Warning: This is only a basic guide to a transaction that almost all of us will become involved in at one time or another. The intention of this Entry is to point you towards proper professional advice, explain some of the terms involved and tell you where to go next, and is only relevant to the UK. This is not a full guide; for that you go to the FSA or the Office of Fair Trading websites. Due to changes in UK law, follow only the advice there, do not follow any of the advice here without checking it thoroughly. No responsibility of any kind can be taken for the contents of this Entry, you must refer to the FSA or The Office of Fair Trading for information you can rely on. This Entry could be out of date by the time you read this, and some or all of the information will be invalid.

What is Hire Purchase?

Hire purchase is a contract between a lender (a bank or broker) and an individual (you) that is often arranged by a seller (shop or garage) so you can buy something you can't afford or do not wish to pay for outright.

The hire purchase used by motability customers to finance their vehicles is a type of lease purchase contract - they then have a choice of returning it for a newer one, or to pay the final fee and keep it, which is very useful if they've needed to convert it in some way, and they don't want to have to convert another one. On returning the vehicle, any repairs that need to be done have to be paid for by the lessee, either by getting them fixed, or they'll be sent a bill.

'Hire purchase' means what it sounds like. You hire the article over the period of the loan, and do not own it until purchase; you make the last payment and purchase the article, normally after the payment of an option-to-purchase fee. Remember that under a hire purchase agreement the owner of the goods can repossess the goods if you've paid less than a third of the agreement. If you've paid more than that they have to go to court to get them back or to get the cash out of you.

That is the basic idea of hire purchase, and the banks are reasonable in the way they do business, but it represents an opportunity for the dealer for making some extra profit out of you by handling the hire purchase and getting some commission from the lender.

Jargon

Hire purchase is different from a store card or a loan in that you don't actually own the goods until you have made all the payments.

• The term: This is the period of the loan from one to ten years and generally at a fixed rate of interest.
• Credit: This the amount borrowed; the original cost of the article (less the amount of deposit or part exchanged item).
• Interest or charges: The amount added to the cost (at the time of writing, 07/06, it is typically between 5.75% and 9% per annum).

There are two basic types of hire purchase contract (at the time of writing).

• Regulated: For balances under £25,000. This means that the government has set down rules to provide protection for the borrower upon early settlement. It is sold and advertised in away to protect those that might not be so well-informed.

• Non-Regulated: For balances over £25,000. This means that the rules are relaxed and the borrower can find his protection limited and the costs can rise especially if the loan is paid off early as there is no protection from high settlement fees. The advertising standards are different.

All in all the system works well and everyone is happy. However...

Understand the Basics

All banks make a minimum charge for the money they lend¹; this is known as the bank base rate. Now here is the catch. A dealer selling you any item and arranging finance will have two choices: either arrange a loan at base rates or a little above; or arrange a loan at as much above base rates as possible, and offer it to you the customer, and upon the customers agreement, set up the loan and receive a generous commission from the lender.

Option two is the most popular but you may get charged more than necessary and not realise it.

The Business Manager

This is a paid professional trained by the banks and found in big outlets or dealerships. The business manager is nothing to be afraid of but you must know just one thing. He/she has only one objective, and that is to sell you money at the highest rate possible (for an up-front commission payment) to make you feel better, and sell you insurance to cover your loan. Ask questions² about the rate, you can negotiate this is part of the deal, and some time spent at this point can save you some money.

Remember that they need you more than you need them, and they won't throw you out. Don't be rude and you will get respect as a savvy customer.

The business manager will receive a commission for this. Don't fall into this trap and look around to other lenders for the best deal. Also, as the cost of capital goods come down in price and dealers operate on smaller margins, this is an important method they use to attempt to get back the profit given away by discounts.

The advice you are given by most is to ask what the APR is (APR stands for the Annual Percentage Rate of charge). If you want to know anything it is the flat rate, as it is this one thing that you can use to work out how much extra you are being charged.

For example, an interest rate (flat rate) of 6% sounds reasonable but think of it this way. It is £60 interest charged for each £1,000 borrowed for each year of the loan. So over five years that's an extra £300 for interest charges.

An interest rate of 8% also sounds just as reasonable, but think of it this way. It is £80 interest charged for each £1,000 borrowed for each year of the loan. So over five years that's an extra £100 in interest, giving a total of £400 in interest charges; that is 50% extra interest. The dealer will be making extra profit if you pay the extra 2%, the bank still only charge the base rate.

Always ask how much the set-up³ fees are (average is around £150 per loan). These are sometimes spread over the term of the loan. If they are you will pay interest on them as well.

Dos

It's not a game, these are a few pointers to help give you an advantage.

• Do make sure you need hire purchase, if in doubt you may not need to.
• Do get a quote at the time of sale.
• Do get it in writing (this is your right) if the payments quoted have varied. (If they've gone up, don't sign.)
• Do ask to speak to the lender then and there, and the dealer is likely fold at this point.
• Do check that you can afford the repayments.
• Do shop around for a cheaper credit deal.
• Do work out the total amount you will have to repay.
• Do only sign when you are happy.
• Do always shop around and compare rates. Get professional advice if you can if there is anything you don't understand, ask friends and family.
• Do read any small print, understand it and ask advice if you do not.
• Do check out the FSA or The Office of Fair Trading websites.
• Do understand your rights.

Don'ts

• Don't take this Entry as your only guide. Check the FSA or The Office of Fair Trading sites and follow the advice there and not here. Use this only as a signpost to find the place to get the best advice.
• Don't just accept what you are told; ask questions.
• Don't sign if you think the dealer is attempting to manipulate you.
• Don't take the insurance unless you check whether you really need any insurance offered.
• Never leave the dealership without a copy of the agreement signed by you and the dealer.

Advantages

There are advantages to hire purchase; provided you buy it wisely, it will enable you to buy large and expensive items that you might otherwise find difficult to afford. It will also allow you to pay for things without cashing in investments or savings, or spending your assets that may come in useful to handle any unforeseen problems.

The information provided is intended only as a guide to the law and could be out of date when you read this Entry. If you have any doubts about hire purchase, you should consult a trading standards officer or lawyer.