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Early termination payouts: how bad can it get?

Early termination is the single largest asymmetric risk in a novated lease.

When it does happen, the financial impact is severe and verging on counter-intuitive.

This should be read together with the high level overview of "why early termination leads to financial damage" in the early termination page.

This page focuses on demonstrating the impact with worked numerical examples, using a real-world lease.

Example 1: Being made redundant 3 months into a 5-year lease

I am going to use my actual lease as an example.

  • Tesla Model 3 Long Range (2023)
  • Drive-away price: $81,422.50
  • Lease duration: 5 years
  • Income tax bracket: 45+2%
  • Lease (only the vehicle component), pretax figure: $597.47 per fortnight, or $77,671.10 over 5 years.
  • Lease (only the vehicle component), post-tax equivalent (i.e. actual take home impact): $316.66 per fortnight, or $41,165.68 over 5 years.
  • Residual value payable (inc GST): $23,234.63.

Original car funding:

  • Under FBT-exempt novated lease, the take-home impact for 5 years: $41,165.68 + $23,234.63 = $64,400.31.
  • Compare this to the driveaway price of $81,422.50 which is a full $17k cheaper from cashflow perspective. (Note that this is only a consideration of the vehicle cost alone, running cost is skipped in this analysis)

Now consider the scenario where I am made redundant 3 months (6 fortnights) into the lease.

  • Lease paid so far (only the vehicle component), post-tax equivalent: 6 x $316.66 = $1,899.96.
  • Lease still owing (from remaining 4 years 9 months commitment):
    • I have to pay with post-tax dollars, so 124 x $597.47 = $74,086.28
    • Note that I will also have to pay the GST, so another 10%: $74,086.28 x 1.1 = $81,494.91.
  • Residual value payable (inc GST): $23,234.63.
  • Grand total paid for the car: $1,899.96 + $81,494.91 + $23,234.63 = $106,629.50.
  • Observe this is now $25k costlier than the driveaway price of $81,422.50.

Note that

  • This assumes that I choose to pay out the termination fee with cash. There are other options e.g. turning it into a post-tax lease, refinancing it as a loan etc.
  • There is also the option of de-novating it and paying it with post-tax cash, with the view to seek new employment and re-novate the lease as yet another FBT-exempt novated lease with the new employer.

Example 2: Insufficiently insured vehicle write-off at 2-year 1-month.

Let us reuse the identical vehicle. Re-attaching the details here:

  • Tesla Model 3 Long Range
  • Drive-away price: $81,422.50
  • Lease duration: 5 years
  • Income tax bracket: 45+2%
  • Lease (only the vehicle component), pretax figure: $597.47 per fortnight, or $77,671.10 over 5 years.
  • Lease (only the vehicle component), post-tax equivalent (i.e. actual take home impact): $316.66 per fortnight, or $41,165.68 over 5 years.
  • Residual value payable (inc GST): $23,234.63.

Assume that this car is unfortunate enough to be written off in an own-fault accident, 2 years and 1 month after the lease.

Typically comprehensive insurance only provides new-for-old car replacement in the first 2 years, therefore if the car is assessed as a write-off, the most I will receive is the agreed value payout. Imagine that I have left the "agreed value" to the automatically generated figure, which in this case was $52,000 on the renewal of third-year insurance coverage.

Now let's analyse what happens to the lease payout:

  • Lease paid so far (only the vehicle component), post-tax equivalent: 54 fortnights x $316.66 = $17,099.64.
  • Lease still owing (from remaining 2 years 11 months commitment):
    • I have to pay with post-tax dollars, so 76 x $597.47 = $45,407.72
    • Note that I will also have to pay the GST, so another 10%: $45,407.72 x 1.1 = $49,948.49
  • Residual value payable (inc GST): $23,234.63.
  • Grand total paid for the car: $17,099.64 + $49,948.49 + $23,234.63 = $90,282.76 (of which $52,000 comes from the insurance)

Note two things:

  • My insurance agreed value payout is $52,000; however I am actually supposed to pay $73,183.12 to conclude the lease. Therefore I will be out of pocket a further $21,183.12 to fully settle the account.
  • This is the ultimate irony of novated lease: in this example of a vehicle write off with insufficient insurance coverage, I get a shock bill of $21k out of pocket, and worse of all I will have no car after the insurance payout, as the payout is merely to settle the remaining lease obligation, and does not include any replacement car.
    • Contrast this with typical arrangement of an outright car ownership: The agreed value is typically the estimated market value of your vehicle, so when you receive the payout, you could theoretically use it to buy an equivalent vehicle as replacement without significant out of pocket expense.
    • Theoretically in the case of novated lease, once the bill is settled, you could also "continue ownership" by starting a new lease; however the total amount spent would remain higher, and frankly after such experience most users may no longer wish to take up another lease.

Risk mitigation ideas (not financial advice)

It is important to be precise about what this page is — and is not — saying.

Early termination does not mean:

  • novated leases are bad on average, or
  • early termination is likely.

It means:

The downside is huge during these uncommon events.

Therefore it is extremely important to anticipate, quantify and mitigate the various potential risks of early termination.

These are some suggested strategies (not financial advice and not a comprehensive list)

  • job security: if redundancy risk is significant, either split the lease to 1 + x; and/or consider "lease protection" insurance.
  • possibility of relocating internationally, going sole trader etc in the future: minimise lease duration.
  • insufficient insurance payout: either consider "gap assist" type insurance, go for insurance with extended new-for-old option, or consider increasing agreed value such that it would cover the payout.

Key takeaway

If you remember nothing else:

Early termination can destroy the entire financial benefit of a novated lease, therefore understanding, quantifying and mitigating this scenario should form part of consideration when one considers novated lease.

Novated leasing should therefore be evaluated not only on expected savings, but on:

  • worst-case exposure,
  • employment stability, and
  • whether the upside adequately compensates you for the rare but impactful downside risk.

Optional Support

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