Chattel mortgage vs lease vs hire purchase: Which is best?
A chattel mortgage, lease and hire purchase agreement are all forms of asset finance allowing a business to acquire the likes of vehicles, equipment or machinery.
Quick overview of how they differ
Chattel mortgage
This is a loan secured by the business asset being financed. You own the asset from the start but pay off the finance through regular repayment over a fixed term.
Lease
This is effectively a long-term rental agreement where a business pays for ongoing use of an asset but does not have an automatic ownership right on the asset. The lease is not specific to a particular piece of equipment i.e. it can be upgraded throughout the lease.
Hire purchase
Think of hire purchase as being a mixture of a loan and a lease. In other words, a business agrees to purchase an asset and does so by making regular payments to a lender, but the business does not own the asset until the end of the agreement. Until the final payment is made, the business is effectively hiring the asset.
Now, let’s take a look at each of these options in a bit more detail, focussing on ownership, tax implications and other pros and cons.
How does a chattel mortgage work?
The basics...
A chattel mortgage works like a secured car loan for vehicles or assets purchased primarily for business purposes (i.e. business use more than 50% of the time).
The lender will give you the money to buy the vehicle or asset (known as the chattel) and you repay the loan with interest over a fixed term (that’s the mortgage part).
What’s a chattel mortgage used for?
A chattel mortgage is most commonly used to purchase business vehicles and high-value equipment or machinery.
That’s why it’s a popular asset finance option for small businesses with a vehicle fleet and for manufacturing industries, construction companies, tradespeople and transport companies. According to Lend proprietary data, 15% of small businesses opt for a chattel mortgage to buy vehicles.
Chattel mortgage asset ownership
Your business has full ownership of the vehicle or asset from the start. This means you’re responsible for registering, maintaining and insuring the asset.
Chattel mortgage tax benefits
Depending on the value of the asset, you may be able to claim part or all of the the GST on the initial vehicle purchase as an input tax credit through your Business Activity Statement (BAS). You may also be able to claim interest on the loan and the depreciation on the vehicle as a tax deduction.
Businesses purchasing an eligible asset using a chattel mortgage may benefit from the instant asset write-off.
Chattel mortgage pros & cons
Pros
• Lower interest rates
Chattel mortgages often come with lower rates compared to other types of business finance.
• No upfront deposit
Most lenders don’t require a deposit, so you can finance the full cost of the asset.
• Potential tax benefits
You may be able to claim interest charges and depreciation as tax deductions.
Cons
• Ongoing costs are yours
You’re fully responsible for maintaining and running the vehicle or equipment.
• Hard to sell early
Selling or upgrading the asset mid-loan can be difficult and may require lender approval.
• Fees for early payout
Paying off the loan early may attract additional fees or break costs.
How does hire purchase work?
The basics...
Hire purchase is an agreement to buy a vehicle or equipment for business purposes over an agreed period. The lender (lessor) buys the asset at your request, and your business hires it in return for regular repayments. During the hire purchase period, your business does not own the asset but is generally still responsible for maintaining and insuring it. When the final payment on the asset is made, only then does your business own it.
What’s hire purchase used for?
A hire purchase agreement is typically more suitable to buy assets with a medium to long lifespan and medium value. It’s a popular asset finance option for hospitality, retail and construction. As you’ll own the asset at the end of your term, a hire purchase loan isn’t ideal if you believe you’ll need to upgrade the asset throughout this period.
Hire purchase asset ownership
Ownership of the vehicle or equipment is transferred to your business after the final payment is made. This is commonly known as the residual or balloon payment. The final payment is generally a larger lump sum payment, which is generally smaller on longer hire purchase agreements.
Hire purchase tax benefits
You can claim GST on the purchase price (when you purchase the asset at the end of the lease), in addition to any GST payable on interest and fees. The interest component of the loan and depreciation are also tax deductible if you use the asset(s) to generate income.
Businesses purchasing an eligible asset under a hire purchase arrangement may benefit from the instant asset write-off.
Hire purchase pros & cons
Pros
• Ownership at end of term
You’ll own the vehicle or equipment outright once the final payment is made.
• Flexible repayments
Terms can often be tailored to suit your business’s cash flow needs.
• Tax deduction potential
Interest and depreciation on the asset may be tax deductible.
Cons
• Higher repayments
Monthly costs are usually higher than for leasing arrangements.
• You cover all costs
You’re responsible for insurance, registration and maintenance from day one.
• Limited asset flexibility
You can’t sell or modify the asset during the term without lender approval.
How does a lease work?
The basics...
An asset lease or capital lease agreement gives your business operating control of an asset in return for a regular payment. Think of it like renting a car, but over a long period of time (1-3 years, for example).
What’s a lease used for?
An asset lease is often used for assets where the business does not need or want to own the asset. For example, if the asset is needed for a relatively short period of time only. Leases are also commonly used for assets that need to be upgraded regularly (e.g. IT hardware), or are too expensive for a small business to purchase outright (e.g. heavy excavating machinery).
Lease asset ownership
You have no ownership rights on the asset during the lease agreement, nor do you automatically own the asset when the lease term ends. Depending on the lease type, you may have the option to purchase the asset from the lender by making a residual value/balloon payment. Or you can simply return the asset or extend the lease.
Lease tax benefits
You can generally claim GST credits for any GST included in the lease charges. The capital and interest portion of lease payments are tax deductible throughout the lease term. You cannot claim depreciation as the lessor owns the asset(s) during the lease term.
Lease pros & cons
Pros
• No purchase obligation
You can return the asset at the end of the lease — no need to buy it.
• Easy to upgrade
Leasing gives you the flexibility to upgrade to newer equipment as needed.
• Possible tax advantages
GST and lease payments may be tax deductible for your business.
Cons
• No ownership benefits
You can’t modify or sell the asset since you don’t own it during the lease.
• Running costs still apply
You’re responsible for insurance, registration and maintenance expenses.
• On-balance sheet asset
In most cases, leased assets still need to be reported on your balance sheet.
Which option is best for my business?
A chattel mortgage, hire purchase or lease agreement can all be suitable options for financing a business asset. Which one is best will depend on your business and its goals.
Questions to consider to help you decide:
How long will you need the asset for?
If your business will get long-term (7-10+ years) use from the asset, a chattel mortgage may be the most appropriate option as you will own the asset from day one and will typically have it paid off within 3-5 years. This means you should get value from the asset well beyond the finance term and you will have the option of recouping some of your investment by selling the asset.
What is the life-span on the asset?
Unless the asset has a life-span of 10+ years, a lease may be worth considering. Purchasing a shorter-term asset using finance is unlikely to be economical for your business.
Will you need to modify the asset?
If you lease an asset you will generally have very limited ability to modify the asset to suit your needs.
How long have you been trading for?
For businesses with a limited trading history, it may be difficult to get approval on a chattel mortgage or hire purchase agreement. The somewhat brutal reality here is that the lender may not have the confidence that your business will survive to the end of the finance term. In this case, a short-term lease may be your best/only bet.
Is your business seasonal?
Seasonal businesses may not want to commit to the ongoing costs (e.g. insurance) of owning an asset if they will only be able to generate income from it for parts of the year. Leases are generally more flexible. The exception might be if you own the asset and are in a position to lease it to someone else while you don’t need it.
Where can I get a chattel mortgage, lease or hire purchase?
You can get a chattel mortgage, lease, or hire purchase from traditional banks (e.g. Westpac, NAB), non-bank lenders or specialist asset finance lenders. Be sure to compare rates from different lenders before you make a decision, but avoid submitting loan applications with multiple lenders as this could hurt your business credit score