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How Does a Chattel Mortgage Work?
Under a chattel mortgage the lender (bank, finance company) takes the asset (chattel) that you’re using the loan for (e.g. car, boat) as collateral. The lender registers an interest (also known as an encumbrance) in the chattel to show others that they are using it as security for the mortgage.
Whilst you take ownership of the chattel at the time of purchase the lender will keep their interest registered until the mortgage is fully paid. Once the mortgage is paid in full the lender removes their interest and you have what is known as ‘clear title’.
In the event that you don’t make your repayments as you’ve agreed the lender has certain rights and can potentially repossess the asset, which they can then sell to recover what is owed to them.
Chattel mortgages are commonly used by companies, partnerships and sole traders when the chattel is going to be used predominantly (50%+) for business use. Under Australian Taxation Office (ATO) rules, businesses that account for GST on a cash basis (they record business income and expenses as and when they occur) are generally entitled to claim an Input Tax Credit (ITC) for all of the GST contained in the purchase price of the chattel on their next Business Activity Statement (BAS).*
Who Does a Chattel Mortgage Suit?
A chattel mortgage is suitable when the asset will be used for predominantly (50%+) business purposes. The product is mainly used by ABN holders – companies, sole traders, trusts and partnerships.
Before you buy a second-hand asset you can check to see if the owner has ‘clear title’ or if there is a registered interest in it by doing a PPSR (Personal Property Securities Register) check to protect yourself against potential repossession.
The Personal Property Securities Register is the register where details of security interests in personal property can be registered and searched. The Australian Financial Security Authority (AFSA) is the Australian Government agency responsible for administering the PPSR. You can visit their website at www.ppsr.gov.au .
For used cars you can also arrange checks through other service providers to see whether the asset has ever been an insurance write-off or stolen and if the vehicle has suffered from flood or water damage.
The Key Factors
Finding the best chattel mortgage for you will depend on your individual circumstances but the main factors to consider are:
Interest Rate – The rate of interest plays a large part in determining your repayment amount. The higher the interest rate the higher the repayment amount. But you need to be aware that the interest rate isn’t the only factor that will effect the total cost of your loan.
Fixed and Variable Rates – The interest rate is usually fixed, meaning that it will remain the same for the life of the loan, but it can also be variable. If the interest rate is variable this means that it can change during the time that you have the loan. Variable rates can be linked to the rate of interest that the lender is paying for its money in the same way that a lot of home loans are. So generally speaking if you have a variable rate and the Reserve Bank increases interest rates your interest rate and repayment amount will increase. If the interest rate is fixed you know exactly how much your repayments are going to be for as long as you have the loan and you can budget around them accordingly.
Comparison Rate – The comparison rate combines the interest rate with any foreseeable fees and charges involved with your loan to help you to identify the actual cost of the loan. However, it doesn’t include government and statutory fees, any insurance premiums or any fees that could possibly occur during the term of the loan such as statement fees or late payment fees for example.
Fees – There are various fees that can be included in your loan. Usual fees include, establishment fees, which are one off amounts charged by the lender (bank, finance company) for accepting and setting up your loan, as well as ongoing fees such as account keeping or loan service fees. The fees are included within your loan repayments so you should not have to pay them from your own funds. Make sure that you are aware of all the fees associated with your loan and make sure that they are included within the repayment amount that you are quoted.
Loan Term – Lenders have minimum and maximum periods for repaying the loan. Depending on the type and age of asset the minimum loan term is usually 1 year with the maximum usually being 7 years (less for some assets and older second-hand assets). The term of the loan is another significant factor in determining what your repayment amount will be. The shorter the term the higher the repayment, and the longer the term the lower the repayment. But remember the longer the term the more interest you will be charged and the more you will pay back in total.
Deposit – You can use cash or a trade in to reduce the loan amount. By reducing the loan amount you can reduce your repayments and the total amount payable.
Total Amount Payable – This is the total amount that you pay back to the lender for your loan, including the original amount borrowed, the total amount of interest charged over the full term of the loan and any fees charged.
Additional Repayments and Early Termination – Some lenders provide the option to make additional repayments into your loan. Making extra payments into your loan has the effect of paying your loan off sooner and reducing the amount of interest that you pay and in turn reducing the total amount payable. You need to bear in mind that some lenders will charge fees if you pay the loan off early. If making extra payments and paying off your loan early is important to you then make sure to check that your loan allows you to do this and any costs associated with doing this are acceptable to you.
Minimum and Maximum Loan Amounts – Normally the lowest loan amount available from mainstream lenders is $5,000 or $10,000. The maximum varies from lender to lender but $100,000 to $150,000 is the most that many lenders will provide for a chattel mortgage.
Residual Value (Balloon Payment) – A residual value amount, often referred to as a balloon payment, can be applied to the loan. This is an amount of the loan that is offset until the end of the loan term which has the effect of reducing your regular repayments. If you include a residual value the lender will generally cap the maximum loan term at 5 years. Be aware that whilst you do not make principal repayments on the residual value amount you will be charged interest on it. If you take out a loan with a residual value, at the end of the term you can decide to pay the amount and keep the asset, re-finance the amount and start a new loan agreement or you can sell / trade in the asset and if the amount you get is greater than the residual value than you can use this equity towards a new asset or simply retain it.
Lower Interest Rate – By using the asset that you’re buying as collateral the lender has increased security and as a result can offer you a lower rate of interest, which means lower repayments for you.
Potential Tax Benefits* – Under a chattel mortgage when the asset is used for business purposes you can claim the interest charges, running costs and depreciation as tax deductions. If you are registered for GST you can claim some or all of the GST contained in the purchase price of the asset when you lodge your next Business Activity Statement (BAS) rather than over the term of the loan.
No Capital Outlay – You can get the asset that you need for your business with zero or minimal outlay, so any capital that you do have can be used for other things.
Effective Cashflow – You can opt to include a residual value (balloon payment) at the end of your loan which reduces your repayment and frees up more cash.
Inclusions – You can potentially include things like government fees, insurance premiums and accessories as part of your loan, so one repayment covers all of your costs.
Minus Equity – If you are trading in an asset which is financed and you owe more on the outstanding loan than the asset is worth you may be able to include this minus equity amount in with the loan for the asset that you’re buying.
Costs – Any type of borrowing is going to cost you money and a chattel mortgage is no different. But don’t forget using your own money comes with its own costs too. Just think of the return that you could you get if you invested the funds in your business or interest that you would generate if you invested the money. You just need to make sure that you do your research and get the best the loan for you.
Security – Although using your asset as security can help to get you a lower interest rate it also means that if you don’t make your agreed payments you risk the asset being repossessed.
Personal Use – If you’re using the vehicle for predominantly personal purposes then a chattel mortgage is not the most effective option for you.
Asset Only – By securing the loan against an asset it means that the amount that you borrow can only be used for the purpose of buying the asset. You can’t split the funds and use part for the asset and part for something else.
Things to Consider
Total Loan Amount – One thing that some people don’t realise is that your total amount borrowed will include any lender or government fees and insurance premiums that you decide to finance. For example, if you’re buying a car and after your trade in the amount to pay is $20,000 but you then have lender and government fees of $750 and an insurance premium of $600, your loan amount is $21,350.
Payment Frequency – Most lenders will give you the option of making weekly, fortnightly or monthly repayments. Choose the frequency that will help you to budget best.
Your Current and Future Circumstances – Think about what your requirements are right now but also your plans for the future. For example, if you’re planning other expenses and your business’s income is going to reduce whilst you have your chattel mortgage, ask yourself if you would still be able to make the repayments. Maybe you need to look at a loan over a longer term to reduce your repayment. If you expect that your income will increase during the time that you’re paying your chattel mortgage off check at the outset that you have the flexibility to make additional payments.
Rate for Risk – Some lenders use a system whereby they determine the rate that they offer to you based on their analysis of your profile. This includes your credit history and business history as well as what asset you are buying and if you are using any of your own cash as a deposit. The better they deem your profile to be the lower the rate you will get.
0% and Low Rate Finance – We sometimes see this being offered on new assets such as cars. It can look like a great deal but always check the terms and conditions. To qualify you may require a large deposit or the offer may only be available over a short term which could make the repayments too high to be affordable. Also, you’ve got to ask how is the below market rate finance being paid for. Normally the price that is being charged for the asset is inflated to cover the financing costs. So while you may be getting a great deal on the loan you may be paying over the odds for the asset.
Structured / Seasonal Payments – Depending on your type of business and the industry that you operate in the lender may agree to a structured payments loan. This enables you to structure your loan to make payments less often depending on when you receive income for your business activities. It is a popular option with primary producers who generally receive large amounts of income on a seasonal basis.
LoanPlace.com.au is here to help you make sense of it all by providing you with information resources and connecting you with experienced professionals who will search their lenders to find the latest deals so that you get 3 Free Quotes to evaluate and compare.
*We strongly recommend that you consult your accountant or tax advisor to confirm the tax benefits available to you prior to entering into any finance agreement. The information provided is for product description purposes and is not intended to be used as taxation, financial or legal advice.