A hire purchase (HP) is a solution employed by businesses who would like to purchase assets, but cannot or would rather not pay the full price immediately. Under a hire purchase agreement, the business would typically pay a deposit initially, with the remaining balance paid in instalments over time, with interest. Ownership of the asset is not transferred to the business until the full payment is complete.
An asset is anything with monetary value, owned by either an individual or an organisation. For a business, this might include tangible assets like equipment and office space, or it might be intangible goods like property rights.
A hire purchase is, essentially, leasing an asset until it can be paid off fully.
Who can make a hire purchase?
Hire purchases are especially common in sectors that involve pricey equipment, like construction, freight, engineering, and manufacturing. It can also be used for small-scale assets, for things like company cars or mobile phones, for example.
Individuals are able to take out hire purchase agreements for personal use, too – it’s not just for businesses. The most common hire purchase agreements for personal use are for vehicles.
How does a hire purchase agreement work?
Generally, hire purchases must be taken out through a finance facility like a bank or building society, or sometimes directly through the owner, such as through a car dealership. However, if you are taking out a hire purchase directly through a retailer, it’s worth noting that the retailer will still be working as an agent for a finance company who is providing the loan, and the retailer will be receiving a commission from the finance company for facilitating the arrangement.
In some cases, hire purchase agreements will include a final payment to confirm the transfer of ownership.
The payment period for larger hire purchase agreements typically ranges between 2 and 5 years, while smaller purchases may be significantly shorter.
During the hire purchase payment period, you can use the asset as if you own it, but you cannot legally sell or dispose of an asset that you’re borrowing via hire purchase until you’ve paid for and thus own it.
If a business fails to make payments on time, they run the risk of the assets being repossessed and returned to the original owner. The lender will need a court order to repossess the goods unless you’ve paid less than a third of the total amount.
Businesses are within their rights to terminate a hire purchase agreement at any time and return the assets if they no longer need or can no longer afford them. Payments will still need to be made to cover the time the business did have with the asset, and if the payments at the time of termination fall below half the value of the asset, the business may be required to make additional payments to meet an agreed-upon minimum. A business will never be required to pay the entire amount of an asset they have returned.
Hire purchase calculator
The price for a hire purchase will often be higher than the price to buy the item outright (cash price). The term ‘hire purchase cost’ refers to the difference between the cash price of the item and the hire purchase price. So, to calculate the hire purchase cost, subtract the cash price from the hire purchase price. Hire purchase cost represents how much extra you’d have to pay for the convenience of paying in instalments.
Outside of the hire purchase cost, there are often additional fees involved with a hire purchase contract. This could be penalty charges for late payments, fees for admin and documentation, interest surcharges for missed payments, and balloon payments for transfer of ownership, among other potential costs.
How to record a hire purchase agreement
Despite the fact that a business does not own the asset until it’s been paid for entirely, the new asset must still be recorded as a fixed asset on the business’s balance sheet.
A hire purchase contract must include the following:
The term “Hire Purchase Agreement”, included prominently and clearly
The exact asset being loaned must
Both the cash price and hire purchase price of the asset
The payment amount for each instalment and the amount of final balloon payment if applicable
The dates each instalment must be paid
Details of all parties involved, including names and addresses
A statement confirming the hirers right to withdraw from the agreement within a cooling off period, typically within 10 days of the agreement being received
A statement confirming that the hirer must inform the finance company of the location of the asset
Any additional fees or charges that will apply
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