What is a Hire Purchase
Hire purchase is an arrangement for buying expensive consumer goods on credit, where the buyer makes an initial down payment, with the balance being paid in installments plus interest. It is similar to an installment plan, except unlike installment plans, where the buyer gets the ownership rights as soon as the contract is signed with the seller, the ownership of the merchandise is not officially transferred to the buyer until all the payments have been made.
BREAKING DOWN Hire Purchase
Hire purchase agreements are similar to rent-to-own transactions which 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 does 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.
Because ownership is not transferred until the end of the agreement, hire purchase plans offers more protection to the vendor than other sales or leasing methods for unsecured items, since the items can be repossessed more easily should the buyer be unable to keep up with the repayments.
The Pros and Cons of Hire Purchase to Businesses
Businesses where expensive machinery is required, such as construction, manufacturing, plant hire, printing, road freight, transport, engineering and professional services commonly use hire purchase agreements — as well as startups that have little collateral to establish lines of credit. 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.
As a form of off-balance sheet financing, a hire purchase can flatter a company's return on capital employed (ROCE) and return on assets (ROA). This is because they do not need to use as much debt to pay for assets.
However, hire purchase agreements may prove more expensive in the long run than making a full payment on an asset purchase, due to the much higher interest costs and administrative complexity, even if the business then has to pay depreciation costs.
The Downside of Hire Purchase Agreements
Hire purchase and installment system may tempt buyers to buy extravagant goods which are beyond their means. And they may also end up paying an extortionate interest rate, which does not have to be explicitly stated. Rent-to-own arrangements are exempt from the Truth in Lending Act, because they are seen as rental agreements instead of an extension of credit. Because only people with low means use hire purchase, default rates tend to be higher.
Hire purchase buyers can return the goods, rendering the original agreement void as long as they have made the required minimum payment. However, purchases suffer a huge loss on returned or repossessed goods, because they lose the amount they have paid towards the purchase up to that point — unlike installment plans, such as a car loan.