Chattel mortgage, hire purchase, lease or rental: what each one does to your books

Fund a work ute or a machine and you will be offered four structures that sound similar and are not: chattel mortgage, commercial hire purchase, finance lease and rental. The right one depends on whether you want to own the thing at the end, and what you want it doing to your books in the meantime.

The difference is not really about rate. Two of these can be quoted at similar money and still leave you in very different positions three years later, because ownership, GST timing and what appears on the balance sheet all change with the structure. It is worth ten minutes now rather than a conversation with your accountant in July that starts with the word unfortunately.

The question that decides it

Before comparing quotes, answer three things. Do you want to own the asset at the end of the term, or hand it back? How long will the asset actually be useful to you, as opposed to how long the finance runs? And is your priority the lowest possible monthly cost, or the cleanest tax and ownership position?

Gear that you will still be using in ten years usually points one way. Gear that dates quickly, gets flogged, or gets replaced on a cycle points another. A business that is about to apply for other finance may care a great deal about what shows up on the balance sheet. One that is not may care more about cash flow this quarter.

Chattel mortgage

You own the asset from day one and the lender takes security over it. Asset and liability both sit on your balance sheet. If you are registered for GST on an accruals basis you can generally claim the GST on the purchase price in your next BAS rather than dribbling it out across the term, and the interest and depreciation are typically deductible to the extent the asset is used for business.

The security is registered against the asset, which means it cannot be sold with clear title until the loan is paid out. Once it is paid out the security is discharged and the asset is simply yours. There is no decision waiting at the end of the term unless you have set a balloon, which is a separate choice rather than a feature of the structure.

Two things worth raising with your accountant. Depreciation on a passenger car is capped at a limit that is indexed and changes from year to year, and the GST credit on a car is capped in line with it, so a more expensive vehicle does not necessarily deliver a proportionally larger claim. Write off and immediate deduction provisions have also changed repeatedly, so the rules that applied to a mate's purchase two years ago may not be the rules that apply to yours.

Who a chattel mortgage usually suits

Businesses registered for GST that want to own the asset, that will keep it well past the end of the finance, and that can make use of the GST claim early. Tradies buying a ute they intend to run into the ground, operators buying machinery with a long working life, transport businesses buying trucks they will hold. It is the most common structure in commercial vehicle and equipment lending for exactly those reasons.

Commercial hire purchase (CHP)

With a commercial hire purchase, the financier owns the asset for the life of the agreement and you make repayments to take ownership at the end. You get full use of the vehicle or equipment from day one, but legal title does not pass to you until the final payment, or a small option fee if the contract has one.

Day to day it feels much like a chattel mortgage. You hold and use the asset, you insure it, you maintain it and you wear the running costs. The financier's name sits on the agreement as owner and the transfer happens at the end. Read the contract for how that final transfer works, because whether it happens automatically on the last payment or needs an option fee is set out in the document rather than being standard across lenders.

On GST, the gap between the two has largely closed. For hire purchase agreements entered into from 1 July 2012, a GST registered business can generally claim the GST credit up front, the same way it would on a purchase, whether it accounts for GST on a cash or accruals basis. For income tax the arrangement is generally treated as though you had bought the asset, so interest and depreciation are typically deductible to the extent the asset is used for business. Have your accountant confirm both for your own agreement.

So the practical difference is who holds title during the term. Under a chattel mortgage the asset is yours from the start and the lender holds security over it. Under a CHP the financier owns it until the end. Some lenders offer one and not the other, and pricing can differ, so compare the same term, deposit and balloon across both before you choose.

Can you get out of a CHP before the end?

Yes, but on the contract's terms. You ask the financier for a payout figure, which is what is owing to end the agreement on a given date. That figure can include charges for ending early, and it is not always the sum of the remaining repayments, because part of what you would have paid is future interest. If there is any chance you will want out early, ask how the payout is calculated before you sign.

Finance lease

The financier owns the asset and leases it to you, with a residual owing at the end of the term. Lease payments are generally deductible where the asset is used for business, and the GST sits inside the payments rather than up front.

The residual is not a number you pick freely. Lease residuals are set within accepted ranges that vary with the term, which is why a longer lease has a smaller residual and a short one has a large one. At the end of the term the contract sets out your options, which typically involve paying the residual to take ownership, refinancing it, or returning the asset. Read that clause before you sign rather than in the final month, because it decides what the end of the term feels like.

A finance lease can suit a business that is not registered for GST, or one that would rather have the GST spread through the payments than claimed in a lump. It also suits a business that wants the deduction sitting in a single clean payment line rather than split between interest and depreciation.

Rental or operating lease

The closest thing to renting. You use it, you hand it back, you never own it. That suits gear which dates quickly or gets replaced on a cycle, and it takes the end of term decision out of your hands.

Rentals are often quoted for things like computers, point of sale systems, screens, coffee machines and shop fitouts, where the asset is worth very little at the end and nobody wants to own it. Some arrangements bundle maintenance or replacement into the payment, which has genuine value if downtime costs you money. The trade is that you are paying for use rather than building equity, and if you keep renting the same category of asset indefinitely, you will pay for it several times over.

Do not assume a rental stays off your balance sheet. Accounting standards on leases have changed in recent years for entities that prepare financial statements under them, so how a rental is presented depends on your business and how your accounts are prepared. That is a question for your accountant, not for the finance quote.

Is a novated lease one of these?

No, and it gets confused with them constantly. A novated lease is an arrangement between an employee, their employer and a financier, where the employer takes on the lease obligations and the payments come out of the employee's salary. It belongs to salary packaging and it brings fringe benefits tax into the picture. If you are a business funding a work vehicle, the four structures above are your field. If you are an employee being offered a car through your workplace, that is a different conversation with different rules.

Putting the four side by side

• Ownership: yours from day one under a chattel mortgage, yours at the end of the term under a CHP, the financier's under a lease or a rental
• End of term: nothing to decide on a chattel mortgage without a balloon, title passing to you on the final payment under a CHP, a residual to deal with on a finance lease, a hand back on a rental
• GST on the purchase: generally claimable up front on a chattel mortgage or a CHP, sitting inside the payments on a lease or rental
• Deductions: interest and depreciation on a chattel mortgage or a CHP, the payment itself on a lease or rental, in each case to the extent of business use
• Balance sheet: asset and liability both appear under a chattel mortgage, while lease and rental presentation depends on your accounts
• Flexibility: paying out early and selling is simplest when you already own the asset

The bit people get wrong

A residual or balloon lowers the monthly payment by pushing a lump sum to the end of the term. That is a cash flow decision, not a saving. Set it too high and you are either refinancing the tail or handing back something you have half paid for.

The trap is the gap between what you owe at the end and what the asset is worth by then. Machinery that holds its value and a ute with two hundred thousand kilometres on it depreciate on completely different curves, and the residual does not care which one you bought. Set it against a realistic view of resale rather than against the repayment you would like to see on the quote.

What happens when the residual falls due?

You pay it, you refinance it, or in a lease you return the asset under the terms of the contract. Refinancing the tail is common and it is not a disaster, but it extends the finance on an asset that is now several years older, sometimes at a higher rate because of that age. Knowing which of those three you intend to do, at the point you set the residual, is what keeps the decision yours.

How a lender assesses a business application

Commercial lending looks at the business as well as the asset. The usual questions are how long you have been trading, whether the business can service the commitment, and whether the asset is one the lender is comfortable holding as security.

• ABN and GST registration, and how long each has been held
• Time in business, and whether the entity is a sole trader, company or trust
• Recent BAS lodgements and business bank statements
• Financial statements and tax returns for full documentation applications
• Existing commitments, including other equipment finance and any director guarantees
• The credit file of the directors or the sole trader behind the business
• Whether a director owns property, which some lenders weigh in the assessment
• The asset itself: type, age, hours or kilometres, and whether it is being bought from a dealer or privately

Low doc or full doc?

A full documentation application supplies financials and tax returns and is assessed on them. A low documentation application relies on a shorter set, often BAS statements and a declaration, and is aimed at established businesses that cannot easily produce current financials. Low doc is not a lesser product, but it is generally priced to reflect the reduced verification and it usually comes with tighter conditions around time in business and asset type.

What to have ready

Most delays in commercial finance are document delays rather than credit decisions. Gathering this before you start takes days out of the process.

• ABN, entity details and GST registration status
• Your most recent BAS lodgements
• Business bank statements covering recent months
• Financials and tax returns if you are going full documentation
• Director identification and a current address
• A written quote or invoice for the asset, including any attachments or fitout you want funded
• Serial or identification numbers and the hours or kilometres on used gear
• Your accountant's view on the structure, before you commit to one

Where to land

If you want to own it and you can use the GST claim, a chattel mortgage is usually the starting point, and a CHP is worth pricing alongside it. If ownership matters less than the payment profile, a lease deserves a look. If the gear is going to be obsolete before it is worn out, renting it is not a failure of ambition, it is the structure that matches the asset.

Structures affect tax and every business is different, so run the final call past your accountant. We will put the options side by side with real numbers so there is something worth running past them. Start with business vehicle finance or equipment finance.