on pricing.

In other words, a sole workplace novated lease provider has little incentive to compete on price when employees are effectively forced to choose between accepting a still-reasonably-good deal (after margin extraction) or walking away entirely.

The result is that interest rates are set not by competitive lending markets, but by how much margin can be extracted without breaking the deal’s perceived attractiveness.

Direct conversion to an "equivalent rate" is impossible

People familiar with financial calculations often try to convert pre-tax figures into post-tax equivalents.

In some contexts, this is valid.

For example, interest earned on a high-interest savings account is taxed at your marginal tax rate. A nominal 5% interest rate becomes roughly 3.4% after tax at a 30% + 2% marginal rate. That conversion works because the tax applies directly to the interest component.

For novated leases, however, this logic breaks down.

The tax benefit does not apply neatly to the interest component alone. Instead:

  • the tax benefit applies to the entire lease cost (for FBT-exempt leases),
  • GST treatment further distorts the arithmetic,
  • running costs receive their own “discount effect”,
  • and different components of the lease are treated inconsistently for tax purposes.

As a result, attempting to “convert” a novated lease interest rate into a post-tax equivalent (e.g. “12% becomes 8.4%”) is conceptually wrong.

Why novated lease interest rates are inherently unreliable

Unfortunately, many people have formed the habit of comparing novated lease interest rates in the same way they compare home loan rates.

Unfortunately this is fraught with danger and traps. Below we list three reasons.

Effective interest rate is inconsistently defined

Another problem is the lack of any regulated or standardised definition of an “effective interest rate” for novated leases.

Unlike home loans — where comparison rates must be calculated using a prescribed methodology under the National Credit Code — novated lease providers are free to include or exclude different components when reporting an interest rate, such as:

  • administration or account-keeping fees,
  • brokerage or commissions,
  • whether optional insurances (e.g. lease protection) are included in the financed amount,
  • or whether certain charges are labelled in ways that exclude them from interest calculations (e.g. "account-keeping fee" forming part of the vehicle lease figure).

This creates situations where:

  • a provider advertising a lower “interest rate” may deliver a more expensive lease overall, and
  • effective interest rates from two quotes are not directly comparable.

I have personally seen cases where a self-reported “8%” lease turned out to be more expensive than a “10%” lease once all components were properly accounted for. That is the outcome when methodologies are inconsistent.

Some providers bundle insurance into the financed amount

Some novated lease providers include the first-year comprehensive insurance premium inside the financed amount.

This matters because:

  • amounts included in the financed balance attract interest over the life of the lease
  • genuine running costs (rego, fuel, insurance when budgeted normally) do not attract interest; they are simply set aside and claimed as needed

If insurance is bundled into the financed amount, you are now paying interest on your insurance, which could have been avoided.

Ask explicitly whether insurance can be funded from the running cost allowance instead.

Some providers inflate the financed amount with undisclosed brokerage

The financed amount in a novated lease should be:

Vehicle drive-away price
+ documentation fee
− GST saving

However, there have been cases where people have posted quotes showing a financed amount significantly higher than this — in one case by nearly $8,000.

On further investigation (and only after persistent questioning), it emerged that the novated lease provider had added their own brokerage fee into the financed amount without clearly disclosing it.

In that particular example:

  • Expected financed amount:

    Vehicle drive-away price + documentation fee − GST saving
    = $60,000

  • Actual financed amount used:

    Vehicle drive-away price + documentation fee − GST saving
    + undisclosed brokerage
    = $68,000

The provider then calculated and advertised their “interest rate” based on this inflated figure, making the rate appear artificially lower than that of another provider who calculated interest on the correct $60,000 figure, even though the total cost to the employee was higher.

How to compare novated lease quotes when interest rates are unreliable

If headline interest rates are unreliable, how should two novated lease quotes be compared?

There are two possible approaches:

  • estimate the effective interest rate using a standardised methodology (for example, using the novated lease spreadsheet interest rate tab that applies the same assumptions to all quotes), or
  • more simply, compare the total vehicle lease cost plus fees, excluding running costs.

Running costs are not financing costs; they are prepaid budgets. They do not change your outcomes all else being equal.

In short, a meaningful comparison requires modelling:

  • the same vehicle,
  • over the same time period,
  • with the same usage assumptions,
  • compared against realistic alternatives (car loan or offset cash; not a strawman lease),
  • incorporating tax, fees, residuals, and opportunity cost.

Only then does the interest rate take its proper place — as one of the many inputs, not the sole verdict.

The opposite mistake: pretending the rate doesn’t matter

It is also worth stating the reverse error.

Some novated lease quotes implicitly suggest that:

“The interest rate doesn’t matter because it’s all pre-tax.”

This is also wrong.

  • interest is still a real cost
  • fees are still a real cost
  • and poor pricing can overwhelm tax benefits

A novated lease can be bad despite favourable tax treatment.

Obviously, all else being equal, a quote with a lower effective interest rate will cost less. Any novated lease consultant who insists that “the rate doesn’t matter because it’s all pre-tax” is simply ignoring this.

Key takeaway

If you remember nothing else:

A high-looking interest rate does not automatically make a novated lease bad — and a low-looking interest rate does not automatically make one good.

A novated lease provider’s self-reported “effective interest rate” often means very little because of large discrepancies in methodology, and should not be used for direct comparison across providers.

What matters is your overall net financial position, not the headline rate. Only careful calculation and a proper benchmark can answer the question; not intuition that “x% interest is too high”.

Optional Support

Both this guide and the spreadsheet are free. If they prove helpful, consider: