Hire Purchase

Hire purchase is a type of instalment credit the essence of which consists in the consumer
agreeing to hire the asset / goods at a stated periodical rental wit h an option to purchase.
Hire Purchase Agreement Meaning

Hire Purchase is a kind of agreement where the buyer buying an expensive asset chooses an
option to pay for the asset by paying some down payment at the time of purchase of an asset
and clearing the remaining dues in regular instalments including interest.

Hiree (purchaser/lessee)

Initial payment/Part Payment Periodical instalments (hire charges

and principal)
 Example – Let’s say Mr. Gopal, desire to buy a car priced INR 10,00,000/-
1. He make Down Payment INR 2,50,000/-
2. Equal Monthly Installment payment of balance + interest for 24-36 months
3. Ownership of the goods transferred to Mr. Gopal (post all
EMI’s are paid off)
 Status of Hire Purchase in India

1. The Hire Purchase Act was passed in 1972, which is controlling the hire purchase transactions.
2. The hire purchase finance companies come under non banking finance companies (NBFCs).
3. These hire purchase finance companies are subject to the regulations of Reserve Bank of India
Act (Section 45[i]).

In 1998, certain restrictions were imposed by RBI on the acceptance of deposits by non banking
finance companies involved in hire purchase finance.
To overcome the above handicap, many automobile companies such as Maruti Udyog Limited,
Tatas and Ashok Leyland Finance have themselves promoted their own hire purchase finance
companies.
 Types of Hire Purchase Agreement

1. Under the first type, the third entity (lender) purchases goods on behalf of the customer and
gets into this agreement with the customer. Under this agreement, the customer becomes
the owner on payment of the final instalment. The lender owns the ownership of goods,
pays the purchase price to the seller and get it recovered from the customer. Here, a lender
may seize goods in case of non-payment.

2. Under the second type of agreement purchaser, himself enters into this agreement with the
seller and pays to the seller, becomes the owner of goods on payment of the last instalment.
Here, a seller may seize goods in case of non-payment.
Important Points in Hire Purchase –

1. Purchaser pays a rental (the charge for hiring) for an agreed period of time.
2. If the purchaser makes default in payment, the seller has the right to recover/seize assets
from the purchaser.
3. Frequency of instalment may be yearly/quarterly/monthly etc.
4. Goods possession gets transferred initially but ownership of goods remains with the seller
until the payment of the final instalment.
5. Usually, the purchaser pays a certain percentage of cash price as a down payment.
6. Since property in goods vests with a seller, he can claim depreciation on sold goods for income
tax benefit purposes.
7. Similarly, the purchaser can claim income tax benefit on hire charges (Hire purchase price
minus Cash price).

Hire purchase price (HPP): Price at which goods can be purchased under this agreement. (Cash
Price + Hire Charge i.e. documentation expenses, interest for repayment term etc)

Cash Price: Current market price at which goods can be purchased.

Advantages –

1. Assets can be bought into use without paying for the full amount.

2. A convenient method for procuring assets in case an entity is facing a cash shortage or does
not want to spend a huge amount at once.

3. Since the amount of expenditure is well known in advance, it makes easier for the entity to
make budgeting decisions.

4.It can be said as a convenient way of financing an asset purchase.

Disadvantages –

1. Since it creates a fixed amount payment burden on the purchaser, he may find difficulty in
payment during a cash crunch position which may also lead to loss of the asset and damage
your credit rating.

2. The cost of purchasing an asset will always be higher than purchasing on the cash price.

3. Legal ownership vests with the seller which may seize the same in case of non-payment of
hire purchase instalments.

4. If the purchased asset gets stolen/ destroyed before it is fully paid for, the insurance may not
cover the replacement value which may lead you to face a shortfall (in recovery).
 Calculation Examples of Hire Purchase

Anmol Ltd. (buyer) purchased a machine on hire purchase from ABB Ltd. (seller),

On January 1, 2020, paying down payment of INR 80,000/- immediately and agreeing to balance
pay three annual instalments of INR 80,000/- each on December 31, every year.

The cash price of the machine is INR 2,98,000/- and ABB Ltd. (Seller) charge interest @ 5% per
annum.

Calculate the following:

1. Hire Purchase price
2. Total Interest Paid
3. The breakup of Principal and Interest paid by the buyer to the seller every year.
Solution -
Particulars Value
Cash Down Payment 80,000
Balance in Equal Yearly Instalments 80,000
Total No. of Instalments 3
 The breakup of Principal and Interest paid

Closing
  Opening Balance Principle Interest @ 5% pa
Balance
0 298000 80000 0 218000
1 218000 69100 10900 148900
2 148900 72555 7445 76345
3 76345 76345 3655 0

    INR 298000 INR 22000  

There fore
Cash Price = INR 2,98,000/-
Hire Purchase Price = INR 3,20,000/- (Cash Price INR 2,98,000 + Total Interest INR 22,000)
Total Interest Paid = INR 22,000/-
Examples - 2

A Machine cost Rs. 500000 /-

Ms. Sule considering to purchase the machine on Hire Purchase basis.
She is willing to make down payment of Rs. 200,000/- and 3 equal yearly instalments of Rs.
100,000/- each
If she is charged interest rate of 5% per annum.

Calculate

Hire Purchase price

Total Interest Paid
The breakup of Principal and Interest paid by the buyer to the seller every year.
   Opening Balance Instalment Interest @ 5% pa Closing
Balance
0 500000 200000 0 300000
1 300000 100000 15000 200000

2 200000 100000 10000 100000

3 100000 100000 5000 0

    Rs. 5,00,000 Rs. 30,000  
There fore
Cash Price = INR 5,00,000/-
Hire Purchase Price = INR 5,30,000/- (Cash Price INR 5,00,000 + Total Interest INR 30,000)
Total Interest Paid = INR 30,000/-