What is hire purchase and how does it work?

Hire Purchase is a simple way to finance a new or used car, without having to pay for it upfront. By spreading the cost over a period of time, this popular type of finance can make car ownership more affordable.

What is hire purchase?

Hire purchase, also known as HP, is a finance agreement that allows you to purchase your car through fixed monthly instalments. Once you’ve made all the repayments, you become the legal owner. 

As the name suggests, you effectively hire the car while you purchase it.

Hire purchase terms can last anywhere from as little as one year up to five years. Split into two parts, at the start of the agreement, you can choose to pay an initial deposit. This is then followed by a period of monthly payments throughout the term length. 

When the agreement ends, you’ll have paid off the full value of the car plus interest and you become the legal owner. 

At that point, you can simply keep the car without having any more financial obligations, or you could part exchange it for a new one.

How does hire purchase work? 

A Hire Purchase agreement usually starts with an initial deposit, although, at Hippo Leasing, all our hire purchase deals come with a £0 deposit option. 

Once you’ve decided on the car you want, you can choose to put down a sum of money as a deposit. You can pay a small or larger deposit if you wish – generally, the options are a deposit worth three, six or nine months of monthly payments.

The deposit has a big effect on what comes next – your monthly repayments. If you put down a larger sum initially, you’ll have less to pay back over the term, so your repayments will be lower. 

Monthly repayments

Once the deposit has been paid, the remaining balance and interest on the loan are split into a series of fixed monthly instalments. 

Depending on which term length you choose, those repayments can be spread over a course of 12 to 60 months. 

The longer the term, the lower your monthly repayments will be. However, the amount of interest you’ll pay overall will be greater, as you’re borrowing the money for longer. 

The interest rate on hire purchase is always fixed, no matter what Bank of England rates do. So you’ll always know how much you need to pay every month and can budget accordingly. 

Your credit score is an important factor when it comes to calculating how much interest you’ll pay, though. 

Almost always, the better your credit score, the better your interest rate. That’s because a good credit score indicates less risk for the lender.

What happens at the end of a hire purchase agreement?

Once you’ve made all the repayments, the car is yours to keep. Until that last payment has been made, though, you don’t own the car. For the duration of the agreement, the car belongs to the finance company. 

The finance company or lender will transfer legal ownership over to you when the term is over and all the payments have been made. 

With some agreements, you have to pay a small administrative fee for this transfer, also known as the option to purchase fee.

Then you are free to decide what to do next. That could simply be enjoying car ownership without the obligation of making regular repayments.

Or, if you do wish to change your car once the finance has been paid off, you can part exchange it for another and upgrade. 

Your car will be valued, and you can use the equity as a deposit for a new car and even start a new hire purchase agreement if you wish. 

What are the pros and cons of hire purchase?

Paying for a car using some form of finance is now more common than paying outright with cash. But what type of finance you choose is very much down to your own personal circumstances. 

So while hire purchase makes sense if you want to own a car and don’t have the money readily available, it’s best to look at all the pros and cons first before making your decision.

Hire purchase vs personal contract hire (PCH)

The glaring difference between hire purchase and personal contract hire, also known as leasing, is that with HP, you’ll own the car at the end of the agreement. 

If you opt for a PCH deal, you never have that option. 

The monthly payments for PCH also tend to be much lower, because you aren’t paying off the total value of the car; only the depreciation amount. 

As PCH payments are based on the depreciation of the car, there’s an annual mileage allowance that you need to stick to. If you exceed the allowance, you could face a hefty charge. With HP, there are no such mileage restrictions.

However, because with an HP agreement you’re paying off the total value of the car, the monthly instalments tend to be higher than PCH. 

If you ever want to change the car after you’ve fully paid off the finance, you’ll also have to factor in depreciation. 

But with a HP agreement, unlike a PCH contract, you won’t need to estimate your mileage at the start of your agreement. However, as you won’t own the car until you’ve made all the repayments, you’ll need to keep the car properly maintained until the full value is paid off. 

The term differences between HP and PCP are also slightly different. With PCP, the contract usually runs for two to three years, whereas HP agreements can be anything up to five years.

PCH offers lower short-term costs too, and you can usually get a better car for your monthly budget, changing it every few years. 

Hire purchase (HP) vs personal contract purchase (PCP)

Both personal contract purchase (PCP) and hire purchase (HP) are very popular ways to finance a car – so what’s the difference? 

Firstly, they have a few things in common – both have interest added onto the monthly payments, and you can lower the monthly payments by providing a bigger deposit.

There are two major differences between these finance agreements. The first is with a HP agreement; the repayments are equal to the value of the car plus interest. 

PCP payments, meanwhile, are lower because you’re only paying for the difference between what the car is estimated to be worth at the start of the contract and the end – otherwise known as its depreciation – plus interest. 

The end of a PCP deal is different too, as you can either choose to hand it back – as you would a lease car – or you can offer a lump sum payment (balloon payment) to keep the car. 

On the other hand, once you’ve made the final payment on your HP agreement, you legally own the vehicle. However, you’ll need to bear the cost of depreciation if the time ever comes that you want to sell it.

Finally, HP is not subject to the same restrictions as PCP, such as a mileage allowance or extra charges if the car is not in good condition if you choose to hand it back when the agreement ends. 

Who is hire purchase right for? 

Hire purchase is a good finance option for those who want to own a new or used car, but who need or want to spread the cost of it over time. 

Although monthly payments for a PCP or PCH deal are lower, over the long run, hire purchase works out to be the cheaper option if you wish to keep it. It’s like an investment. 

If you don’t want to have an additional lump sum to pay for the car at the end of the agreement or don’t want to be hampered by mileage restrictions, hire purchase could be the right choice for you.