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Hire Purchase Agreements Definition & Overview

Updated: November 22, 2022

What happens when you want to make a purchase but might not necessarily have all the funds? Or, what if it would make more financial sense for you to spread the payments out over time? Is there anything you can do when you face these obstacles? 

A hire purchase contract is often put into place to help make more expensive purchases easier to manage. Yet, there are still some important aspects that you should know and understand. Keep reading our guide to learn how hire purchase agreements work, the advantages and disadvantages, and a few other bits of information.

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    KEY TAKEAWAYS

    • It’s important to remember that with a hire purchase agreement, ownership doesn’t get transferred until all payments get made.
    • Even though they help with more expensive purchases, a hire purchase agreement often tends to be more expensive in the long run.
    • A hire purchase agreement isn’t the same as a line of credit.

    What Is a Hire Purchase Agreement? 

    Hire purchase agreements are a common arrangement that is used when you need to purchase a good or service that is expensive. They work by paying an initial installment or providing a downpayment at the beginning. Then, there is a series of additional payments you will have to make over a period of time until the balance is paid off. 

    There is also going to be an accumulation of interest that is generated throughout the life of the agreement. In the US, it can be common to refer to hire purchase agreements as  installment plans. They can be a beneficial way of making a purchase of something to avoid the initial high price. 

    Essentially, you would hire the goods you want to purchase by agreeing to a periodic payment schedule. Interest would get added on until you can pay off the total price in full. 

    As well, there can be cases where even once the good is paid off you still won’t have secure ownership rights. There can even be a previously agreed-upon fee that you must pay off before any title is transferred to you. This can be common with other financing programs that include rent-to-own or never-never frameworks. 

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    How Hire Purchase Agreements Work

    Similar to rent-to-own transactions, hire purchase agreements work by providing the option for you to buy during the agreement. These types of agreements can come in especially handy for consumers that have poor credit. This is since they would be able to spread out the cost of more expensive items over time. 

    It’s worth recognizing that a hire purchase agreement isn’t the same as an extension of credit since you don’t actually own the item until after you have made all the necessary payments. 

    And, since ownership doesn’t get transferred until the length of the agreement has passed, there is more protection offered to the vendor. They gain this added protection through a hire purchase agreement compared to more typical sales or leasing methods for unsecured items. 

    How Do You Calculate a Hire Purchase Agreement?

    There are a few things to consider when calculating a hire purchase agreement. 

    The first thing is to determine the hire purchase price. To calculate this, you multiply the installment amount by the number of installments. Then, you add this to the down payment to find the hire purchase price. 

    After this, you will also need to determine the total interest or the hire purchase cost. To find this you need to subtract the cash price from the hire purchase price. Interest gets calculated by determining the total amount due at the time of installment. Then, you multiply this by the rate of interest divided by 100. 

    It’s also worth knowing that the cash price is going to be the current market price that a good can get purchased. The hire purchase price is the price it can get purchased based on the agreement. 

    Advantages of Hire Purchase Agreements 

    There can be several advantages that come from a type of hire purchase agreement, for both you and the vendor. They allow a company that might have inefficient working capital to utilize more assets. As well, they can be more tax-efficient compared to a standard loan. This is since all the payments get listed as an expense.

    So, if you have a business that has a need for expensive equipment and machinery, hire purchase agreements can make it more affordable. Startups can also experience these benefits to establish lines of credit if they don’t have a ton of collateral. 

    Another advantage of hire purchase agreements is that the payments are spread out over time. This reduces the burden on you and provides the opportunity to secure more expensive assets. As well, if you have a poor credit rating you’re still able to use a hire purchase agreement.

    This works the same if your business doesn’t have much working capital. There becomes a minimal risk to the seller as well because the item can get repossessed if installments aren’t made. 

    Vendors also benefit from a hire purchase agreement because they can increase demand for their goods. So even though many consumers might not be able to purchase a product that’s more expensive, it becomes more feasible by spreading the payments out over time. 

    Hire contracts can also provide a business with a broader customer base and increased revenue. 

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    Disadvantages of Hire Purchase Agreements 

    Even though common hire purchase agreements can make purchasing a more expensive product easier at the time, they often end up being more expensive in the long run. Making a full payment on a cash purchase ultimately ends up being cheaper. This is in large part due to the interest costs that you will have to pay on the asset purchase. 

    And since hire purchase and installment systems reduce the initial cost, it can be tempting to buy goods that aren’t actually affordable. Plus, a high-interest rate can also be included, increasing the cost even more. 

    Because hire purchase agreements aren’t seen as extensions of credit, they become exempt from the Truth in Lending Act. So, as long as you make the required minimum payments, goods can get returned at any time which would render the original agreement void.

    Summary

    The term hire purchase agreement relates to making a purchase of a good on a series of periodic installments. These scheduled, predetermined installments are made over an extended time period instead of making a single purchase. The installment period could depend on the specific vendor or the type of product. 

    It’s critical to make payments on time and transfer of ownership doesn’t always happen as soon as the hire purchase payment period ends. Be sure to confirm these details with the finance company so you’re aware of your consumer rights. Larger hire purchase agreements can be a good strategy for consumers to utilize if they don’t have the capital right away.

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    FAQs About Hire Purchase Agreement

    What Is a Hire Purchase Agreement Example?

    When you use a hire purchase agreement you basically hire an item, like a company car or a piece of machinery, for example. You then pay an agreed amount in monthly payments until the total amount is paid off.

    What Are the Types of Hire Purchase Agreements?

    They typically come in two forms. The first is when goods get purchased by a seller from a dealer. The second is when you, as a customer, would purchase the goods through a hire purchase agreement with the seller.

    What Are the Important Elements of a Hire Purchase Agreement?

    The specific elements might vary depending on the item and the seller. However, there are still some common elements. These include the agreement, the guarantor, the deposit, the interest rate, and the payment.

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