What is a security deposit?

The deposit is applied against the purchase price and the lender funds the balance. Every dollar of deposit reduces the amount financed by a dollar, so a $16,000 deposit on an $80,000 asset means the lender finances $64,000 instead of the full price. Less principal means smaller regular repayments and less interest over the term.

The deposit appears under different names in different structures. Under a chattel mortgage or hire purchase the borrower pays the deposit and the lender finances the balance secured against the asset; under a finance lease it is often called an advance or initial rental and reduces the capitalised amount. On a car loan it is often savings or a trade-in that cuts the amount borrowed. If the contract also has a balloon payment, the deposit lowers the starting balance but the balloon is still payable at the end.

A deposit means the lender funds less than the full value of the asset, so if the borrower defaults and the asset is repossessed and sold, the lender is more likely to recover what is owed. It also signals commitment: a borrower with cash in the deal has more to lose. And because vehicles and machinery lose value quickly, the deposit creates a buffer so the loan balance does not overtake the asset's market value early in the term, reducing collateral risk.

Because the lender's risk is lower, a deposit can bring better pricing, reduced fees or more flexible terms, and a lower LVR can open the door to prime lenders with stricter thresholds. Borrowers with limited credit history or a weaker credit rating may find a deposit essential to being approved at all.

Deposit requirements depend on the lender, the asset and the borrower: new assets with a strong resale market may need less, used, specialised or niche equipment tends to need more, and some lenders offer no-deposit finance to strong applicants. Established businesses with solid cashflow and a clean credit record can often negotiate a smaller deposit, while start-ups and applicants with limited trading history may be asked for more. A broker can tell you what each lender expects for your deal.

The deposit can come from savings, retained business earnings, the sale of an existing asset or a trade-in, which lenders typically accept as equivalent to cash. Borrowing the deposit on a personal loan or line of credit is possible but adds to total debt, and lenders may not accept borrowed funds. Expect to show bank statements or a trade-in valuation as evidence of the source.

For a business using the asset to earn income, the tax treatment follows the finance structure. Under a chattel mortgage, commercial loan or hire purchase the deposit is part of the asset's cost, so depreciation, or the instant asset write-off where eligible, is claimed on the full cost including the deposit, and interest on the financed balance is deductible. Under a finance lease the deposit is an advance rental and may be deductible over the lease term or when paid, depending on the arrangement. The outcome depends on your ABN status, turnover and how the asset is used, so check with your accountant or the ATO.