Your guide to the different forms of equipment finance and how they could benefit your business.
Equipment financing, as its name suggests, is a funding solution that helps businesses obtain the equipment they need to operate and grow their business. It is well suited for businesses that require expensive equipment or vehicles, but who don’t want to fund the full outlay upfront.
Attention: In response to the coronavirus pandemic, the Australian government has increased the instant asset tax write off to $150,000.
This means that any equipment purchased for business purposes between 12 March 2020 and 30 June 2020 under $150,000 can be instantly written off in your next tax return.
To find out what else the government is doing to help small businesses during the outbreak, click here.
Typically, a lender will provide the financing based on the particular equipment being given as loan security. Put simply, equipment finance is most often a self-securing loan where the equipment being purchased acts as the collateral.
Equipment finance is common among small businesses and start-ups as an alternative to traditional loans. Businesses are able to get their hands on necessary and often costly equipment, while avoiding the cash flow stress associated with a large one-off purchase. Cash flow can then be redirected towards other areas of the business, and the equipment is repaid over time. Below is an overview of the different types of equipment finance options available in Australia.
Chattel Mortgage (or Secured Loan Agreement)
A chattel mortgage is similar to a home loan, and is used when a lender provides funds to a borrower to buy equipment for business use. A mortgage is taken over the equipment (the chattel) which allows the borrower to have legal ownership of the equipment.
Chattel mortgages can also include a balloon payment. A balloon payment is a balance due at the end of the loan. Opting for a balloon payment can benefit businesses because it lowers the overall regular loan payments and decreases the overall cost of the loan. At the end of the loan the borrower can choose to pay the balloon and take outright ownership of the equipment, or refinance the residual value.
Because the equipment is used as collateral, the borrower does not have the right to sell the equipment without approval from the lender or until after the loan is fully repaid. If the borrower defaults on repayments, the lender can recover the equipment and sell it to cover losses from the loan.
Chattel mortgages can suit a business requiring high-value and long lifespan equipment that they wish to own. This can include industrial machinery, vehicles or fit outs - which aren’t likely to become obsolete during the term of the loan.
Commercial Hire Purchase
In a commercial hire purchase, the lender purchases the equipment on the borrower’s behalf and then hires it to the borrower over the loan period. The borrower does not own the equipment, but is responsible for its maintenance and insurance. If the equipment is fully paid off at the end of the loan, ownership transfers to the borrower. Otherwise, the borrower may have an option to purchase the equipment.
The ownership distinction through the term of the loan is one of the main differences between a commercial hire purchase and chattel mortgage. Commercial hire purchase financing is usually agreed at a fixed rate with monthly repayments. However, it can be made flexible to suit a business’ cash flow by including a deposit or balloon, or by adjusting the length of the term.
Commercial hire purchase is often considered by borrowers as an alternative to a chattel mortgage, and can suit where a business is looking to own high value and long lifespan equipment.
Finance Lease (Capital Lease)
In a finance lease, the lender purchases the equipment for the borrower and then leases it to the borrower over the lease period. The risks and benefits of ownership are borne by the borrower, meaning the borrower is responsible for the running costs, maintenance and repair of the equipment.
A residual value for the equipment is predetermined according to tax guidelines, and at the end of lease the borrower may have the option to buy the equipment from the lender. Finance leases will generally cover a substantial part of the equipment’s lifespan, and so are a longer term financing option.
A finance lease can suit a business where it plans to use equipment without an obligation to purchase at the end of the lease term. The predetermined residual feature also allows businesses to mitigate residual value risk, as this is instead carried by the lender.
Operating Lease (Rental Agreement)
An operating lease is a short-term lease option that is beneficial for businesses wanting to use an asset without wanting to take ownership. In operating leases the borrower pays “rent” to the lender for use of the equipment for the duration of the contract.
Unlike a finance lease, the borrower does not participate in the risks of ownership and the lender retains full ownership of the equipment, and is responsible for its service and maintenance. At the end of the lease, there is no option to purchase the equipment and it is returned to the lender.
Business owners may prefer an operating lease for assets that require regular updates, or those that are likely to become obsolete in the future. For example, computer equipment may be suitable for use under an operating lease, as it may require regular maintenance and/or become outdated and have to be upgraded. An operating lease allows businesses the flexibility of using the equipment on a short-term basis without the commitment of owning something that may need to be replaced in the near future.
When looking into any kind of business finance, business owners should consider the best fit for their company’s needs. They should also consider potential fees and charges, and weigh up their options carefully, prior to committing to a loan.