Hire Purchase refers to an agreement between a buyer and seller for purchasing expensive consumer goods, whereby the buyer takes the custody of goods (without the transfer of ownership) by paying an initial down payment and the rest of the payment is paid in installments over a period of time. A fixed percentage of interest is charged on the balance amount which has to be paid along with the installments. Under such agreements, the ownership of goods is transferred to the buyer only after he pays the final installment.
Example of Hire Purchase
Mr. Verma wants to purchase new machinery for his factory. The cost of Machinery is $75,000. Mr.Verma doesn’t have $75,000 in his hand. Therefore, he entered into an agreement with the vendor that initially he will pay $15,000, and the balance of $60,000 will be paid by him in five equal monthly installments of $12,000 along with the interest @10% p.a. that will be charged monthly on the outstanding balance. The terms & conditions also include that the ownership of the asset will be transferred only after the payment of the last installment and in case of failure in the payment of installments by Mr.Verma, the machinery will be taken back by the vendor.
Features of Hire Purchase
- The buyer gets possession of the goods immediately after making the initial down payment.
- In case of any non-payment of an installment by the buyer, the seller has the right to repossess the goods.
- The hire purchase installment amount includes the principal amount as well as the interest charged upon the balance amount.
- Interest is generally charged at a flat rate.
- Hire purchase agreements usually prove to be more expensive in the long run than purchasing an item outrightly.
Types of Hire Purchase
There are two types of Hire Purchase, Consumer Hire Purchase and Industrial Hire Purchase.
Consumer Hire Purchase
In this type, the goods are hired by the buyer for non-business purposes i.e. for his personal use. The buyer does not intend to use the hired goods for business purposes. Such agreements are not made by any business institutions or companies. People generally enter such contracts with their friends or acquaintances
Mr. Sen. and Mr. Gupta are friends, Mr. Gupta is planning to sell his car for $50,000, Mr. Sen wishes to purchase the car for his personal use. However, he doesn’t have $50,000 in his hands, so, he entered into an agreement with Mr. Gupta that he will make the down payment of $5,000 initially and the balance of $45,000 will be paid in 5 equal installments of $9,000 each month with 10% interest charged on balance. In case, Mr.Gupta fails to pay any instalments then the car will be taken back by Mr. Sen. The ownership of the car will be transferred only after payment of the last installment.
Industrial Hire Purchase
Contrary to the above, under industrial hire purchase, business organisations/companies hire an asset from financial institutions for business purposes. The asset acquired under such agreements is used solely for business transactions.
ABC Ltd. needs industrial equipment costing $70,000. Due to a shortage of funds, it decides to enter into a hire purchase agreement with XYZ Ltd., whereby ABC acquires the equipment by paying $10,000 and agrees to pay the balance $60,000 in 6 equal installments of $10,000 each a month with an interest rate equalling 5% per annum.