If you’re considering entering into a hire purchase arrangement, there are some things you need to consider first.
It’s a secured loan
The asset you are initially hiring, then intending to purchase, is used as security for the loan. This means that the lender can repossess the asset should you fail to maintain repayments, and thus prevent you from using it any longer.
Your credit rating could be affected
If you miss any repayments on a hire purchase arrangement, you should expect this to appear on your credit report. The missed payments will reduce your credit score, which may affect your ability to obtain credit in the future.
The asset could depreciate
Although your business has to use the asset during the repayment term, the lender is the legal owner at this stage. You only become the owner once all repayments have been made. By this stage, there is a risk that the asset’s value could have been reduced, or even that the asset become obsolete in the face of technological advances. These risks are heightened by the fact that hire purchase repayment terms can be quite long, perhaps up to five or six years.
Total repayments can be significant
Especially if the term is five or six years long, you can end up paying a significant sum in repayments. These might, in some cases, add up to much more than the value of the asset, so it really can be an expensive way of purchasing an asset.
How does hire purchase work?
This type of arrangement involves you buying a business asset and then paying the purchase price in installments over a set period of time. This might, for example, be a common way of purchasing a company vehicle, although it can also be used to purchase other business assets, such as IT equipment or machinery. You would become the legal owner of the asset at the end of the term, upon making the final repayment. However, although you won’t own the asset during the repayment term, you should still expect to be responsible for the insurance and maintenance of the asset during this period.
The lender will usually ask for some of the purchase price, perhaps 10%, to be paid upfront as a deposit. Sometimes, a larger lump sum is required as the final payment, which is known as a balloon payment.
The repayment term, in this case, could be anything from one to six years. The longer the term, the more you can spread the cost, and the lower your monthly repayments are likely to be.
When might you use hire purchase?
Hire purchase might be your best option if you want to acquire an asset, but don’t have the means to purchase it in one lump sum, and also intend to use that asset over an extended period of time.
Some of the advantages of hire purchase include:
- As you won’t need to make a large upfront payment to purchase the asset, there will be less of an impact on your cash flow
- It can give you access to high-quality, high-specification assets that you might not be able to afford were you forced to pay the purchase price in one go. Being able to use the very best equipment can then give you a competitive advantage
- Interest rates are often lower than for an overdraft or a traditional business loan from a bank
- With hire purchase, you can claim tax relief, subtracting the value of the asset from your net profit figure before any tax is due
- The interest rate is likely to be a fixed rate, meaning your payments won’t change at any time during the repayment term, allowing you to budget for these monthly repayments without the worry that they will suddenly increase
For your hire purchase needs, get in touch with Funding Bay.
Check out our Asset Finance Calculator.
