by Hire Purchase
A hire purchase (HP), also known as an installment plan, is an arrangement whereby a customer agrees to a contract to acquire an asset by paying an initial installment (e.g., 40% of the total) and repaying the balance of the price of the asset plus interest over a period of time. Other analogous practices are described as closed-end leasing or rent to own.
In other words installment means to let a thing without giving total price while payment will be given in a given time period. The buyer will pay monthly agreement installment.
The hire purchase agreement was developed in the United Kingdom in the 19th century to allow customers with a cash shortage to make an expensive purchase they otherwise would have to delay or forgo. For example, in cases where a buyer cannot afford to pay the asked price for an item of property as a lump sum but can afford to pay a percentage as a deposit, a hire-purchase contract allows the buyer to hire the goods for a monthly rent. When a sum equal to the original full price plus interest has been paid in equal installments, the buyer may then exercise an option to buy the goods at a predetermined price (usually a nominal sum) or return the goods to the owner.
If the buyer defaults in paying the installments, the owner may repossess the goods, a vendor protection not available with unsecured-consumer-credit systems. HP is frequently advantageous to consumers because it spreads the cost of expensive items over an extended time period. Business consumers may find the different balance sheet and taxation treatment of hire-purchased goods beneficial to their taxable income. The need for HP is reduced when consumers have collateral or other forms of credit readily available, such as credit cards.
These contracts are most commonly used for items such as automobiles and high-value electrical goods where the purchasers are unable to pay for the goods directly.
Standard provisions
To be valid, HP agreements must be in writing and signed by both parties. They must clearly lay out the following information in a print that all can read without effort:
- A clear description of the goods
- The cash price for the goods
- The hp price (i.e., the total sum that must be paid to hire and then purchase the goods)
- The deposit
- The monthly installments (most states require that the applicable interest rate is disclosed and regulate the rates and charges that can be applied in hp transactions)
- A reasonably comprehensive statement of the parties’ rights (sometimes including the right to cancel the agreement during a “cooling-off” period)
- The right of the hirer to terminate the contract when he feels like doing so with a valid reason
The hirer’s rights
- To buy the goods at any time by giving notice to the owner and paying the balance of the HP price less a rebate
- To return the goods to the owner
- With the consent of the owner, to assign both the benefit and the burden of the contract to a third person. The owner cannot unreasonably refuse consent where the nominated third party has good credit rating.
- Where the owner wrongfully repossesses the goods, either to recover the goods plus damages for loss of quiet possession or to damages representing the value of the goods lost.
The Hirer’s obligations
- To pay the hire installment
- To take reasonable care of the goods (if the hirer damages the goods by using them in a non-standard way, he or she must continue to pay the installments and if appropriate, recompense the owner for any loss in asset value)
- To inform the owner where the goods will be kept.
- A hirer can sell the products if, and only if, he/she has purchased the goods finally or else not to any other third party.
The owner’s rights:
The owner usually has the right to terminate the agreement where the hirer defaults in paying the installments or breaches any of the other terms in the agreement. This entitles the owner:
- To forfeit the deposit
- To retain the installments already paid and recover the balance due
- To repossess the goods (which may have to be by application to a court depending on the nature of the goods and the percentage of the total price paid)
- To claim damages for any loss suffered
Common use
The use of HP or leasing is particularly common in industries where expensive machinery is required, such as construction, manufacturing, plant hire, printing, road freight, transport, engineering and professional services.
- Smaller items
- Cars
The asset provider usually dictates this type of linked finance.
Costs
There are two main costs that need to be considered:
interest rate charged for financing. Rates are favourable to assets with higher resale value (ie machinery, agricultural equipment, vehicles etc). Assets that are considered ‘soft’ due to their low resale value (ie printers, vending machines, office furniture etc), will be given less favourable rates
fees charged by the financing company for loan processing and administrative work meeting conditions. For example, a car purchased on HP may need servicing at regular intervals and from a pre-approved workshop.
Timeframe
An HP or leasing facility can normally take up to a week to complete, depending on the size and complexity of the deal.
Advantages
- Fixed-rate funding makes budgeting easy as the lessee has clear sight of future expenditures.
- HP or leasing allows companies to control and deploy assets without significant drain on working capital.
- flexibility of repayment structuring is available to allow for seasonal business (eg one repayment a year), and to reduce monthly outlay by factoring in a ‘balloon’ payment at the end of the term.
- Financing asset purchases can be more tax efficient than standard-term loans due to lease payments being booked as expenses. Although asset depreciation also provides tax benefits, the useable lifetime of the asset will vary depending on the asset and on local regulation.
- High accessibility of financing for businesses due to the financing being secured with the leased asset and the asset being owned by the financing company.
- Leasing prevents the risk of an asset’s value depreciating quickly and provides flexibility to enter into a new contract at the end of the original lease’s fixed term.
- In certain circumstances there is maintenance included within the terms of the agreement.
Disadvantages
- Administrative complexity and costs will be greater if any covenants are applied to the arrangement.
- Total sum of capital payments for HP or leasing will be higher than the full payment on the asset purchase.
- If the business changes its strategy, resulting in the leased asset no longer being useful, there can be early termination charges or restrictions on subleasing.
Lease
Lease is a contract whereby the owner of the asset(lesser) grants to another party(lessee), the exclusive right to use the asset usually for an agreed period of time in written for the payment of rent.
A lease is a contractual agreement in which:
- Provides an asset for use to another party i.e. lessee
- A party owing an asset i.e. lesser
- For an agreed period of time i.e. lease period
- For a consideration i.e. lease rentals
Features Of Leasing
- 2 Parties
- Purchase of an asset
- Selection of an asset
- Use of the asset
- Recovering the cost of an asset.
- Rentals and installments payment
- Option of acquiring ownership of the asset.
Types:
Financial Lease
Finance lease, also known as Full Payout Lease, is a type of lease wherein the lessor transfers substantially all the risks and rewards related to the asset to the lessee. Generally, the ownership is transferred to the lessee at the end of the economic life of the asset.
The lease term is spread over the major part of the asset life. Here, a lessor is only a financier. An example of a finance lease is big industrial equipment.
Operating Lease
In an operating lease, risk and rewards are not transferred completely to the lessee. The term of a lease is very small compared to the finance lease. The lessor depends on many different lessees for recovering his cost. Ownership along with its risks and rewards lies with the lessor. Here, a lessor is not only acting as a financier but he also provides additional services required in the course of using the asset or equipment. An example of an operating lease is music system leased on rent with the respective technicians.
Conveyance type lease
In Conveyance type lease, the lease will be for a long-period with a clear intention of conveying the ownership of title on the lessee.
Leveraged and non-leveraged leases
In leveraged and non-leveraged leases, the value of the asset leased may be of a huge amount which may not be possible for the lessor to finance. So, the lessor involves one more financier who will have charge over the leased asset.
Sale and Leaseback
In a sale and leaseback, a company owning the asset sells it to the lessor. The lessor pays immediately for the asset but leases the asset to the seller. Thus, the seller of the asset becomes the lessee. The asset remains with the seller who is a lessee but the ownership is with the lessor who is the buyer. This arrangement is done so that the selling company obtains finance for running the business along with with the asset.
Specialized service lease
The lessor or the owner of the asset is a specialist of the asset which he is leasing out. He not only leases out but also gives specialized personal service to the lessee. Examples are electronic goods, automobiles, air-conditioners, etc.
Full and non pay-out lease
A full pay-out lease is one in which the lessor recovers the full value of the leased asset by way of leasing. In case of a non pay-out lease, the lessor leases out the same asset over and over again.
Net and non-net lease
In non-net lease, the lessor is in charge of maintenance insurance and other incidental expenses. In a net lease, the lessor is not concerned with the above maintenance expenditure. The lessor confines only to financial service.
Cross border lease
Lease across national frontiers are called cross border lease, Shipping, air service, etc., will come under this category.
Net and non-net lease
In non-net lease, the lessor is in charge of maintenance insurance and other incidental expenses. In a net lease, the lessor is not concerned with the above maintenance expenditure. The lessor confines only to financial service.
Tax oriented lease
Where the lease is not a loan on security but qualifies as a lease, it will be considered a tax oriented lease.
International lease
Here, the parties to the lease transactions may belong to different countries which is almost similar to cross border lease.
Import Lease
In an Import lease, the company providing equipment for lease may be located in a foreign country but the lessor and the lessee may belong to the same country. The equipment is more or less imported.
Differences:
Agreement type
Hire purchase is a tripartite agreement involving the seller, finance company and the purchaser / hirer whereas Leasing is only a bipartite agreement, involving lessor and lessee.
Transfer of ownership
In Hire purchase, the agreement is entered for the transfer of ownership after a fixed period. But in Leasing it is only in financial lease, the ownership will get transferred. While in operating lease, the ownership is not transferred.
Depreciation Claim
Depreciation is claimed by the purchaser / hirer in a hire purchase. But in leasing, Depreciation is claimed by the lessor in the lease agreement.
Period of Agreement
Period of HP agreement is longer as valuable goods or properties are purchased. But in Leasing, the period of lease will be of shorter duration as technological changes will affect the lessee.
Buyers count
In hire purchase, the goods or property is sold once and there cannot be more than one buyer. But in operating lease, though the lessor can be one person, there can be a number of lessees.
Relationship in agreement
The relationship between the seller and the buyer will be that of owner and hirer in a hire purchase. But the relationship in a lease agreement is that of lessor and lessee.
Sales Tax
Sales tax is paid by the buyer on the total value of goods in a hire purchase. Sales tax depends on the actual value at the time of sale in leasing.
Transfer of ownership
In Hire purchase ownership passes on to the buyer only on the last installment from the finance company. But in leasing, the Ownership will pass on when the lessor has acquired enough money from the lessee, which is equivalent to the value of the goods or equipment.
Hire Purchase agreement is more common with the consumer durable goods. But lease agreement is entered more among business concerns.
Payment defaults
Any default in payment of installment enables the seller / finance company to seize the goods from the purchaser / hirer. On the termination of lease agreement if it is a operating lease, the equipment is taken back by the lessor. In the case of financial lease, the equipment can be sold for a particular value to the lessee.
Interest rates
The interest rate charged on HP is on a flat rate which is distributed for the entire period of HP agreement and collected along with the principal amount on the equated monthly installment basis. In leasing, Interest does not form a major part of lease agreement, but the lease charges will include interest also as a part of it.
