Hire purchase (HP) is a popular form of asset finance for businesses, allowing them to acquire essential equipment, vehicles, or machinery without the need to pay the full price upfront. Instead, a business makes an initial deposit, followed by regular instalments over a set period. Once the final payment is made, ownership of the asset is transferred to the business. In this article, we’ll explore how hire purchase works, its advantages and disadvantages, and how it compares to other finance options like leasing.
How Does Hire Purchase Work?
The process of hire purchase for businesses is relatively straightforward. Here’s how it works:
- Asset Selection: The business identifies the asset it needs to purchase. This could be anything from machinery, vehicles, office equipment, or other high-cost items.
- Deposit Payment: The business pays an initial deposit, usually around 10-30% of the asset’s total value. This deposit secures the asset and forms part of the total payment.
- Monthly Instalments: After the deposit, the business pays the remaining balance over an agreed term, typically between 1 and 5 years. These payments are fixed, making it easier to budget and manage cash flow.
- Ownership Transfer: Once the final instalment is made, the business pays a nominal ‘option to purchase’ fee, at which point ownership of the asset transfers to the business.
During the repayment period, the business has full use of the asset, though technically, ownership remains with the finance provider until the final payment is made.
Example of Hire Purchase in Action
Let’s say a construction company needs to purchase a piece of machinery worth £50,000. With a hire purchase agreement, the company might pay a 10% deposit of £5,000 upfront. The remaining £45,000 is then paid in monthly instalments over, for example, five years. At the end of this period, the business pays a small final fee to own the machinery outright.
The Advantages of Business Hire Purchase
1. Ownership at the End of the Agreement
One of the key benefits of hire purchase is that, once the final payment is made, the business owns the asset. This can be a valuable long-term investment, as the company can continue using or reselling the asset without further payments.
2. No Large Upfront Costs
Hire purchase allows businesses to access necessary equipment without the strain of paying the full cost upfront. This can be particularly helpful for SMEs with limited cash reserves. Instead of a lump sum, the business can spread the cost over manageable monthly payments.
3. Fixed Payments
With hire purchase agreements, payments are fixed throughout the contract term, making it easier for businesses to plan their budgets. This predictability helps avoid unexpected costs and makes managing cash flow more straightforward.
4. Flexible Terms
Hire purchase agreements are often flexible, allowing businesses to tailor the length of the repayment term and size of the deposit according to their cash flow needs. This flexibility means businesses can structure the agreement to suit their financial situation.
5. Asset Usage Without Ownership Delays
Businesses can begin using the asset immediately, even though they don’t yet own it outright. This can be crucial for industries where having access to tools and equipment is necessary to keep operations running smoothly.
6. Easier Approval for Businesses with Poor Credit
Because the asset being purchased serves as collateral, hire purchase agreements can be easier to obtain for businesses with a lower credit score compared to traditional loans. The finance provider has the security of reclaiming the asset if payments aren’t made.
The Disadvantages of Business Hire Purchase
While hire purchase has many advantages, it’s important to consider some potential drawbacks:
1. Higher Overall Cost
The total cost of the asset, when interest and fees are added, can be higher than if the business purchased it outright. The business will also need to pay interest on the outstanding balance throughout the repayment term, which increases the overall cost.
2. No Ownership Until Final Payment
Until the final payment is made, the asset remains the property of the finance provider. This means that if the business struggles with payments and defaults, the provider can repossess the asset, and any payments already made will be lost.
3. Maintenance Responsibilities
Even though the business doesn’t technically own the asset until the final payment, it’s often responsible for maintaining it during the hire period. This includes any repairs or servicing that may be required, which can add to the cost of ownership.
4. Potential for Higher Interest Rates
Compared to some other forms of finance, hire purchase can come with higher interest rates, especially for businesses with lower credit scores. It’s essential to shop around for the best deal and ensure that the terms suit the company’s financial health.
Hire Purchase vs Leasing: Key Differences
When deciding between hire purchase and leasing, it’s important to understand the key differences between the two options:
- Ownership: With hire purchase, the business owns the asset at the end of the term. With leasing, the asset is rented, and ownership remains with the leasing company unless there is an option to purchase at the end.
- Deposit: Hire purchase typically requires a deposit, whereas leasing often doesn’t. This means that leasing may be a better option for businesses that want to avoid an upfront cost.
- Flexibility: Leasing tends to be more flexible in terms of upgrading equipment. Businesses can return the asset and lease a newer model once the lease term is over, which is ideal for industries where technology quickly becomes outdated.
- Tax Considerations: With hire purchase, the business can claim capital allowances on the asset, whereas leasing payments are typically tax-deductible as a business expense. Depending on the asset and the business’s tax situation, one option may be more advantageous than the other.
Why is Hire Purchase Popular in Business?
Hire purchase is popular in business because it offers a way for companies to acquire expensive assets without having to pay the full cost upfront. It’s especially useful for businesses that need to maintain cash flow or don’t have the reserves to make a large capital investment. This form of finance is also favoured because businesses can plan their budgets around fixed monthly payments, knowing that they will own the asset at the end of the agreement.
Can You Exit a Hire Purchase Agreement Early?
It is possible to exit a hire purchase agreement early through a process known as voluntary termination. However, businesses should be aware that early termination may come with additional costs. Typically, the business will need to have repaid at least 50% of the total contract value before being allowed to terminate the agreement. In addition, the asset must be returned in good condition, or the business may be charged for repairs.
What Happens at the End of a Hire Purchase Agreement?
At the end of the hire purchase term, the business can take full ownership of the asset by paying a final fee. Once this fee is paid, the asset belongs to the business, and it can sell, modify, or continue to use the asset without any further payments.
Final Thoughts
Hire purchase is an effective way for businesses to finance essential assets while spreading the cost over time. It offers the benefit of eventual ownership, fixed payments, and easier access to finance for businesses with varying credit profiles. However, it’s important to weigh the potential drawbacks, such as higher overall costs and maintenance responsibilities. For businesses looking for a straightforward way to acquire assets and secure long-term ownership, hire purchase can be a valuable option.