Hire Purchase Agreements Definition & Overview
What happens when you want to make a purchase but might not necessarily have all the funds? Or, what if it would make more financial sense for you to spread the payments out over time? Is there anything you can do when you face these obstacles?
A hire purchase contract is often put into place to help make more expensive purchases easier to manage. Yet, there are still some important aspects that you should know and understand. Keep reading our guide to learn how hire purchase agreements work, the advantages and disadvantages, and a few other bits of information.
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KEY TAKEAWAYS
- It’s important to remember that with a hire purchase agreement, ownership doesn’t get transferred until all payments get made.
- Even though they help with more expensive purchases, a hire purchase agreement often tends to be more expensive in the long run.
- A hire purchase agreement isn’t the same as a line of credit.
What Is a Hire Purchase Agreement?
Hire purchase agreements are a common arrangement that is used when you need to purchase a good or service that is expensive. They work by paying down payment at the beginning. Then, there is a series of periodic payments, including accrued interest, you will have to make over a period of time until the balance is paid off.
Interest is generated throughout the life of the agreement. In the US, these types of agreements are often referred to as installment sales. They can be a beneficial way of making a high price purchase.
Essentially, you would rent the goods you want to purchase by agreeing to a periodic payment schedule. Interest would accrue until you pay off the purchase in full.
In some cases you may have to pay a fee before a title is transferred to you. This is common with other financing programs that include rent-to-own or never-never agreements.
How Hire Purchase Agreements Work
Similar to rent-to-own transactions, hire purchase agreements work by providing the option for you to purchase the goods during the agreement. These types of agreements can come in especially handy for consumers that have poor credit since they are able to spread out the cost of more expensive items over time.
It’s worth noting that a hire purchase agreement isn’t the same as an extension of credit since you don’t actually own the item until after you have made all the necessary payments.
And, since ownership doesn’t get transferred until the term of the agreement is completed, there is more protection offered to the seller. A hire purchase agreement offers more benefits compared to typical sales or leasing methods for unsecured items.
How Do You Calculate a Hire Purchase Agreement?
There are a few things to consider when calculating a hire purchase agreement.
The first thing to do is to determine the hire purchase price. To calculate this, you multiply the periodic payment amount by the number of installments and add the down payment amount. The total is the hire purchase price.
You will also need to determine the interest rate on the purchase. An amortization schedule is a useful tool to keep track of interest and remaining balance, especially if all periodic payments are the same.
It’s also worth mentioning that the cash price is going to be the current market price that a good can be purchased for.
Advantages of Hire Purchase Agreements
There can be several advantages that come from a hire purchase agreement, for both you and the vendor. They allow a company that might have inefficient working capital to utilize more assets and they can also be more tax-efficient compared to a standard loan. This is since all the payments are listed as an expense.
So, if you have a business that has a need for expensive equipment and machinery, hire purchase agreements can make it more affordable. Startups can also benefit from such agreements to establish lines of credit if they don’t have a sufficient amount of collateral.
Another advantage of hire purchase agreements is that the payments are spread out over time. This reduces the financial burden and provides the opportunity to secure more expensive assets. Additionally, if you have a poor credit rating you’re still able to enter into a hire purchase agreement.
This works the same if your business doesn’t have much working capital. Hire purchase agreements pose little risk to the seller because the item may be repossessed if installments aren’t made.
Vendors also benefit from hire purchase agreements because they can increase demand for their goods. Many consumers who may not be able to afford an outright purchase, instead have an option to buy the product through installment sales.
Hire contracts can also provide a business with a broader customer base and increased revenue.
Disadvantages of Hire Purchase Agreements
Even though common hire purchase agreements can make purchasing an expensive product more affordable at the time, they often end up being more expensive in the long run. Making a full payment on a cash purchase ultimately ends up being cheaper. This is in large part due to the interest costs that you will have to pay on the asset purchase.
And since hire purchase and installment sales reduce the initial cost, it can be tempting to buy goods that aren’t actually affordable. Plus, the seller may charge a high-interest rate, increasing the cost even more.
Because hire purchase agreements aren’t seen as extensions of credit, they become exempt from the Truth in Lending Act. So, as long as you make the required minimum payments, goods can be returned at any time which would render the original agreement void.
Summary
The term hire purchase agreement relates to making a purchase of a good on a series of periodic installments. These scheduled, predetermined payments are made over an extended time period. The term of the agreement depends on the specific vendor or the type of product.
It’s critical to make payments on time. Transfer of ownership doesn’t always happen as soon as the agreement is fulfilled. Be sure to confirm these details with the finance company so you’re aware of your consumer rights. Larger hire purchase agreements can be a good strategy for consumers to utilize if they don’t have the capital available.
FAQs About Hire Purchase Agreement
When you use a hire purchase agreement you basically rent an item, like a company car or a piece of machinery, for example. You then pay an agreed amount in monthly payments, including interest, until the total amount is paid off.
They typically come in two forms. The first is when goods get purchased by a seller from a dealer. The second is when you, as a customer, purchase the goods through a hire purchase agreement with the seller.
The specific elements might vary depending on the item and the seller. However, there are still some common elements. These include the agreement, the guarantor, the deposit, the interest rate, and the payment.
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