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Hire Purchase for Business | What You Should Know
When it comes to asset finance, hire purchase for businesses is one of the most established loan arrangements to exist, yet there’s still so much confusion regarding what it is and how it works.
In this guide, we get into the nitty gritty of hire purchase agreements for businesses and see how it stacks up against some other forms of asset finance - such as an operating lease or finance lease.
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Table of Contents
What is Hire Purchase?
How It Works
Case Studies
Understanding the Deposit
The Size of Repayments
Balloon Hire Purchase Agreements
Hire Purchase and Accounting
Hire Purchase and Second-Hand Assets
Hire Purchase vs. Finance and Operating Lease
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What is Hire Purchase?
Hire purchase (HP) is one of the three main types of asset finance, a selection of financial products designed to allow businesses to afford assets that they do not have the free capital to invest in.
Asset finance provides companies an option to spread the cost of assets over time, with the three main options (hire purchase, finance lease, and operating lease) a slightly different way of achieving that aim.
Of the three, hire purchase is most suited to companies that are looking to own the asset in the long term, rather than simply lease or rent the asset. The term ‘hire purchase’ comes from a combination of the idea to both ‘hire’ the asset, and ‘purchase’ it.
How Hire Purchase Works - The Basics
The core of hire purchase is that you pay for the asset over time. It is a form of asset-based finance, where the asset serves as collateral against the agreement and, if you fail to make a repayment, it can be taken back or repossessed by the finance company.
Hire purchase consists of a large upfront payment, often called the deposit, then regular monthly payments over an agreed term until the entire payment for the asset is completed. Once these payments are completed, the asset belongs entirely to the company.
Often asset finance such as hire purchase is used to buy a vehicle, such as a company van or car. In this instance, the company would pay a deposit upon receipt of the car, followed by regular monthly repayments until the entire value of the car has been repaid.
While there are payments outstanding in a hire purchase agreement, the asset is considered owned by the finance company (known as the lessor); however, there are typically few restrictions on its use and the purchasing company (known as the lessee) can use the asset as they see fit, which includes making modifications or taking it out of the country.
Hire Purchase Case Studies
Read some of our most recent asset finance case studies below for real examples of how asset financing works in practice:
Understanding the Hire Purchase Deposit
One of the biggest downsides to hire purchase when considered against other forms of asset finance, such as finance lease or operating lease, is the size of the initial payment, or deposit.
The size of this initial deposit is often as much as 30% of the cost of the asset, which can seem high. However, this is because it is important for the lessor to charge the appropriate VAT for the asset, as well as insuring a significant initial payment to mitigate risk.
Thus, two thirds of the initial deposit (20% of the total asset value) represents VAT, with one third (10%) the actual payment towards the asset.
It is thus, rare to secure a hire purchase agreement with a smaller deposit value.
Related: VAT loans →
The Size of Hire Purchase Repayments
Unlike other forms of asset finance, where the asset is returned to the lessor at the end of the contract term, a hire purchase agreement is one where the ownership of the asset is given to the lessee once payments are completed. Thus, the sum payable is equal to the full value of the asset.
Of course, 0% hire purchase agreements are extremely rare, and in a real example, the repayments would be higher to represent the current interest terms.
In this way, hire purchase has a higher monthly cost to a business than finance lease and some operating lease contracts, however, with the asset becoming the property of the business at the end of the contract, no further payments are needed to continue its use, or it can be sold to furnish the business with additional capital.
Balloon Hire Purchase Agreements
One subset of hire purchase is that of agreements with a final balloon payment. These are relatively rare but can be arranged if required. In this example, rather than spreading the cost of the asset equally over the monthly repayments, an agreement is undertaken that the final payment is larger to lower the size of all other repayments.
Using the former example, but with an agreed final balloon payment of £10,000, the payments would be as follows:
|
Payment |
Size |
|
Deposit |
£6,000 |
|
34 Monthly Repayments of… |
£1,000 |
|
Final Balloon Payment |
£10,000 |
|
TOTAL PAID |
£50,000 |
Using a balloon payment does help with business cashflow during the months of the hire purchase contract, but can cause stress as the final balloon payment comes closer. In these cases, often the business chooses to sell on the asset at the end of the term to make the final payment and potentially some additional return.
Hire Purchase and Accounting
While legally, the asset remains owned by the finance company until the full agreement is paid, from an accounting perspective, an asset obtained through hire purchase is treated as if it has been purchased. It is added to the balance sheet and depreciated is applied annually as would be usual. Repayments are then shown as an expense in the profit and loss account.
It is important to work with your accountant to ensure your HP asset is properly considered in your accounting.
Hire Purchase and Second-Hand Assets
One advantage of hire purchase when compared to other asset finance is its use to obtain used, or second-hand, assets.
Typically, both finance leasing and operating leases are focussed on brand new machinery and equipment, meaning businesses looking to save by utilising previously-owned assets can find it both difficult and more expensive to obtain assets.
Hire purchase does not suffer from this limitation and is excellent for acquiring used assets, often making it more cost-effective and less of a strain on monthly finances than other asset finance.
Hire Purchase vs. Finance and Operating Lease
The advantages and disadvantages of hire purchase when compared to finance and operating leases include:
- Hire purchase provides full eventual ownership of the asset.
- Hire purchase can be used for second-hand assets.
- Few to no restrictions on asset use.
- Usually no large balloon payment at the end of contract.
- Fewer and smaller fees.
- Excellent for long term use and ownership of the asset.
- Large deposit means a greater drain on company capital at the outset.
- Larger monthly repayments on like-for-like comparison with finance leasing.
- Greater ownership responsibilities, such as maintenance.
- Less flexibility for upgrading to newer assets.
When deciding between hire purchase and other forms of asset finance, it is worth speaking to an expert to get a full overview of the finer differences between them.
Apply for Hire Purchase with Clifton Private Finance
At Clifton Private Finance, we have a team of specialists in asset finance who are here to help you. We can talk you through your hire purchase options as well as find the best HP deals for the assets your require. Contact us today to find out more.
