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What is Hire Purchase?

Posted 04 September 2015

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Are you thinking of taking out a hire purchase agreement? Before you do, read our pros and cons, so that you’re in-the-know about this type of borrowing.

Hire purchase (HP) is a term that’s used a lot, but not everybody knows exactly what it means and how it works. In a nutshell, it means that a person has the use of something, like a car or a sofa, while they are still paying for it in pre-arranged instalments. You hire whatever it is you need, with the option of buying it at the end of the term.

As you can imagine, it’s sometimes impossible to be able to afford something that you need all in one go, especially if it’s something large like a new washer, or three-piece suite. So hire purchase can really come in handy if you find yourself in this situation.

How it works

Probably the most common hire purchase contract you’ll come across is when you’re buying a car, as most people cannot afford to pay for the whole thing upfront, so let’s use that as an example. If you were to buy a car on hire purchase, you would normally be expected to put a deposit down first of 10% of the cars value. You would then need to pay the rest over instalments; how much and for how long obviously depends on the value of the car, the lender and what you can afford. When you make the last payment then the car belongs to you.

It’s secured lending

Hire purchasing is secured lending, just like your mortgage is secured against your home. Meaning that should you stop making the payments, the car could be repossessed, meaning the Hire Purchase company will take it back. Because of this you are taking a risk, especially if you absolutely need a car to run your everyday life.

As with all borrowing, it’s absolutely vital that you take the time to understand how much you need to pay and for how long, so read the contract carefully.

Balloon Payments

There is a second kind of hire purchase called Balloon Hire Purchase. This involves you paying smaller monthly amounts, leaving a large chunk at the end that you’ll be expected to pay in one go – that’s the balloon part. So you’ll pay a deposit and monthly instalments the same as you would with a regular hire purchase agreement, but you’ll pay less per month than a normal hire purchase agreement, making up the shortfall with the balloon payment at the end. Make sure you check which of these two your agreement is. You do not want to be caught out by having to pay a lump sum at the end of the term that you’ll struggle to afford. 

The Upsides

This type of borrowing can really work for you, depending on your situation, of course. As we’ve said, it gives you more time to pay for the car, and the repayment term is flexible, to a certain degree, normally lasting from one to five years. There’s also the added benefit of fixed interest rates, so you know what to expect to pay every month ( of course the longer the repayment term, the more interest you will pay).

The Downsides

The major downside is that you don’t really own the car, until you’ve paid that last instalment. So, you’d have to be 100% sure that you could afford the instalments over a long period of time before committing to anything – you don’t want to run the risk of losing your transport. If there’s any doubt about being able to do this, see whether it would be possible for you  save up for a cheaper car instead.

Also, until you’ve paid for a third of the car, the lender can repossess the vehicle without a court order.

You need to consider that in reality, you will be paying more for the vehicle than it is actually worth, due to the interest payments over the term of the agreement. Take some time to figure out how much more you’re going to be paying, and if you’re prepared and able to do it, before you sign anything.

So there you have it – hire purchase in a nutshell. As with any type of borrowing, it has its upsides and downsides. The most important things to know before you sign are how much it will cost you overall, as well as what you’ll be paying each month, so that you know you can easily afford it. 

by Christine Walsh

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