Two offers, and the answer flips
One at 8.5%, one at 7.9%, and which costs less depends on a number only you can supply. Where the answer changes, the rate nobody can quote you, and the one rule that has nothing to do with money.
You have two quotes for the same $220,000 asset, both over five years. One is 8.5%. One is 7.9%. Most people stop there, and most of the time stopping there is fine. Sometimes it picks the wrong one, and the reason it picks the wrong one is not subtle once you see it.
A rate prices the money you borrow. It says nothing at all about when you hand money over, and when you hand money over changes what it costs you.
Money has a date on it
A dollar you pay today is worth more than a dollar you pay in five years, because the one you keep can do something in the meantime. Pay down other debt, buy stock, sit in an offset account. Whatever your business does with a spare dollar, it does it for five years instead of never.
So a deposit is expensive in a way a rate never shows, because it is the earliest possible money. And a balloon is cheap in the same hidden way, because it is the latest.
The two offers, worked out
Offer A is 8.5%, wants nothing up front, has a $495 fee and defers 25% to a balloon. Offer B is 7.9%, wants $44,000 down, has a $1,500 fee and no balloon.
| A, at 8.5% | B, at 7.9% | |
|---|---|---|
| Paid up front | $495 | $45,500 |
| Amount financed | $220,000 | $176,000 |
| Each month | $3,775 | $3,560 |
| Balloon at the end | $55,000 | Nothing |
| Total paid, undiscounted | $281,984 | $259,114 |
| Cost in today's money, at 10% | $211,586 | $213,063 |
B is $22,870 cheaper in raw dollars and $1,477 more expensive once the timing is accounted for. Both figures are correct; they answer different questions.
The offer with the higher rate and the higher total wins, because it lets you keep $45,000 for five years and defer a quarter of the debt to the end. That is worth more than the six-tenths of a percentage point it costs.
Note the total paid column. It says B is $22,870 cheaper, and it is right, in the sense that fewer dollars leave the business. It is just not the question you are asking. You are asking which offer leaves you better off, and that depends on what you would have done with the money in between.
And then it flips
Run the same two offers at a lower discount rate and the answer reverses. At 8% the finance lease wins. At 10% and 12% the chattel mortgage does.
| If your money is worth | A costs | B costs | Cheaper |
|---|---|---|---|
| 8% | $223,579 | $221,085 | B |
| 10% | $211,586 | $213,063 | A |
| 12% | $200,467 | $205,550 | A |
This is not a flaw in the method. It is the method telling you something useful: these two offers are close enough that the answer depends on an assumption rather than on the offers themselves. When that happens, stop optimising the cost and decide on the things that are not money.
The rate you cannot be given
The obvious next question is which discount rate to use, and it is the one question we will not answer for you. Not out of caution for its own sake: choosing a discount rate for a business is financial advice, and that requires a licence this firm does not hold.
What we can tell you is what it represents. It is what a spare dollar is worth inside your business. If you carry debt at 9%, a dollar that pays it down earns you 9%. If you are turning away work for lack of stock, it is worth considerably more than that. Your accountant can help you land on a figure, and the sensitivity band exists so that you can see how much the choice actually matters before you agonise over it.
What this deliberately leaves out
Tax. In practice, depreciation entitlement and the timing of GST credits often decide between these structures outright, and they can move the answer further than the rate does. Working out what they are worth for a particular business is tax advice, so it is not in the tool and it is not in this article.
Take the present cost comparison to your accountant and ask them to layer the tax treatment over it. The ranking can change once they do, and that is the point at which you have actually compared the two offers.
One rule that is not about money
Never compare two facilities over different terms. A three-year facility costing less than a five-year one tells you that three years of payments are cheaper than five, which you knew before you started. If the terms differ, either set them the same or compare what each costs per year of use.
General information only. It does not take your objectives, financial situation or needs into account, and it is not credit, tax or financial product advice. Figures are illustrative. Finance is arranged through The Lending Lab Pty Ltd (ACN 651 936 337), Credit Representative 538291. Nicholas Clunes is Credit Representative 530711. Both are authorised under Australian Credit Licence 387856.
Keep reading
All insights- A balloon is not a discountWhy the deferred money is what makes an offer look cheap.
- Your overdraft is not costing you 8%The same problem on working capital facilities, where fees do the damage.
- Paying an overseas equipment supplier
- Why a lender values your equipment at half what you think
Bring the numbers you have. You'll leave with a clear answer and a fee in writing.