What Is Hire Purchase Agreement?

What Is Hire Purchase Agreement?

A hire purchase plan allows you to purchase an expensive item that you may not otherwise be able to pay for. You are essentially “renting” the item on a month-to-month basis until the sum of your payments matches the purchase price plus interest.

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.

Hire purchase agreement

How does a hire purchase agreement work?

Generally, hire purchases must be taken out through a finance facility like a bank or building society, or sometimes directly through the owner, such as through a car dealership. However, if you are taking out a hire purchase directly through a retailer, it’s worth noting that the retailer will still be working as an agent for a finance company that is providing the loan, and the retailer will be receiving a commission from the finance company for facilitating the arrangement.

In some cases, hire purchase agreements will include a final payment to confirm the transfer of ownership. The payment period for larger hire purchase agreements typically ranges between 2 and 5 years, while smaller purchases may be significantly shorter.

During the hire purchase payment period, you can use the asset as if you own it, but you cannot legally sell or dispose of an asset that you’re borrowing via hire purchase until you’ve paid for and thus own it.

If a business fails to make payments on time, they run the risk of the assets being repossessed and returned to the original owner. The lender will need a court order to repossess the goods unless you’ve paid less than a third of the total amount.

Businesses are within their rights to terminate a hire purchase agreement at any time and return the assets if they no longer need or can no longer afford them. Payments will still need to be made to cover the time the business did have with the asset, and if the payments at the time of termination fall below half the value of the asset, the business may be required to make additional payments to meet an agreed-upon minimum. A business will never be required to pay the entire amount of an asset they have returned. 

Terminating a Hire Purchase Agreement

If the buyer needs to end the agreement, there are two options:

  • Terminate the agreement and voluntarily return the goods.
  • Have the creditor terminate the agreement, then repossess the goods.

How the agreement is terminated will affect the final amount owed when the agreement ends. If the buyer terminates the agreement and returns the goods voluntarily, the amount that must be paid should be up to half of the amount payable listed on the agreement minus any amount paid. If any dues are outstanding, those will have to be paid.

If the buyer voluntarily terminates the agreement, it must be presented to the creditor in writing. If it is not sent in writing, the creditor will not see it as voluntary, and the 50 percent liability limit will not be given. Copies of the termination letter should be saved for future reference if the termination comes into question.

When can the lender repossess the goods?

The finance company can only repossess (take back) the item under certain conditions:

  • If you are in arrears and have not yet paid off one-third of the total hire purchase cost, the owner can repossess the goods at any time without taking legal action against you. They must send you a default notice first and give you at least 21 days to put things right, unless a court says they do not have to.
  • If you have paid one-third or more off the total hire purchase cost, the owner cannot repossess the goods without taking legal action.

Any deposit that you pay at the start of the agreement or the value of any trade-in, for example, is taken into account in calculating one-third of the cost.

If this one-third rule is breached by the owner, you are entitled to end the agreement and can ask for a refund of all payments made. The lender will sell the repossessed goods at auction and the money they get will be used to repay your debt.

If there isn’t enough to pay the whole amount off, you will have to pay whatever is left plus any court costs. It’s worth asking the lender if you can try to sell the goods yourself as you will often get more money for them this way.

How to record a hire purchase agreement?

Despite the fact that a business does not own the asset until it’s been paid for entirely, the new asset must still be recorded as a fixed asset on the business’s balance sheet.

A hire purchase contract must include the following:

  • The term “Hire Purchase Agreement”, included prominently and clearly
  • The exact asset being loaned must
  • Both the cash price and hire purchase price of the asset
  • The payment amount for each instalment and the amount of final balloon payment if applicable
  • The dates each instalment must be paid
  • Details of all parties involved, including names and addresses
  • A statement confirming the hirers right to withdraw from the agreement within a cooling off period, typically within 10 days of the agreement being received
  • A statement confirming that the hirer must inform the finance company of the location of the asset
  • Any additional fees or charges that will apply.

Benefits of Hire Purchase Agreements

The primary financial benefits for a company using a hire purchase plan include maximizing working capital, the ability to enhance the financial appearance of the company to investors, and the potential of payment flexibility.

The most obvious benefit for a company is using a hire purchase plan is it does not have to pay the full amount of the purchase upfront. This can be very beneficial for a company that needs to obtain expensive equipment but does not have the necessary capital and does not want to increase its debt burden by borrowing money.

Companies can sometimes manage to keep the money used to lease the equipment and the equipment off their balance sheets, thereby providing a better-looking return on assets (ROA) ratios.

Another financial benefit of using a hire purchase plan is such plans often include maintenance in the contract, so the company does not have to worry about having to pay for any expensive repair costs that may arise.

Expensing the rental payments may be more tax advantageous than buying and depreciating the equipment. A hire purchase plan is also beneficial in that it does not obligate the company to keep the equipment, and payment terms are often flexible. For example, if the use of the equipment varies seasonally, payments can often be structured to coincide with the level of usage.

Drawbacks of Hire Purchase Agreements

1. The loan is secured against the equipment

With a hire purchase agreement, you’re in a fixed contract. As you don’t own the car until the final payment is made, if, for any reason, you can’t afford to make payments, the finance company could take your car away.

2. It will cost more overall

The interest charges on hire purchase mean the final cost of your equipment will be more than if you were to purchase it outright. Monthly payments with hire purchases are also generally higher than for PCP or leasing deals.

3. Monthly payments are based on credit rating

As it’s a secured loan, hire purchase agreements are available to buyers with poor credit ratings. However, if you happen to have a poor credit rating or even no credit (for instance, if you haven’t borrowed in the past), you may not be eligible for the lower interest rate deals.

4. It can be expensive for short term agreements

If you’re looking for a short-term agreement rather than one spread out over several years, choosing a hire purchase can turn out to be an expensive route.

5. Missing or late payments could affect your credit score

It’s usual for a hire purchase agreement to be registered with credit agencies. So if over the term, you miss a payment or even make a late payment, it will be flagged on your credit report and may affect your credit score or even your ability to borrow in the future.