What is a chattel mortgage?

So-called chattel mortgages are often used by businesses or sole traders to purchase assets such as equipment or cars for business use.

There are benefits and drawbacks to chattel mortgages, but let's start with the basics. 

Chattel mortgage definition

A chattel mortgage is essentially a secured loan a business can take out to buy an asset where the asset acts as security for the loan.

It works in much the same way as a secured car loan or traditional home loan where the lender can take back the car or property should the borrower default on the loan.

“A chattel mortgage is the most common type of loan that businesses use to purchase vehicles.

“It has a similar structure to a fixed-rate traditional home loan which is also usually secured against the home.” CarLoans.com.au

How does a chattel mortgage work?

Under a chattel mortgage, a business, business owner, or individual will buy equipment, motor vehicles, or another asset using cash provided by a lender.

They will then pay back the money borrowed, plus interest, over an agreed period of time, generally one to seven years.

If there's a default on repayments, the lender can typically repossess the item the loan is secured against.

“It can be a good option for purchasing a car because the loan is secured, so that could get you a more attractive interest rate.

“Chattel mortgages are available for some businesses or individuals who use their car mainly for business purposes.

“An individual who uses their car primarily for business could also get a chattel loan without having an ABN.” Carloans.com.au

Chattel mortgages with a balloon

But some chattel mortgages may differ from the traditional home loan structure in that some may offer a ‘balloon payment’. That means the borrower can choose to pay a portion of the asset’s cost as a lump sum at the end of the loan term, rather than throughout. 

“A balloon payment lowers monthly repayments to free up cash flow which can then be used for other business purposes.

“The drawback is that you could pay more in the long run because you have a larger amount outstanding for longer, and you do have to make the large repayment at the end.” Carloans.com.au

Do you need a deposit to take out a chattel mortgage?

Whether you need a deposit to take out a chattel mortgage will likely depend on your financial situation and lender.

Many lenders don’t demand a deposit on vehicles or equipment bought through a chattel mortgage. But having one might make a business or sole trader a more attractive borrower - or see them qualify for a lower interest rate.

Tax benefits from chattel mortgages

Chattel mortgages can also offer some businesses notable tax benefits.

Interest paid on a chattel loan can often be claimed as a tax deduction, as can depreciation on the asset while the GST portion of the purchase price of an asset may qualify as a tax credit.

Mark Chapman

Director of tax communications, H&R Block

Expert tax advice

"There are several provisions that may apply to chattel mortgages within Australia’s taxation system:

• Your business can claim the GST on the initial purchase price of the asset.
  

If the business is GST registered, it may be able to claim back the GST portion of the cost of the asset as a tax credit (not a tax deduction) via the business activity statement (BAS).

• You can claim depreciation on the asset.
  

Businesses can often claim depreciation of cars, equipment, and other assets as a tax deduction. The deduction amount and when you can claim it will depend on the type of expense (for example, certain capital expenditures are deductible over time) and whether the asset has any private or domestic purpose which will reduce the deduction.

• All interest payments – but not the repayments of capital – are tax deductible.
  

The interest component of chattel mortgage repayments may be able to be claimed as a tax deduction."

The ATO provides further details on business tax deductions. 

Pros and cons of a chattel mortgage

As with all financial products, there are some pros and cons of taking out a chattel mortgage. Let's consider them.

Benefits of a chattel mortgage

• The borrower owns the asset the loan is used to purchase – potentially offering businesses balance sheet benefits that other types of finance may not

• A borrower can use the asset they’re purchasing as security for their loan, which may secure them for a lower interest rate than an unsecured loan

• Potential to realise tax benefits from repayments and depreciation, as well as GST credits

Drawbacks of a chattel mortgage

• If a borrower doesn’t meet their repayments, their lender can repossess the asset which may be integral to the business

• Chattel mortgages, like many other financial products, may come with additional or unexpected fees

• Assets purchased with chattel mortgages typically have to be used for business purposes, not private use

1. Savings.com.au's two cents

There is no one-size-fits-all finance solution when it comes to funding your business.

Consult your accountant to determine what tax benefits you may gain with a chattel mortgage, but also how repayments may affect your business's cash flow and if there may be any operational trade-offs.

It's also worth exploring other finance alternatives available to businesses (we'll touch on these below) so if you're in doubt, it's best to consult an independent financial advisor who'll be able to lay out your options and determine which will be the best for your circumstances.

Spot the difference: Chattel mortgage, hire purchase, or lease

If you’re a business owner or sole trader researching how you might fund the purchase of a new car or piece of equipment, a chattel mortgage is probably just one of a handful of options you may come across. Here are some others:

Hire purchase (or commercial hire purchase)

A hire purchase, or commercial hire purchase, differs from a chattel mortgage as the borrower doesn’t actually own the asset. Instead, the lender will purchase the car or equipment on their behalf and hand ownership over on the loan’s expiry.

Finance lease (or vehicle lease)

Like a hire purchase, a finance or vehicle lease also requires the lender to purchase an asset on a borrower's behalf.

However, unlike a hire purchase, this type of financing means the person or business using the asset simply leases it for an agreed amount of time. At the end of the agreement, they typically have the option to pay a balloon payment in return for full ownership of the asset or to start a new lease on a new asset.

Operating lease

Like a finance or vehicle lease, an operating lease sees a lender provide a customer with an asset – typically a car – for a set period of time in exchange for a fee.

The reason it differs from the leases above is because under an operating lease, the lessee isn’t responsible for the day-to-day costs that cars bring. At the end of the agreement, the lessee can walk away consequence free.

It’s also worth mentioning that neither a finance lease nor an operating lease sees any debt chalked up on a company’s balance sheet, which can be an attractive proposal for some businesses.