Hire purchase is an agreement that lets you buy expensive goods without paying the whole price right away. The difference from a purchase on credit is that you do not own the item outright. Instead, you get it all to yourself, start paying for it in several instalments over a long period of time — and once you are done, you buy the rights to the item from the seller.
How does it work?
You find something you want to buy but can’t spend the whole sum of cash outright. Either the business that sells can finance the hire purchase deal themselves or they refer you to a credit organisation that finances the deal for them. They secure the loan against the product you buy.
For consumers, the course of action looks like this:
- You really like that SUV. Like, really.
- First, you pay a deposit that is usually close to 10% of the vehicle’s full value. For a £30,000 car, it will be £3,000.
- Then you agree to pay monthly instalments with say 5% APR on £27,000 for three years. That will be £809 a month over 36 months. In total, you will pay £29,000
- Fast forward three years. Once you have paid all the instalments. Now for a fee of £200 pounds the rights to the vehicle are transferred to you.
In total for a vehicle that costs £30,000, you have paid £32,200.
You get to formally own the things you buy this way only after you have completed all the terms of the deal. This means that you can not sell the SUV before the three-year term and before you paid the transfer fee.
You may, in the end, decide not to buy the rights for the SUV, but this way you will end up virtually leasing the car with a down payment and a high interest rate.
This scheme is widely used not only by the individuals but by businesses, too. You get to use the assets you need for your business right away and both down payments and instalments can be put forward towards capital allowance. Any interest you pay is treated as expenses and reduces your taxable income. You don’t have to part with a large amount of cash straight away and still get to enjoy all the tax benefits at a relatively low cost.
When is it used?
In the UK, around a fifth of all new cars are bought using the Hire Purchase scheme. In the used car market, this method is even more popular. Dealerships like to sell cars this way because many manufacturers have their own in-house lenders that they promote to both dealers and customers. The terms are usually favourable and monthly instalments are not subject to VAT for dealerships which reduces the consumer cost as well.
How’s Hire Purchase different from a leasing agreement?
Another way to spread the cost of items over time are lease agreements. But there are some key differences.
It might be hard to figure out from the get-go if you should buy on hire purchase or lease. The side-by-side comparison below can help you decide.
|Issue||Hire Purchase||Lease Agreement|
|Who owns the asset?||Until you pay all the instalments and the ‘option to purchase’ payment, the vendor does. After that, you own full rights to it||Lessor (vendor) does. Usually there is no option to purchase after the term of agreement|
|Structure of the deal||You put a down payment. Then the vendor or their partner finances the rest and the parties agree on the terms. In some cases, as the down payment approaches 50% of the product cost, the deal might be interest-free||The lessor and you agree on how much, how often and what percentage they get on top of the item’s cost|
|Who is in charge of fixing the asset?||You are. However, you can put the expenses towards capital allowance.||You have to agree on that with the lessor. But if you fix the thing you can not put whatever you have spent towards your capital allowance.|
What are the benefits of Hire Purchase?
It spreads the cost of assets across longer periods of time. It is important because whenever starting a new business, especially if you plan to manufacture the product, you need a significant amount of capital to afford the equipment. Although it is clearly a worthy investment, the sheer value of it ties your hands in terms of business development by taking big chunks of cash away from you.
Hire purchase deals are rarely refused. Whoever is financing the hire purchase deal will be less likely to turn a customer down because of their credit history as they secure the loan with the merchandise itself. That means, however, dropping out of the deal midway leads to the financer simply repossessing whatever you bought.
You don’t have to pay VAT for the whole sum. A lot of the times the vendor rolls the VAT into the initial agreement itself. This reduces the cost of the monthly instalments. In leasing, every single monthly payment is treated as a separate transaction and is subject to VAT. You virtually prolong your rent for the next month. In hire purchase, your down payment is the transaction. You pay all the taxes upfront and decrease the cost over the long term.
The interest rate might be as low as 0%. Financers tend to agree to do that if the down payment covers 50% of the full cost or more. Yes, it somewhat defeats the purpose of spreading the cost of investment over longer periods of time but saves you money in the long run.
1974 Consumer Credit Act has a clause that lets individual customers terminate agreements early with no penalties. If they paid half of the instalments, they simply hand the item back to you and you have to take it. You can charge for repairs if it’s broken, but the deal at this point is over anyway. The definition of an individual stretches to partnerships up to four persons and sole trader businessmen.
What are the drawbacks?
If you are unable to pay the monthly instalment, you lose the asset and hurt your credit score. It happens because the loan is secured against the product. Banks look sideways at businesses who can’t plan their expenses and burn through cash quickly and will be less likely to give you loans with favourable interest-rates if at all. Inability to secure more financing in the future will hurt big-time.
You do not own the asset right away. That makes you unable to sell or lease it to someone else. But at the same time, you are responsible for fixing it if something goes wrong. Typically, this is not the case with lease agreements. It’s the lessor who takes care of the leased equipment. However, as can be seen in the table above, your maintenance expenses can be put towards capital allowance.
It’s more expensive than leasing the asset or buying it on credit. Even though credit score isn’t likely to cost the buyer the deal, it still can cost worse interest rate. And even more likely a bigger sum in down payment. Whoever is providing you with a hire purchase deal is virtually selling a secure loan. And the riskier it is to lend money, the higher interest rates have to be.
Benefits of selling on Hire Purchase
Clear advantage of selling this way is relatively low risks. If your client defaults on their payments, you can always repossess the item and even charge them for repairs down the line if the goods you have repossessed are of worse quality now then when you sold them.
You still get down payment most of the time and the interest on the instalments. So in the long term, especially if you have many items in the inventory that you sell this way, you make a good profit because of the interest rate you charge.
If you own a car dealership, most manufacturers have their own financing programs. In most cases, they even incentivise dealers to sell the cars using this scheme.
Even though you don’t get the full price of the item straight away, you know that the cash is coming at the same time every month. That alone can extend your credit line with your bank since you have a steady flow of cash.
Selling this way is easier for the customer because they don’t have to part with a big sum of cash right away. That may very well help you to increase the turnover. That, along with the fact that you charge interest rates, can be a very profitable business model.
The drawbacks of selling on hire purchase
- You don’t get the cash right away;
- There still are risks, even though they are limited;
- You need to set time aside to negotiate the deals and check the credit histories of the customers.
What do you need to sell on Hire Purchase?
However, there are a couple of regulation hoops you need to jump through first if you plan to sell to individuals. If you operate B2B, you can ignore the following list.
Before you can sell on hire purchase to individuals
You need to register with the Financial Conduct Authority (FCA). You will need to meet their Threshold conditions to carry out credit services. The application process can be done online, but there is a pretty long list of requirements and a fee to pay that depends on a load of detail.
There are two ways of doing that:
- You can get limited permission from FCA. This way you will get licensed faster and cheaper but you will be limited in the amount you can loan to your customers and the interest rate you can charge.
- Or you can find a partner who will be in charge of financing the deals. Many consumer creditors are open to partner up with retail businesses. But it might be more profitable to do it yourself in the long run because they raise the costs for the customer to make a profit for themselves.
Hire purchase has been around for a very long time. The longevity of this instrument derives from the fact that it puts both business and consumer in a win-win situation if used right. Risks are balanced with guarantees and not too many strings are attached.