While most commonly associated with the car industry, hire purchase agreements are commonplace across the wider business landscape. A great way to secure assets without paying their full value straight away, utilising hire purchase is an effective strategy for companies with limited working capital who want to make the most of the assets they have available to them.
There are, however, considerations that accompany hire purchase agreements. Higher long-term costs and interest rates – as well as the illusion of affordability they potentially paint for individuals and companies who haven’t calculated the true costs – mean any hire purchase agreement should be handled with care.
But what is hire purchase, what can it offer – good and bad – and does it make sense for your organisation?
Hire purchase is a type of asset finance that allows you to purchase an asset without paying its full value immediately. In a typical hire purchase agreement, the buyer pays an initial down payment followed by the remainder of the balance (plus interest) in instalments across an agreed period. While the agreement is indeed a purchase that will transfer ownership to the buyer, this transfer is not completed until all payments have been made.
Hire purchase options are readily used by individuals and organisations in a few circumstances, including to counteract poor credit on an expensive purchase or to make use of limited working capital assets.
Hire purchase, by definition, is not a loan. It’s a type of contract of purchase where the buyer effectively rents the asset for the agreed term until payments are completed, only obtaining ownership once all payments have been made. In a typical loan agreement, the buyer borrows money to own an asset immediately.
This is an important distinction, as hire purchase offers vendors more security in the instance of the buyer failing to meet repayments. If a buyer cannot keep up with their repayments, the vendor can simply repossess the asset with limited negative financial impact to them.
The fundamental difference between hire purchase and leasing surrounds ownership. A hire purchase agreement is designed with ownership in mind, consisting of an initial down payment and monthly instalments that cover the entire value of the asset plus interest.
Leasing agreements, meanwhile, do not transfer ownership at the end, instead consisting of an initial deposit and monthly payments that cover the depreciation of the asset throughout the agreement.
At the end of a completed hire purchase deal, the buyer owns the asset. At the end of a completed leasing agreement, the buyer either returns the asset and walks away or begins a new lease on a new asset – for example, a new vehicle or upgraded machinery. For the same asset, hire purchase payments will be larger than those in leasing, because the intention is you will own the asset at the end of the agreement.
There are a few further differences to note between hire purchase and leasing. In terms of interest paid, interest on hire purchase agreements is representative, which means rates can be higher for those with poor credit. Leasing agreements are typically subject to a VAT flat rate, meaning you won’t usually be hit with a bigger charge than the advertised monthly amount.
As a caveat to that, leasing agreements are likely to be much more particular around credit history, with a good credit score required for many leases. You can also expect more restrictions on an asset in a leasing agreement – for example, a mileage cap on a vehicle – which you probably won’t find in a hire purchase.
Hire purchase agreements offer buyers many benefits in relation to financial flexibility and accessibility, but buyers must consider the higher long-term costs attached to the purchase in their financial planning. Here’s a breakdown of the pros and cons attached to this type of agreement.
Hire purchase on an individual level is most commonly seen in the car market. Buyers regularly pick between hire purchase (HP) agreements, personal contract purchases (PCP) and leasing when getting a new or used car.
Hire purchases for vehicles are also common at the company level in industries such as construction, engineering, manufacturing, plant hire and transport where heavy machinery is required.
Common examples of hire purchase agreements include:
Hire purchase agreements are useful for businesses with limited working capital, but some alternatives can help you buy your assets outright and avoid the interest rates attached to rental.
At Nucleus, we offer a variety of funding formats that can help, including asset-based lending, cash flow finance and business growth loans. If you want to know about how we can assist you – and weigh up the pros and cons of our lending options versus the likes of hire purchase – speak to one of our team today.
4 August, 2022