Difference Between Leasing vs Hire Purchase - What’s The Difference?
When deciding between leasing an asset or considering a hire purchase (HP) as a means of obtaining the item, what do you need to know? What are the main differences between leasing and hire purchase?
The main distinction between leasing vs hire purchase agreements is that at the end of HP contracts, the customer is the legal owner of the asset. On the other hand, at the end of a lease agreement, the ownership of the asset remains with the lessor (also known as the “funder”).
Both a lease agreement and a hire purchase agreement involve the customer paying the funder a set, committed fee periodically.
For smaller value ticket items – such as cars or computers – this fee will be charged monthly, but bigger items might be quarterly timed payments or longer. For both HP and leases, the agreement lasts for a fixed duration which is agreed at the outset. For business lease agreements, the duration can be many years, with a caveat often added that the supplier will have to upgrade or replace the leased asset to keep it in line with being of a comparable standard or quality as when the agreement was formed.
This similar-quality agreement means, in real terms, if you leased multiple smartphones for your workforce and had a condition that you would always have the latest-but-one model, your provider would issue an upgrade when the timing was right, but you’d continue to be responsible for the lease payments until the end of the lease agreement.
Practical Ownership Rights
Another similar feature is that in leasing, the asset does not belong to the lessee (the user) when making the monthly payments to the funder (the lessor) or even at the end of the lease term; you do have sole use of the asset and – barring selling the asset – you can within the agreed period treat it as though it’s your own or as if it is on hire purchase.
On the other hand, under a hire purchase agreement, you would make timely payments like those you’d make for a lease, but at the end of the agreed schedule, you would then have the option to purchase and own the asset. The payments would include interest towards financing the use of the asset, different from the price of the asset itself. Think of hire purchase like “rent-to-own” and leasing is simply borrowing the asset for a specified period of time in which you pay the lessor the depreciation value of the asset.
You are effectively the acting owner in practice in either case, but the actual owner of the asset – the funder – can repossess the items should your payments fall into arrears.
Since HPs and leasing are both lucrative industries for the vendors, there are plenty of finance and lease options available for consumers. Many people choose to lease or hire purchase to protect capital and they understand just what their payments will be each month in the full knowledge that the vendor makes a profit from the agreement and the user enjoys more flexibility. Whether you go with leasing or hire purchase, you will invariably be able to find a deal that’s right for your business.
Purchase Options & VAT Payment
The key difference between a lease agreement and a hire purchase finance agreement is that at the end of a lease, you return the asset and at the end of an HP, you have the option to purchase and keep the asset if you so choose.
Sometimes, at the end of a hire purchase, you can refinance your agreement (extending the deal and payment terms) if you have an outstanding balance to pay, or you can pay said balance in a lump sum which is known as a “balloon payment.” However, in each HP agreement, there will be some sort of agreed-upon balloon payment at the end of the terms and the full VAT payable on the “hire” of the asset must be paid over on day one – an important cash flow consideration particularly when a company is VAT exempt.
With a lease agreement, on the other hand, once the lease terms have been paid, the lessee may return the asset to the lessor, the owner of the asset. If the lessee and lessor do not agree to an extension of the lease agreement, then the lessor has to find a buyer for the depreciated asset or negotiate with another willing lessee to take it off their hands. Most lessees know, however, that they will pay more for the asset over time, so depreciation is also taken into account.
Depreciation In Value Consequences
That depreciation of the asset is also a difference worth noting: on leased items, because the lessee is not the legal owner of the asset, the depreciation stays off their financial records and remains on those of the owner. But a hire purchase agreement is the opposite because once completed, it will leave the asset under ownership of the user of the asset. With IFRS 16 updates looming, the types of agreements you have will need to be considered and weighed accordingly.
Servicing and warranty items are entirely the purchaser’s domain under an HP agreement unless the seller includes them as a means of winning the contract. Under a lease agreement, however, the lessor (provider of the agreement) may be, though is not always, responsible for keeping the asset in a fully maintained state.
Of course, the lessee (user) has to keep up their end of the bargain and cannot misuse the leased assets, assuming the lessor will demand payment for any repairs. Often a clause of acceptable use is placed in the leasing contract and anything outside of those terms will be the lessee’s responsibility.
Which Is Preferable? Leasing Over Hire Purchase Agreements
The preference for leasing over hire purchase can be summed up in a single word: flexibility.
Leasing offers businesses the ultimate flexibility to be able to pick and choose their assets more readily with the budget at their disposal. Essentially, leasing allows you to have use of the asset all the while it is forecast to be useful, to pay for the asset as the benefits of its usage are realised and to plan for its return and replacement without due concern over disposal issues – or the asset outlasting its usefulness.
Barring unforeseen damage and misuse, the costs incurred for use of the leased asset will be known for the full duration of the agreement, allowing your finance department to budget accordingly.
The supplier of the leased asset will be able to address maintenance and warranty issues, as long as the user utilises the asset under no more than appropriate wear and tear. The disposal of the asset at the end of its usable life will be the responsibility of the funder (the lessor).
Also, historically and until the upcoming lease accounting changes come into effect, there have been many financial reporting and accounting benefits to using lease agreements as a means of acquiring assets. For example, operating leases have traditionally been able to be kept off company balance sheets.
Even though this rule is being changed, there are plenty of other financial benefits for your business to take advantage of once the IFRS 16 lease accounting changes come into effect.
Overall, being able to use an asset for part or all of its usable lifespan for a specified period of time often works in a company’s favour. On the other hand, HP agreements may mean you’d own an asset you may not be able to use once your agreement has ended. Leasing is often an intelligent business strategy, especially for those businesses that need rare speciality equipment or those who need the most current available technology.
Want To Find Out More?
Take a look in further depth at the pros and cons of leasing for your business in our free guide. Find out all about leases and the basic principles, the difference between operating and finance leases, how to document and report leases, an analysis of the leasing process, advice and guidance from start to finish of the process, IFRS new accounting standards and its effects, and the pros and cons. Download your free copy today.