Hire Purchase – Instead of buying a product you pay for it with monthly regular payments. Technically, the product is on hire until you have paid the final instalment when it then becomes your purchase
Note: Hire purchase is known as an instalment plan in the United States.
To remember what hire purchase means use the following mnemonic:
I hired a product but only fully purchased it (hire purchase) when I had finished the last payment instalment.
Hire purchase (HP) is an agreement with a company that only trades by lending in this way. An agreement is made on a fixed monthly payment for a set time period and this company will lend you the money for the purchase. For example, you may buy a lorry for £100,000, but instead of paying all the money upfront, you agree to pay £3194 a month for 36 months (total £115,000) to the hire purchase company (the lender of the money).
The interest rate on a hire purchase agreement is typically higher than the interest rate on a loan. However, a loan with a bank can be expensive to set up and can take a while to negotiate.
The eventual total cost of the purchase will be higher than if the business purchased outright.
Hire purchase can be a good option for businesses that need to acquire equipment but do not have the cash up front.
Hire purchase agreements are often used to buy cars for staff, lorries for transportation or machines for a factory.
- Allows businesses to acquire assets without having to pay the full price upfront.
- Can be a good option for businesses that need to spread the cost of buying over time.
- Can be beneficial for growing businesses that do not have immediate access to cash but need equipment to increase growth.
- The interest rate attached to a hire purchase agreement is often higher than a bank loan.
- The total cost of the asset will be higher than if it was bought outright.
- The business does not own the asset until all payments have been made.
Here are some factors that a business should consider when deciding whether to use hire purchase:
- The cost of the equipment: The higher the cost of the equipment, the more likely it is that hire purchase will be a good option, otherwise too much immediate cash is taken from the business.
- The cash flow of the business: If the business has a steady cash flow, it may be able to afford to purchase the asset outright. However, if the business’s cash flow is more susceptible to fluctuations, hire purchase may be a better solution.
- The risk of default: If the business fails to keep up with the routine payments on the equipment, it may be repossessed.