What Is a Chattel Mortgage?

A chattel mortgage is a financial arrangement where a lender provides you with money and then accepts the asset as the security for the loan. This type of financing works much in the same way as a secured personal loan. In this context, the chattel refers to the equipment, and the mortgage refers to the loan.

If you run a business and are in the market for a new car or business-related equipment, you may want to consider a chattel mortgage to finance the expenditure.

How does chattel financing work?

With a chattel mortgage, the borrower takes immediate ownership of the goods and then makes regular repayments, usually monthly but sometimes fortnightly. Once the loan is paid off, the borrowing business assumes outright ownership of the assets. Some providers, such as the Commonwealth Bank, also refer to these types of loans as car or equipment loans. They are also sometimes called a goods loan.

Loan terms are usually between one and seven years but sometimes shorter. Businesses can generally claim interest on loans and depreciation for tax purposes if the vehicle and goods are used to produce income.

Chattel mortgages differ from other arrangements, such as a hire purchase or a finance lease, in that the borrower assumes ownership of the equipment immediately and repays the loan with business income.

The interest rate can be fixed or variable, depending on what you agree to at the outset. Fixed chattel mortgages can take on the characteristics of a fixed-rate home loan.

If you cannot repay the loan, the lender may repossess the car or equipment. This is the same as how your home could be repossessed in a worst-case scenario if you stop making mortgage repayments.

» MORE: Chattel mortgage vs. car loan

What happens at the end of a chattel mortgage?

Unlike other types of personal loans or car loans, chattel mortgages give you the option of making a balloon payment at the end of your loan term. A balloon payment is an outstanding amount that becomes payable at the end of the loan term but is agreed upon at the start of the loan.

For example, say you purchase $40,000 worth of equipment and choose a balloon payment of $10,000. Your monthly repayments over the loan term, say seven years, will only be for $30,000 of the loan. To close out the loan, you pay a lump sum of $10,000 at the end of the term.

This can be good for cash flow because your repayments are lower. But you should be aware that your total repayment figure will be higher because, as with all interest-paying loans, you won’t be paying off the principal as quickly, and the interest on the balloon component of the loan will be higher.

Pros and cons of chattel mortgages

Like all things finance-related, there are both advantages and disadvantages to chattel mortgages.

Pros

You can choose the loan term — usually from one to seven years.
You can also choose the structure — interest rates can be fixed or variable. They are also usually lower than for unsecured loans.
Some lenders also provide flexible repayment options that sync with your business’s cash flow. Typically, repayments can be made quarterly, half-yearly or even annually.
As a business owner, you own the asset upfront.
You can set a balloon payment amount at the end of the loan term. This can lower monthly repayments and assist with cash flow.
There are potential tax deductions from the interest component of the loan and tax depreciation savings on the vehicle or equipment over time.
You can claim an input tax credit on the goods and services tax component of the purchase price upfront.
A fixed interest rate can provide certainty regarding your repayments.

Cons

The assets could be repossessed if you can’t make the repayments.
This could hurt your credit rating if you fall behind in repayments.
The balloon payment means a higher overall repayment amount. This could come as a shock at the end of the loan term and could be difficult to manage.
The National Consumer Credit Protection Act does not cover chattel mortgages. This means borrowers are not protected in confusing conditions and could find themselves over-extended.
You may be hit with a fee if you want to pay the loan out early, especially if you’re on a fixed interest rate.

Alternatives to a chattel mortgage

Chattel mortgages will definitely suit a wide range of businesses. Still, other options may be a better fit, depending on the circumstances of your business.

Lease agreement

A lease agreement gives you the option of using the vehicle or equipment for a particular time, during which you make regular repayments. Once the period expires, you can purchase the vehicle or equipment or return it to the lender. Lease arrangements have various tax incentives that can be favourable and are good for those who wish to update their car or equipment every few years.

Hire-purchase arrangement

You also could opt for a hire-purchase arrangement, where a lender buys the car or equipment on your behalf and provides it for your use in return for repayments. Ownership is transferred to your business once the final payment is made. Once again, this arrangement has its unique tax advantages regarding depreciation.

Car loan

Alternatively, you could choose a more conventional car loan as if you were buying a car for personal use. This option has its advantages and disadvantages and will probably suit you better if you only use the car occasionally for your business.

» MORE: Can you buy a car with a credit card?

Other considerations

When it comes to a chattel mortgage, ask yourself how long you expect to use the car or the equipment. Also, assess your cash flow expectations throughout the loan.

You also should talk to an accountant about the various tax implications of each type of loan and which one is most suitable for your business. Some tax considerations can be unnecessarily complicated, so the expertise could prove invaluable.

Additionally, check out the fees and charges associated with the loan. Sometimes, the cheapest interest rate doesn’t equate to the best value over the loan’s full term.

You can also use a chattel mortgage calculator. You’ll key in critical details — the amount you wish to borrow, a balloon amount, and fixed and variable interest rates — to see how repayments will likely affect your cash flow over the loan term.