Hire purchase is a type of contract of purchase in which the seller/financier rents the asset for an agreed period of time in return for a set of monthly installments. The buyer obtains ownership only when the full amount of the contract has been paid to the financier/seller of goods. So, the buyer doesn’t own the asset until the last installment.
The term loan is a financial assistance provided by banks and special institutions for lending money. In case the buyer needs the ownership of the asset as and when he purchases, then he can opt for “Term Loan Financing”. After assessing his net worth and financial position, the banks or special institutions provide the required amount to the borrower, restricted to his financial credentials.
In return, the provider asks for interest at a certain rate upon the principal, which the borrower has to pay together with the principal amount in installments. For purchasing an asset, or for any sort of expansion, the term loan is an easy option to arrange finance in a short span of time.
Hire Purchase vs. Term Loan
In Easier Terms: Should I Hire or Should I buy?
In hire purchase, the seller/financier owns the asset until the buyer makes the final payment and hence the word “Hire” is used. Whereas in the term loan, the buyer borrows money, pays for the asset, and own it immediately. So, in the case of hire purchase, one cannot sell the asset if he runs into problems making periodic payments but in the term loan, it can be sold.
Cost of the Asset
The cost of the asset in case of the term loan is the cost at which the buyer purchases + installation cost if any, whereas, in the case of hire purchase, the cost to the buyer is normal cash price + HP Interest. The interest cost is incurred in case of term loan also but that forms part of finance cost of the company and is not capitalized with the asset.
Repossession of the Hired Asset
It may happen that the buyer is unable to pay all the payments required under the agreement. Once the buyer stops making the installments, the seller/financier has the right to take away the asset. This is called Repossession. In term loan, the borrower can only take away the assets which are provided as security against the loan. Normally, the purchased asset is the primary security of the term loan along with the collateral security. So, the bank or financial institution can take away the underlying asset as well as the collaterals.
Mortgage of Assets in the Form of Security
No security, in any form, is required for taking an asset on hire. Whereas the borrowers need to pledge his assets as security in case of the term loan.
In hire purchase, the value of the asset is not included in the financial statements since the owner is the financier company till the buyer pays the last hire charges installment. Whereas in the case of a loan, the value of asset appear on the asset side and a corresponding liability for loans against such asset appear on the liability side.
Effect of Taxation
In both the cases, i.e. when the asset is purchased by loan, or if it is taken on hire, the user of the asset can take deduction on the depreciation of the asset (which decrease every year due to written down value effect) and also for interest on term loan or hire purchase installments. The only difference being in the quantitative amount of interest.
Since there is no purchase of an asset in hire purchase, the cash flow is limited up to the hire purchase installments. Whereas in a case of the term loan, the cash flow includes down-payment, loan received, purchase of asset and installment paid at the required time.
The risk of Holding the Asset: In the case of hire purchase, there is an option called “The Half-Rule” which states that the user can return the asset and terminate the agreement at any time giving the seller/ financier a notice in writing. Whereas in the case of loan financing, the user of the asset has to bear all the risk of asset devaluation due to change in technology.
With a term loan, one can use the lump sum borrowed to pay for the asset and take immediate possession whereas if one takes assets on hire, a deposit is paid to take possession and the remainder of the purchase price is repaid by fixed installments over a fixed period. Legal ownership is obtained only after payment of final installment.