What is a Hire Purchase
Hire purchase is an arrangement for buying expensive consumer goods, where the buyer makes an initial down payment and pays the balance plus interest in installments. The term hire purchase is commonly used in the United Kingdom, and it's more commonly known as an installment plan in the United States. However, there can be a difference between the two: With some installment plans, the buyer gets the ownership rights as soon as the contract is signed with the seller. With hire purchase agreements, the ownership of the merchandise is not officially transferred to the buyer until all the payments have been made.
Understanding Hire Purchase
Hire purchase agreements are similar to rent-to-own transactions that give the lessee the option to buy at any time during the agreement, such as rent-to-own cars. Like rent-to-own, hire purchase can benefit consumers with poor credit by spreading the cost of expensive items that they would otherwise not be able to afford over an extended time period. It's not the same as an extension of credit, though, because the purchaser technically doesn't own the item until all of the payments are made.
Because ownership is not transferred until the end of the agreement, hire purchase plans offer more protection to the vendor than other sales or leasing methods for unsecured items. That's because the items can be repossessed more easily should the buyer be unable to keep up with the repayments.
Advantages of Hire Purchase Agreements
Like leasing, hire purchase allows companies with insufficient working capital to deploy assets. It can also be more tax efficient than standard loans because the payments are booked as expenses—though any savings will be offset by any tax benefits from depreciation.
Businesses that require expensive machinery—such as construction, manufacturing, plant hire, printing, road freight, transport, and engineering—may use hire purchase agreements, as well as startups that have little collateral to establish lines of credit.
A hire purchase can flatter a company's return on capital employed (ROCE) and return on assets (ROA). This is because the company doesn't need to use as much debt to pay for assets.
[Important: Using hire purchase as a type of off-balance-sheet financing is highly discouraged and not in alignment with Generally Accepted Accounting Principles (GAAP).]
Disadvantages of Hire Purchase Agreements
Hire purchase agreements usually prove more expensive in the long run than making a full payment on an asset purchase. That's because they can have much higher interest costs. For businesses, they can also mean more administrative complexity.
In addition, hire purchase and installment systems may tempt individuals and companies to buy extravagant goods that are beyond their means. They may also end up paying a very high interest rate, which does not have to be explicitly stated.
Rent-to-own arrangements are also exempt from the Truth in Lending Act because they are seen as rental agreements instead of an extension of credit.
Hire purchase buyers can return the goods, rendering the original agreement void as long as they have made the required minimum payment. However, purchasers suffer a huge loss on returned or repossessed goods, because they lose the amount they have paid towards the purchase up to that point.
- Hire purchase agreements are not seen as an extension of credit.
- In a hire purchase agreement, ownership is not transferred to the purchaser until all payments are made.
- Hire purchase agreements usually prove more expensive in the long run than purchasing an item outright.