What Do You Mean by Hire Purchase Agreement in Simple Language?
Hire purchase is one of the most preferred ways of asset financing, which
- Allows you to own an asset
- Then lease it out to a hire purchase vendor
A typical hire purchase agreement involves two parties which are:
- The buyer of an asset is known as the Hire purchase buyer and
- A hire purchase leasing company or the Hire purchase vendor
Using a hire purchase agreement, you are not required to invest your capital into buying an asset. You can possess an asset after making a down payment. Post this; pay the monthly rentals to the vendor throughout the agreement.
How Does a Hire Purchase Agreement Work?
We can divide the working of a hire purchase agreement into four distinct phases. We can understand these through the table below:
|Phases||Name of the Phase||Explanation|
|I||The Initial Phase – Making a Down payment||• The process of hire purchase starts when you make the down payment to your vendor|
• This is the first payment that you make to your vendor and is recorded as the rental revenue
• Post this, you get to possess the asset and use it for the period as mentioned in the hire purchase agreement
|II||The Middle Phase – Paying Regular Monthly Rentals||• After the down payment, you will be required to keep paying the rental payments to your vendor every month|
• The quantum of such payments and the period for which you will pay them is usually pre-decided and is mentioned in the hire purchase agreement
• These monthly payments are made up of two different elements – Interest Cost (calculated on the unpaid amount) and Capital Payment
• You cannot skip or default in making the monthly rental payments, as by doing so:
a) You will lose your possession of the asset
b) The asset will be claimed by your vendor
c) All the payments made by you in the past will be worthless
|III||The Middle Phase – Transfer of Ownership||• Under hire purchase, you get an option to own the asset at any point in time|
• To do so, you are required to pay:
a) All the pending or unpaid installments in a lump sum
b) A pre-determined nominal amount
|IV||The End Phase – Maturity of the Hire Purchase Agreement||• After the end of the contractual period and after paying the final installment, you can get the ownership of the asset.|
• You can also be required to pay a nominal amount at this juncture.
What Is the Need for a Hire Purchase Agreement?
Finance is the backbone of every industry. If you own a business, you must have felt the need for money at the various stages of operations. To buy ever-important machinery or the urge to expand, you will need a ready stream of funds to meet your business requirements.
Similarly, retail consumers always need money to fund their personal and family requirements. Electronic gadgets such as high-end television sets, refrigerators, and heaters are a necessity nowadays and define your standard of living.
You can fulfill your business and personal needs by entering hire purchase agreements. It is quite like the concept of a mortgage, but its unique properties and applications.
- We primarily use this method in capital-intensive industries (such as construction, aviation, engineering, etc.) that require expensive assets and machinery.
- It enables them to buy an asset assuming no debt liability on their books of accounts.
- It also resembles the more common rent-to-own contracts.
What are the Pros and cons of a Hire Purchase Agreement?
Hire purchase is a method of asset financing used by parties. However, it has its pros and cons, mentioned:
￼What Are Personal Contract Plans (PCP) In Hire Purchase?
The PCPs is a hire purchase agreement commonly extended by the car dealers to their customers. When you purchase a car using a PCP, you need to:
- Make a down payment to the car dealer, usually 10% of the price of the car.
- Make monthly payments to the car dealer (hire purchase vendor) throughout the contract, which in most cases is 36 months.
- Pay a lump sum amount at the end of the contract period.
You may possess and use the car right after making a down payment. However, since you are not an owner, you cannot sell or mortgage the automobile until your hire purchase agreement expires.
Further, it is a fact that most PCPs have a lower monthly payment, but you will be required to pay a high lump sum payment at the end of your tenure to become the car’s legal owner.
Wrapping It Up
A hire purchase agreement allows you to possess and use an asset by making systematic monthly payments to the hire purchase vendor. It authorizes you to spread the exorbitant cost of an asset over the contract period.
However, if you default in meeting your regular monthly payments, you will lose your asset and previous payments.
Further, PCPs (Personal Contract Plans) are a hire purchase agreement type and have gained popularity recently. It has primarily happened because of the low monthly rentals charged by them. But these payments can get tricky compared to other financing options.
Hence, hiring a purchase could be an excellent way to own an asset, but you must be vigilant and keep exploring the different financing options.