Hire purchase is a method of financing of the fixed asset to be purchased on future date. Under this method of financing, the purchase price is paid in installments. Ownership of the asset is transferred after the payment of the last installment.
Features of Hire Purchase:
The main features of hire purchase finance are:
- The hire purchaser becomes the owner of the asset after paying the last installment.
- Every installment is treated as hire charge for using the asset.
- Hire purchaser can use the asset right after making the agreement with the hire vendor.
- The hire vendor has the right to repossess the asset in case of difficulties in obtaining the payment of installment.
- Rental payments are paid in installments over the period of the agreement.
- Each rental payment is considered as a charge for hiring the asset. This means that, if the hirer defaults on any payment, the seller has all the rights to take back the assets.
- All the required terms and conditions between both the parties involved are documented in a contract called Hire-Purchase agreement.
- The frequency of the installments may be annual, half-yearly, quarterly, monthly, etc. according to the terms of the agreement.
Assets are instantly delivered to the hirer as soon as the agreement is signed.
- If the hirer uses the option to purchase, the assets are passed to him after the last installment is paid.
- If the hirer does not want to own the asset, he can return the assets any time and is not required to pay any installment that falls due after the return.
- However, once the hirer returns the assets, he cannot claim back any payments already paid as they are the charges towards the hire and use of the assets.
- The hirer cannot pledge, sell or mortgage the assets as he is not the owner of the assets till the last payment is made.
- The hirer, usually, pays a certain amount as an initial deposit / down payment while signing the agreement.
- Generally, the hirer can terminate the hire purchase agreement any time before the ownership rights pass to him.
Advantages of Hire Purchase:
Hire purchase as a source of finance has the following advantages:
- Financing of an asset through hire purchase is very easy.
- Hire purchaser becomes the owner of the asset in future.
- Hire purchaser gets the benefit of depreciation on asset hired by him/her.
- Hire purchasers also enjoy the tax benefit on the interest payable by them.
- Immediate use of assets without paying the entire amount.
- Expensive assets can be utilized as the payment is spread over a period of time.
- Fixed rental payments make budgeting easier as all the expenditures are known in advance.
- Easy accessibility as it is a secured financing.
- No need to worry about the asset depreciating quickly in value as there is no obligation to buy the asset.
Disadvantages of Hire Purchase:
Hire purchase financing suffers from following disadvantages:
- Ownership of asset is transferred only after the payment of the last installment.
- The magnitude of funds involved in hire purchase are very small and only small types of assets like office equipment’s, automobiles, etc., are purchased through it.
- The cost of financing through hire purchase is very high.
- The addition of any covenants increases the cost.
- If the hired asset is no longer needed because of any change in the business strategy, there may be a resulting penalty.
- Total amount paid towards the asset could be much higher than the cost of the asset due to substantially high-interest rates.
Term Used in Hire Purchase agreement;
- Hire Purchaser: He is buyer in hire purchase agreement.
- Hire Vendor: He is seller in a hire purchase agreement.
- Cash Price: It is the amount to be paid for outright purchase in cash.
- Down Payment: It is the of initial payment payable by the hire purchaser at the time of entering into a hire purchase agreement.
- Hire Purchase Price: It is the total amount payable by the hire purchasers to the hire vendor of goods are purchased under the hire purchase system.
HIRE PURCHASE IS BEST SUITABLE FOR
Small scale companies and entrepreneurs can benefit from Hire Purchase. Expensive and important assets can be hired and later owned. This ensures that they can start using the asset from very first day and use the money earned to later buy the same assets.
Hire Purchase is an important source of financing in recent times. It provides a convenient way to afford and acquire assets that otherwise be financially unattainable. Thus, hire purchase also helps a nation’s economy to grow further. However, before entering an agreement, one should clearly understand the costs involved and the disclosures provided. There are various other like term loan and installment purchase which looks similar but there is the difference between hire purchase and term loan and also there is the difference between hire purchase and installment purchase.