Hire Purchase Agreements: Definition, How They Work, Pros and Cons

What Is a Hire Purchase Agreement?

The term hire purchase refers to an arrangement for buying expensive goods. In a hire purchase agreement, the buyer makes an initial down payment and pays the remaining balance plus interest in installments. The term is commonly used in the United Kingdom and it's more commonly known as an installment plan in the United States, although there are subtle differences between the two.

How Hire Purchase Agreements Work

A hire purchase agreement is a type of credit agreement between a buyer and seller. People typically enter into these contracts to buy products. After an initial payment, the buyer continues to make installment payments until the total purchase price is paid off. At this point, the buyer becomes the owner of the product.

These agreements are similar to rent-to-own transactions because they give the lessee the option to buy at any time during the agreement, such as rent-to-own cars. Like rent-to-own, hire purchases 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.

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.

Special Considerations

As noted above, hire purchase agreements are used in the U.K. and are known in the U.S., but they are known as installment plans. Although they seem the same, there are some distinctions between the two. For instance:

• With some installment plans, the buyer gets the ownership rights as soon as they sign the contract 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
  

Advantages and Disadvantages of Hire Purchase Agreements

Advantages

Like leasing, hire purchase agreements allow companies with inefficient 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 could startups that have little collateral to establish lines of credit.

A hire purchase agreement 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.

Disadvantages

Hire purchase agreements usually prove to be 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 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 payments. 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 Agreement Contracts

Regardless of the parties involved, several key factors generally find their way into all hire purchase agreement contracts. To be legally enforceable, these contracts must include:

• The name and addresses of the buyer and seller
• The date of the agreement
• The item in question along with a description
• The purchase price, the amount of each installment payment, and the final payment amount
• The payment dates
• The annual percentage rate (APR)
• The fees and additional charges that may apply

Contracts should specify that they are hire purchase agreements and indicate the withdrawal period. For instance, the seller can allow the buyer to vacate the agreement within 15 days of receiving the contract.

The Bottom Line

Hire purchase agreements are used to pay for very expensive consumer goods so that the buyer doesn't have to outlay a large amount of cash in one go. Though hire purchase agreements do include payment installments plus interest, they are not considered an extension of credit. They can be a manageable way for buyers to purchase expensive goods but the goods end up costing more because of the interest.