# Hire Purchase Agreements: Definition, How They Work, Pros and Cons

## What Is a Hire Purchase Agreement?

The term "hire purchase" refers to a financial arrangement for buying expensive goods and services. With a hire purchase agreement, the buyer makes a 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.  

### Key Takeaways

*   Hire purchase is an agreement where the buyer makes a down payment and pays the balance plus interest in installments.
*   These types of agreements are generally used for very expensive goods.
*   Hire purchase agreements are not exactly the same as installment plans because with the latter, the buyer owns the product immediately.
*   Legal ownership transfers to the purchaser in a hire purchase agreement only once all payments are made.
*   Hire purchase agreements usually are more expensive in the long run than paying full price for an item outright.

![Hire Purchase Agreements](https://www.investopedia.com/thmb/Vp0Jdvugl3AQVH2OftNAwMv-NPw=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/hire-purchase_final-5f3732c4abcd4c59aa2e8950ad735510.jpg)

*— Investopedia / Katie Kerpel*

## How Hire Purchase Agreements Work

A hire purchase agreement is a type of credit agreement between a buyer and seller.

After an initial payment, the buyer continues to make installment payments until the total purchase price (and interest charges) is paid off. Once that occurs, the buyer becomes the legal owner of the product.

These agreements are similar to rent-to-own transactions (such as [rent-to-own cars](https://www.investopedia.com/articles/personal-finance/082315/renttoown-car-how-it-works.asp)) which give the [lessee](https://www.investopedia.com/terms/l/lessee.asp) the option to buy at any time during the agreement.

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 period of time.

Hire purchase plans protect a [vendor](https://www.investopedia.com/terms/v/vendor.asp) more than some other financing methods because items can be repossessed more easily should the buyer be unable to keep up with the repayments.

> **Fast Fact**
>
> While you are making your payments according to your hire purchase plan, it is against the law to sell or otherwise dispose of the item without the permission of the seller.

## Purchase Agreements vs. Installment Plans

As noted above, hire purchase agreements are used in the U.K. In the U.S., they are known as installment plans. Although they may seem the same, there are some distinctions between the two.

For instance, with installment plans, the buyer usually gets ownership rights as soon as they sign the contract with the seller.

With hire purchase agreements, the ownership of the merchandise is not officially transferred to the buyer until all the payments have been made.  

> **Important**
>
> Hire purchase agreements used for off-balance-sheet financing are 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.

## Advantages and Disadvantages of Hire Purchase Agreements

### Advantages

*   Hire purchase agreements allow companies with insufficient [working capital](https://www.investopedia.com/ask/answers/100915/can-working-capital-be-negative.asp) to obtain assets that they need.
*   They can 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 need to retain cash but require expensive machinery, e.g., for construction, manufacturing, or transport, might use hire purchase agreements. So might startups that have little collateral with which to establish lines of credit.
*   A hire purchase agreement can enhance a company's [return on capital employed (ROCE)](https://www.investopedia.com/terms/r/roce.asp) and [return on assets (ROA)](https://www.investopedia.com/terms/r/returnonassets.asp). That's because the company doesn't need to use as much debt to pay for assets.

### Disadvantages

*   Hire purchase agreements usually prove to be more expensive in the long run than paying the full cost for an asset at the outset. That's due to [interest costs](https://www.investopedia.com/terms/i/interest_cost.asp). For businesses, they can also mean more administrative complexity.
*   In addition, hire purchase agreements may tempt individuals and companies to buy goods that are way beyond their means.
*   They may also end up paying a very high interest rate (which did not have to be explicitly stated until 2022).
*   Hire purchase buyers can return the goods, rendering the original agreement void, as long as they have made the required minimum payments up to the time of return.
*   However, purchasers suffer a loss on returned or repossessed goods, because they lose the amount they have paid towards the purchase up to that point.

Pros

*   Allows for the purchase of high-value items
    
*   Prevents a large outlay of cash
    
*   Improves a company's ROA and ROCE
    
*   Payments are accounted for as expenses
    

Cons

*   Higher overall cost
    
*   Ownership does not transfer till all payments are made
    
*   Potential for loss of capital if the good is returned before the contract is up
    
*   Increased administrative complexity
    

## Hire Purchase Agreement Contracts

To be legally enforceable, these contracts must include:

*   The names and addresses of the buyer and seller
*   The date of the agreement
*   The item in question along with a description
*   The purchase price, the amount of each installment payment, and the final payment amount
*   The payment dates
*   The [annual percentage rate (APR)](https://www.investopedia.com/terms/a/apr.asp)
*   The fees and additional charges that may apply

Contracts should specify that they are hire purchase agreements and indicate the withdrawal (cooling off) period. For instance, the seller can allow the buyer to vacate the agreement within 15 days of receiving the contract.  

## What Are the Disadvantages of Hire Purchase Agreements?

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. Also, these agreements can be very complex. People may spend beyond their means and lose money if they return the goods.

## What Are the Types of Hire Purchase Agreements?

There are two types of hire purchase agreements. Consumer hire purchase agreements are designed for individual consumers. Industrial hire purchase agreements are used by businesses, such as when they purchase machinery.

## Who Are the Parties to a Hire Purchase Agreement?

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.

## The Bottom Line

Hire purchase agreements are used to pay for expensive consumer or business goods and services. They dispense with the need for large outlays of money for products one needs or wants.

They involve a downpayment and installment payments plus interest. So while they can be a useful way for buyers to purchase high-priced goods, those goods end up costing more that they would in an outright purchase.

> **Article Sources**
>
> 1.  GOV.UK. "[BLM00330 - Introduction: Lease Taxation: Hire Purchase Contracts](https://www.gov.uk/hmrc-internal-manuals/business-leasing-manual/blm00330)."
>     
> 2.  Citizens Advice. "[Hire Purchase and Conditional Sale](https://www.citizensadvice.org.uk/debt-and-money/borrowing-money/types-of-borrowing/hire-purchase-and-conditional-sale/)."
>     
> 3.  Financial Accounting Standards Board. "[Leases (Topic 842)](https://web.archive.org/web/20210611013046/https://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176167901010&acceptedDisclaimer=true)," Pages 2-4.
>     
> 4.  Citizens Information. "[Hire Purchase Agreements](https://www.citizensinformation.ie/en/money-and-tax/personal-finance/loans-and-credit/hire-purchase/#75c609)."