What is a rental purchase
Leasing is an arrangement for the purchase of expensive consumer goods, where the buyer makes an initial down payment and pays the balance plus interest on the payments. The term lease purchase is commonly used in the UK and is more commonly known as a US installment plan. However, there may be a difference between the two: with certain payment plans, the buyer obtains property rights as soon as the contract is signed with the seller. With hire purchase contracts, ownership of the goods is not officially transferred to the buyer until all payments have been made.
Key points to remember
- Rental purchase agreements are not considered a credit extension.
- In a hire purchase contract, ownership is not transferred to the buyer until all payments have been made.
- Rental purchase agreements are generally more expensive in the long run than buying an item outright.
Operation of rental purchase agreements
Lease purchase agreements are similar to lease with purchase option transactions which give the tenant the option to purchase at any time during the agreement, such as cars with hire option with purchase option. Like hire purchase, hire purchase can benefit consumers with poor credit by spreading the cost of expensive items they otherwise would not have been able to afford over a long period of time. It is not the same as a credit extension, because the buyer does not technically own the item until all payments are made.
Since ownership is not transferred until the end of the agreement, hire purchase plans offer the seller more protection than other sales or rental methods for unsecured items. Indeed, the articles can be taken back more easily if the buyer is not able to follow the refunds.
Benefits of Rental Purchase Agreements
Like leasing, hire purchase contracts allow companies with ineffective working capital to deploy assets. It can also be more tax efficient than standard loans because payments are expensed, although any savings are offset by the tax benefits of amortization.
Businesses that need expensive machinery – such as construction, manufacturing, plant rentals, printing, road freight, transportation, and engineering – can use hire-purchase contracts, as can startups that have few guarantees to establish lines of credit.
A hire purchase can flatter a company’s return on capital employed (ROCE) and return on investment (ROA). Indeed, the company does not need to use as much debt to pay for its assets.
The use of hire-purchase contracts as a type of off-balance sheet financing is strongly discouraged and does not comply with generally accepted accounting principles (GAAP).
Disadvantages of rental purchase agreements
Lease purchase agreements are generally more expensive in the long run than paying for an asset purchase in full. This is because they can have much higher interest charges. For businesses, they can also mean more administrative complexity.
In addition, hire purchase and installment systems can encourage individuals and businesses to purchase goods that are beyond their means. They may also end up paying a very high interest rate, which need not be explicitly stated.
Rental option agreements are also exempt from the Truth in Loans Act as they are considered rental agreements instead of a credit extension.
Rental buyers can return the goods, canceling the original agreement as long as they have made the minimum payments required. However, buyers suffer a huge loss on returned or returned products because they lose the amount they paid for the purchase up to that point.