What is a Hire Purchase Agreement?

Under a Hire purchase agreement, a consumer purchases an asset by making part payment. He pays the remaining balance in instalments along with an interest charge. The ownership of the asset remains with the Seller until all instalments are completed. The Purchaser, though, can use the asset as a purchased asset. The arrangement is often made for expensive goods needed for business operations. The cost of the essential asset is thus spread across several years. If the purchaser defaults on repayments, the Seller can take back its possession or sell it to fill in for the default.

 

Summary

• Hire Purchase (HP) agreement is made when an asset seems expensive for a buyer.
• Hire purchase agreement involves paying instalments for immediate use of the asset and later on getting its ownership on settlement.
• The hire vendor earns interest income and profit margins while the buyer gets to use the asset immediately.

Frequently Asked Questions (FAQ)-  

What are the features of hire purchase agreement?

• Payment can be made in instalments by the buyer/ hirer to the seller/Dealer over a predetermined time interval.
• The buyer gets immediate possession of goods and can make use of them.
• In case of a default in payment of instalments, the vendor has full right to repossess goods.
• In case of repossession, payment received is treated as hire charges for period in which goods were with the Hirer.
• Ownership of the goods is transferred to the buyer only on payment of the final instalment.
• Hire purchase instalments to include the principal and the interest charges for the agreement term.
• Interest is very often an agreed flat rate.

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What are the various components of a hire purchase agreement?

• A Hirer or a Purchase is an individual or an entity who purchases goods under the hire purchase agreement.
• A Dealer or a seller is the entity selling goods under the agreement.
• A Down Payment amount is involved, which is the Initial upfront payment from the Purchaser to the Seller. It is often a percentage of the cash price of goods.
• Next, Hire Charges is the amount paid for hiring or using the goods under the agreement. It is like a rental paid for using the goods/ asset.
• Hire Charge is computed as the balance remaining after the down payment is deducted from the Hire Purchase Price.
• Next is Interest charged, which is a percentage of the total amount due at the instalment time. It is expressed as a percentage in the agreement.
• The Cash Price is the current market price of the goods or assets mentioned in the agreement, and
• The Hire Purchase Price is the amount at which goods are purchased under this agreement.

How does the Hire purchase agreement happen?

Any hire purchase agreement involves two parties—a seller of the asset and a buyer for the same asset. In the arrangement, both of them agree to enter into a contract where the Purchaser agrees to pay an initial down payment for asset delivery. The remaining amount is paid in several instalments with Interest over time. Goods are delivered at the time of initial down payment, but ownership gets transferred only when all the dues are cleared. If there is a default in paying instalments, the Seller repossesses the goods/ asset. Any payments received till repossession are treated as hiring charges for the use of an asset.

What are the types of hire purchase agreements?

• Consumer Hire Purchase: Here, the goods are hired by individuals for non-business use. The consumer may hire it for personal or for use in the household. The Hirer in this type of lease is not any business entity but a natural person.
• Business Hire Purchase: Also called an industrial hire purchase agreement. In this type, the Hirer is a company or any other business set up treated as a legal entity. The agreement is entered into to possess goods for operational or business purposes.

Both of these hire purchase agreement types can take place in 2 ways-

• First, where a third entity (lender) purchases goods for the final consumer. Under this agreement, such lender is treated as the owner of goods, paying the purchase price to the Seller. The customer is treated as the owner only on final payment. The lender is responsible for recovering payments from the final user. He may seize the goods in case of default. The Seller often does it to reduce the non-payment risk.
• Another way is the simple route where one seldom agrees with the Seller. Then, he/ She can pay the Seller and become the owner of goods on payment of the last instalment. Only the Seller has a right to seize goods in case of default. No third party is involved.

What are the merits of Hire Purchase Agreements?

• Organizations that run short of working capital can deploy operational assets on hire purchase.
• Assets are available without a huge one-time cash outflow.
• It is a convenient method as the amount of expenditure is known in advance, making budgeting decisions easier.
• It is often the most convenient method of financing an asset purchase.
• The most expensive assets involving complex technologies become easily available for use.
• i.e. the vendor gets the benefits and is responsible for depreciation on the asset.

What are the demerits of hire purchase agreements?

• A long term Hire purchase agreement turns out to be very expensive due to interest payments.
• It adds to the administrative complexity of the hiring organization.
• Sometimes, it brings in very high-interest rates that are not stated explicitly.
• Creates a fixed charge of instalments and interest payments even during a cash crunch.
• In reality, the Hire purchase price is always higher than the current cash price of the asset.
• Legal ownership is not vested till payment of the last instalment. In case of calamities, Hirer cannot claim insurance; instead, damages have to be paid.
• Hire purchase does not allow mortgaging the asset in case of any kind of bankruptcy.