What Is A Hire Purchase Agreement?
Think of this type of agreement as your monthly installment plan. These agreements allow buyers who are short on cash to purchase expensive consumer products by paying only part of the complete cost as a down payment. The balance, mostly with an interest added, is later paid in installments.
However, there is a key difference between this agreement and a regular installment plan. With some installment plans, ownership rights are immediately granted to the buyer upon down-payment. On the other hand, hire purchase agreements reserve that right from the buyer until payment is entirely completed.
How Does It Work
Imagine a sleek BMW catches your eye. Now suppose the urge to run your fingers across its glossy but pricey mirror rims occurs at the same time as the necessity to buy a conveniently priced transport vehicle. What would you do? Your best option would be to enter into a hire purchase agreement.
This agreement, or in other words, your monthly installment plan, will save you the inconvenience of having to pay an excruciatingly large amount all at once. In fact, with the help of this agreement, you can place a payable percentage of the total cost into the hands of your seller as down payment and have the legal right to use the product.
The remaining balance is then paid in installments and upon the completion of the final installment, the buyer is granted complete ownership over the product.
The key takeaway from here is that the agreement must not be seen as an extension of credit since the ownership right is not immediately yielded to the buyer. Also, in the long run, it may be slightly more expensive than paying as you go.
Advantages Of Hire Purchase
Here are some solid upsides to these agreements:
- The agreement enables buyers short on cash to access and use a product they may desperately need
- It can work in the same capacity as leasing for companies with inadequate working capital. By deploying assets, it can help cut back on taxes and decrease liabilities
- Companies with meager collateral can make use of this to acquire expensive machinery such as manufacturing equipment, road freights, plants, and more
- Most companies see a significant acceleration in the return-on-investments as well as the return on capital after entering into these agreements since it allows the companies to cut away from securing expensive loans
- The interest rate fixed at the time of the agreement remains valid until the end, regardless of changes that the national bank makes to base rates
Disadvantages Of Hire Purchase
Here are some downsides to these agreements:
- Remember that these contracts are very inflexible. The agreement is set in stone and any unprecedented financial difficulty may result in losing the asset and damaging credit rating
- Since interest is added, the final payment generally costs more than the on-the-go alternative
- It’s more beneficial for the vendor since the buyer is not technically the owner until the entire payment is made. This information is critical in situations that involve the risk of bankruptcy from the buyer. In such a circumstance, the asset will not lend protection to the buyer as he does not own the asset legally
- When an expensive product such as a car is stolen, broken, or damaged in some way during the term of the agreement, the insurance will not absorb the cost of damage leading to a financial discredit for the buyer
Alternatives To Hire Purchase
- As far as buying equipment or a tangible asset is concerned, capital or sales leases can prove to be a more effective alternative. Similar to this agreement, a sales lease does not grant ownership rights until the final payment is made. On the upside, the lessee takes on a share of the economic risks and returns from changing the value of the asset.
- Another popular alternative is an operating lease. This kind of lease allows more flexibility to all parties involved but retains ownership right from the lessee. In this type of agreement, the lessee is granted rights to operate and use an asset with maintenance and upgrades and will own the asset upon completion of the agreement. Property leasing is a common example where the lessee makes use of the rented space for business purposes.
Although this finance method has its limitations, hire purchase agreements are widely used amongst parties who are looking for timely and convenient solutions to problems needing immediate attention. Nevertheless, parties looking to enter into such an agreement must be aware of both the potential upsides and the downsides to derive maximum value.