Hire purchase is an arrangement whereby a customer agrees to buy an item by paying an initial deposit, followed by a series of monthly payments. The item remains the property of the hire purchase company until the final payment is made. Once this has been made, the customer owns the item outright.
Hire purchase can be a useful way to spread the cost of a large purchase, such as a car or a piece of furniture. It can also be used to obtain items that may be difficult to buy outright, such as a computer or a television.
There are several things to consider before taking out a hire purchase agreement, such as the interest rate that will be charged, the length of the agreement, and any early repayment charges. It is also important to make sure you can afford the monthly payments, as missing payments can result in repossessing the item.
Hire purchase has become increasingly popular in recent years as a way to finance the purchase of big-ticket items. This is because it can be difficult to obtain the funds outright and because hire purchase offers several advantages over other forms of finance, such as personal loans.
Did you know?
Hire purchases can be easier to obtain than other forms of finance. This is because the purchase is made using the asset as collateral, which means that the lender is less exposed to risk.
What is a Hire Purchase Agreement?
A hire purchase agreement is a contract between a customer and a business to purchase an asset, where the customer pays an initial deposit and then agrees to make several monthly payments. The asset is usually something like a car or a piece of machinery. The customer does not own the asset until they have made all of the payments.
A hire purchase agreement is necessary to protect both the customer and the business. It sets out the terms of the agreement and the consequences of breaching it. This means that both parties know what is expected of them and what will happen if they do not meet their obligations.
The hire purchase agreement is also important because it allows the customer to spread the asset’s cost over time. This can make it more affordable for them, as they do not have to pay the full amount upfront.
Also Read: What is Management Accounting? Learn Definition, Importance, Objectives
Understanding How Hire Purchase Works with Examples and Calculation
Hire purchase is a type of financing arrangement where the buyer pays for a good in instalments over time. The good is usually a car, but it can also be furniture or other large items. The buyer typically pays a down payment when they first take out the loan and then makes monthly payments until the loan is paid off. The interest rate on a hire purchase loan is typically higher than a traditional auto loan, but the monthly payments may be lower.
To calculate the monthly payment on a hire purchase loan, you will need to know the loan amount, interest rate, and term of the loan. The loan amount is the total amount you are borrowing, including any down payment. The interest rate is the annual percentage rate (APR) charged on a loan. The term is the length of time you have to repay the loan, typically in months.
To calculate the monthly payment, you will need to use an online loan calculator or the formula below:
Monthly Payment = (Loan Amount x Interest Rate) / (1 – (1 / (1 Interest Rate)^Term))
For example, let’s say you are buying a car for ₹20,000 and you make a down payment of ₹4,000. You have decided to finance the remaining ₹16,000 with a hire purchase loan. The interest rate on the loan is 10%, and the term is 36 months. Using the formula above, we can calculate that the monthly payment on the loan would be ₹476.
If you are considering a hire purchase loan, it is important to compare the total cost of the loan with other financing options. Hire purchase loans can be a good option if you need to finance a large purchase and you cannot get a traditional loan. However, you will need to make sure that you can afford the monthly payments and that you will be able to pay off the loan before the end of the term.
Also Read: Understanding the Limitations of Accounting in Detail | Legaltree
Features of Hire Purchase System.
1. Hire purchase allows you to spread the cost of an expensive item over some time, making it more affordable.
With hire purchase, you pay an initial deposit followed by monthly instalments. The amount of the deposit and the length of the repayment period will be agreed upon upfront. This can make an expensive item more affordable, as you can spread the cost over some time.
2. You are usually only asked for a small deposit when you take out a hire purchase agreement.
The deposit on a hire purchase agreement is usually much lower than if you were to buy the item outright. This means you can get the item you want without having to pay a large upfront sum.
3. The monthly payments on a hire purchase agreement are usually lower than if you were to buy the item outright.
The monthly payments on a hire purchase agreement are usually lower than if you were to buy the item outright, and this is because you are only paying for the item over some time rather than in one lump sum.
4. You do not own the item until you have made the final payment.
You do not own the item with hire purchase until you have made the final payment. This means that if you default on the agreement, the lender can repossess the item.
5. You may be able to negotiate a lower interest rate on a hire purchase agreement than if you were to take out a personal loan.
Hire purchase agreements are usually subject to a lower interest rate than personal loans. This is because the item is used as security for the loan, which reduces the risk for the lender.
6. You can usually cancel a hire purchase agreement at any time, although you may be charged a penalty for doing so.
Most hire purchase agreements can be cancelled anytime, although you may have to pay the penalty for doing so. It is important to check the terms and conditions of your agreement before you sign it so that you are aware of any penalties that may apply.
Also Read: Types of Accounting Errors – What Are the Types of Errors in Accounting
Advantages of Hire Purchase System.
There are several advantages of a hire purchase agreement.
- Firstly, they provide a way for people to buy expensive items that they may not be able to afford outright.
- Secondly, they can be a more flexible way of financing than other methods such as loans, as the monthly payments can be tailored to suit the buyer’s budget.
- Finally, a hire purchase agreement can be a good way to build up a credit history, as timely payments can help to improve a person’s credit rating.
Disadvantages of Hire Purchase System.
There are several disadvantages of a hire purchase agreement.
- Firstly, if the buyer misses a payment or defaults on the agreement, they may lose the item they purchased.
- Secondly, hire purchase agreements can be expensive, as the buyer usually pays more than the item is worth due to interest and other charges.
- Finally, hire purchase agreements can be inflexible, as the buyer is often tied into the agreement for a set period.
Benefits of the Hire Purchase Agreement.
There are several benefits of a hire purchase agreement:
- It allows the customer to spread the asset’s cost over time.
- It allows the customer to own the asset at the end of the agreement.
- It protects both the customer and the business by setting out the terms of the agreement.
- It can help the customer budget for the purchase, and it can finance the purchase of expensive items such as cars and machinery.
Things to Include in a Hire Purchase Agreement.
A hire purchase agreement must include the following:
- The name and address of the customer and the business.
- Details of the asset being purchased.
- The total purchase price of the asset.
- The amount of the deposit.
- The monthly payments that will need to be made.
- The date on which the final payment will be made.
- The interest rate will be charged on the outstanding balance.
- The penalties will be applied if the customer misses a payment.
- The consequences of defaulting on the agreement.
- The customer’s right to cancel the agreement.
- The business’s right to terminate the agreement.
Also Read: Fundamentals of Accounting – Learn About Accounting Process and Steps & Basic Features of Accounting
Conclusion:
In recent years, a hire purchase has become a significant funding source, and it offers a practical approach to affording and obtaining items that would otherwise be out of reach. Consequently, hiring also aids in expanding a country’s economy. Before signing an agreement, one should grasp all the fees involved and the disclosures made. Other similar-looking asset financing choices include term loans, lease finance, and instalment purchases. However, there is a distinction between a term loan and a hire buy.
Follow Legal Tree for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.