A Guide to Advantages and Disadvantages of Hire Purchase!
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It is not possible for every individual to purchase a house or any such costly asset by making 100% payment at a time. The major reason is, they do not have ready and sufficient cash available with them to purchase such an asset. In such case availing a loan either from any financial institution or from a friend is one of the options. Hire purchase method is one such way which is helpful for the individual who wants to acquire an asset. It is a method of purchase in which the buyer of the asset acquires the asset for the desired purpose and payment towards the purchase is done in installments. Ownership of the Asset is transferred to the buyer only after the completion of all installments or after the decided payment is squared off.
What is Hire Purchase?
Hire Purchase is one of the most popular methods for acquiring any asset. Here the owner or the seller lets the asset on hire to the individual but the regular installments are to be paid by the hirer. Though the possession is passed to the buyer, the ownership is not transferred in the beginning. The ownership is transferred only after all the payment is cleared. Thus, it provides flexibility and makes a lot of capital available to the buyer which can be used for other purpose. This periodic payment includes an interest component. In some countries it is also known as an installment plan. This plan is generally implemented when a buyer is unable to pay the asked price in one stoke.
There are a few considerations one must keep in mind while opting for hire purchase. The same are as follows:
Cost Consideration for Hire Purchase
01. Fees Charged for Hire Purchase:
The seller or his financier may charge you some fees such as loan processing fees, administrative charges etc. It is always better to get an idea regarding the same well in advance. The total amount which includes fees and other charges should not exceed your estimated budget.
02. Interest Charged for Hire Purchase:
You must be aware of the current rate of interest. Understand this; there are higher interest rates for assets having a higher resale value such as machinery, agricultural equipment, vehicles etc.
Whereas the rate of interest is less on the assets which have low resale value such as office furniture, printers, vending machines, etc. Please make sure whether the interest rate is affordable to you or no. In case the rate of interest is at the higher end, think and analyze whether your need for acquiring that particular asset is so urgent and important that you would not mind paying higher rate and most importantly, you will be able to make the repayments timely or no.
Along with the considerations mentioned above, it is also necessary to be aware of the advantages and disadvantages of hire purchase system to understand the concept thoroughly and in a better way. Comprehend each point diligently if you want to go for a hire purchase scheme.
Let us have a glance at it.
Advantages of Hire Purchase
The various advantages of hire purchase are listed below:
01. Ease of Payment:
As the payment has to be made in installments; it automatically turns out to be a boon for the buyer, as it does not upset his routine living nor his current cash flow. This is the biggest advantage for the people having a limited income.
02. Boon for Small Traders:
This type of system is a blessing for the small traders and manufacturers. Business that require heavy expensive machinery like construction, manufacturing, printing, transport and engineering can use hire purchase as startups. The machinery and heavy equipment can be purchased on installment basis. The installments of the same can be paid out of the income they earn from it.
03. More Earnings through Interest:
The seller receives the installment which includes the original price and the interest charged on it.
- The interest which is charged on the installment is calculated in advance and added to the principal amount which is to be paid by the buyer.
04. Increase in the Sales Volume:
As the payments are made in easy installment, this system attracts more customers which lead to increase in the sales volume.
05. Increase in the Profits:
As there is increase in the volume of sales; this will eventually lead to increase in the profits.
06. Financial Benefits:
As the installments are paid in smaller amounts, the expenditure is known beforehand so the surplus cash can be used by the buyer for other investments.
07. Immediate Use of Asset:
The asset is available for immediate use without paying the full amount or even while you are paying the amount in installments. Hence you start using and enjoying the asset from day one by paying marginally.
After all the payment has been made, the ownership is transferred to the hiree. But before that, an option is available to him whether he wants to buy the Asset or no.
09. Less Risk to the Seller:
It is beneficial for the seller too as he has the right to take back the property if the hiree fails to pay the installment.
10. Fixed Rate of Interest:
The interest rate for hire purchase is fixed for the duration for the repayment term. This works out better than a bank loan. Hence, for every installment, you can set a fixed amount that works perfectly for you as well as your budget.
This was all about advantages of hire purchase. If you want to know the tax benefits associated with home loan, click on the link given here: What are the tax benefits for Home loans?
Disadvantages of Hire Purchase
If there are advantages associated with hire purchase, on the flip side, there are some disadvantages too. Let us understand them:
01. Higher Interest Rate and Cost:
The buyer has to pay higher amount of interest along with the principal amount while he is making the repayment through installments. Thus, he will end up paying the amount more than the actual one of the Asset or Property. Hence, hire purchase agreements tend to be more expensive in the long run.
02. Longer Payment Duration:
The payments are usually extended over a longer period which will be tiresome and frustrating, keeping you under stress. Hence, if the duration is for something like car, it makes sense, but for other purchases, you really need to think whether there is any benefit in such long duration or not.
03. Artificial Demand:
This system creates an artificial demand for the product. Even though the buyer cannot afford or may not need to buy the product, he is tempted to do so.
04. Higher Risk for Hiree:
For the seller it is a risk under such a system. Though he has the right to take that the Asset or Property from the hiree, the second-hand goods fetches lesser price than the actual cost. Again, if repossessed, it may come with defects needing repairs.
For hiree, there is a risk of loss or usage of the Asset if the buyer fails to pay the installment.
05. Effect on Credit Score:
The hire purchase agreement is generally reported to major credit reporting bureaus. Even if the buyer fails to make a single payment, this will be reported.
This can affect the credit score of the buyer and his ability to buy another thing on hire purchase in the coming days. If you want to know in detail about credit score, for your convenience, here’s a link you need to open: What is a Credit Score & Its Importance for Loans?
06. Ownership at the End for Buyers:
Even after a fair amount of payment is done; the asset is still not his property till full payment with interest is made. Therefore, the vendor has right to seize the asset in case the buyer fails to pay the installment.
07. Fewer Discount Available on Hire Purchase:
In comparison to leasing or an outright purchase, the buyers who pursue higher purchase agreement have fewer discount benefits, as he is dependent on the seller or his financier. He is not in a position to dictate terms or bargain price with the seller, unless the seller is making a distress sale.
In case of outright purchase, there is more possibility of higher discounts as there are no risks to the vendor.
In spite of all the above disadvantages, the hire purchase system creates a Win-Win situation for all the parties involved. Buyers have an opportunity to use it from day one though he can own it at the end. And the sellers have a benefit to sell items retaining the ownership with them to reduce the risk, even though the delivery is made and possession is passed.
Hope this article has provided you with know-how about the hire purchase system. If you have your views on the same and would like to share with us, please feel free to write us in the comment box below.
And just before you leave, before you take a leave from us, if you have gone through our article with the advantages and disadvantages of hire purchase and you want to know in detail about hire purchase, refer the link mentioned here: