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Will Kenton is an expert on the economy and investing laws and regulations. He previously held senior editorial roles at Investopedia and Kapitall Wire and holds a MA in Economics from The New School for Social Research and Doctor of Philosophy in English literature from NYU.
Updated June 24, 2024 Fact checked by Fact checked by Vikki VelasquezVikki Velasquez is a researcher and writer who has managed, coordinated, and directed various community and nonprofit organizations. She has conducted in-depth research on social and economic issues and has also revised and edited educational materials for the Greater Richmond area.
The term hire purchase refers to an arrangement for buying expensive goods. In a hire purchase agreement, the buyer makes an initial down payment and pays the remaining balance plus interest in installments. The term is commonly used in the United Kingdom and it's more commonly known as an installment plan in the United States, although there are subtle differences between the two.
A hire purchase agreement is a type of credit agreement between a buyer and seller. People typically enter into these contracts to buy products. After an initial payment, the buyer continues to make installment payments until the total purchase price is paid off. At this point, the buyer becomes the owner of the product.
These agreements are similar to rent-to-own transactions because they give the lessee the option to buy at any time during the agreement, such as rent-to-own cars. Like rent-to-own, hire purchases can benefit consumers with poor credit by spreading the cost of expensive items that they would otherwise not be able to afford over an extended time.
Because ownership is not transferred until the end of the agreement, hire purchase plans offer more protection to the vendor than other sales or leasing methods for unsecured items. That's because the items can be repossessed more easily should the buyer be unable to keep up with the repayments.
Do not confuse a hire purchase agreement with an extension of credit. In an extension of credit, the purchaser technically doesn't own the item until all of the payments are made.
As noted above, hire purchase agreements are used in the U.K. and are known in the U.S., but they are known as installment plans. Although they seem the same, there are some distinctions between the two. For instance:
Using hire purchase agreements as a type of off-balance-sheet financing is highly discouraged and not in alignment with generally accepted accounting principles (GAAP) unless the assets and liabilities for leases with terms of 12 months or longer are recognized in the financial statement.
Like leasing, hire purchase agreements allow companies with inefficient working capital to deploy assets. It can also be more tax-efficient than standard loans because the payments are booked as expenses—though any savings will be offset by any tax benefits from depreciation.
Businesses that require expensive machinery, such as construction, manufacturing, plant hire, printing, road freight, transport, and engineering, may use hire purchase agreements, as could startups that have little collateral to establish lines of credit.
A hire purchase agreement can flatter a company's return on capital employed (ROCE) and return on assets (ROA). This is because the company doesn't need to use as much debt to pay for assets.
Hire purchase agreements usually prove to be more expensive in the long run than making a full payment on an asset purchase. That's because they can have much higher interest costs. For businesses, they can also mean more administrative complexity.
In addition, hire purchase and installment systems may tempt individuals and companies to buy goods that are beyond their means. They may also end up paying a very high interest rate, which does not have to be explicitly stated.
Rent-to-own arrangements are also exempt from the Truth in Lending Act because they are seen as rental agreements instead of an extension of credit.
Hire purchase buyers can return the goods, rendering the original agreement void as long as they have made the required minimum payments. However, purchasers suffer a huge loss on returned or repossessed goods, because they lose the amount they have paid towards the purchase up to that point.
Regardless of the parties involved, several key factors generally find their way into all hire purchase agreement contracts. To be legally enforceable, these contracts must include:
Contracts should specify that they are hire purchase agreements and indicate the withdrawal period. For instance, the seller can allow the buyer to vacate the agreement within 15 days of receiving the contract.
Some of the key disadvantages of hire purchase agreements include the overall higher cost of the product and the fact that ownership is not transferred until all payments are made. These agreements can also be very complex arrangements with a lot of paperwork, which can cause people to spend beyond their means. There is also the potential for loss if the goods are returned.
There are two types of hire purchase agreements. Consumer hire purchase agreements are designed for individual consumers purchasing personal products. Industrial hire purchase agreements are for businesses, such as a company purchasing machinery.
The parties to a hire purchase agreement are the hire purchaser (the buyer) and the hire vendor (the seller). There can also be a financier involved in the agreement.
Hire purchase agreements are used to pay for very expensive consumer goods so that the buyer doesn't have to outlay a large amount of cash in one go. Though hire purchase agreements do include payment installments plus interest, they are not considered an extension of credit. They can be a manageable way for buyers to purchase expensive goods but the goods end up costing more because of the interest.
