Why should you use an installment purchase agreement?
It is a method of purchasing expensive consumer goods in which the buyer makes a down payment and pays the remainder over a period of time, including interest. Technically, ownership of the goods only passes to the buyer once all payments have been made under a hire purchase agreement. With an installment purchase plan, a business can maximize its working capital, improve its financial presentation to investors, and has the option of flexible payment terms.
Here are five of its advantages:
Reduce upfront payments
The biggest advantage of an installment purchase plan for a business is that it does not require a large upfront payment.
This is particularly beneficial for businesses that need expensive equipment but do not have the immediate funds or want to avoid additional debt. By spreading costs, companies can manage their finances more effectively.
This also means your business can now access higher quality equipment that might otherwise have been unaffordable.
Access better equipment
The most obvious advantage of an installment purchase model for a business is that it does not have to pay the entire purchase price upfront. For a business that needs to purchase expensive equipment but doesn’t have the money or doesn’t want to take on additional debt, this can be a good option. Equipment lease payments and equipment ownership costs can sometimes be removed from a company’s books, resulting in better return on assets (ROA) ratios.
Hire-purchase may give your business access to truly top-notch equipment. With a one-off cash purchase you may not be able to afford to buy the very best equipment, but with a rental purchase you can buy a high-quality piece of equipment, use it immediately, pay back the purchase price in installments over several years and… At the end of the term, you then become the owner of the asset.
If you use rent-to-own, you may be able to get high-quality equipment. Buying the best equipment for one-time money may not be an option; However, with rent-to-own, you can purchase a high-value item, use it immediately, pay for it in installments over a period of time, and ultimately own it.
Improve cash flow
Another negative impact of purchasing an item with a one-time payment is that it could affect your cash flow. Buying in installments allows you to avoid paying a large lump sum, so your cash flow position is hopefully much healthier.
Purchasing items with a one-time payment can also have a negative impact on your cash flow. Buying in installments allows you to avoid making a large single payment, which should improve your cash flow.
Fixed repayments
A hire purchase lender will not change your interest rate during the term. This makes budgeting easy and there are no surprises — you know exactly what you will pay back each month for the remainder of the term. With rent-to-own plans, maintenance is often included in the contract, so the company doesn’t have to worry about potentially incurring expensive repair costs. In some cases, it may be more tax efficient to expense the rental payments rather than purchasing the equipment and depreciating it. The Company is not required to retain the Equipment under a lease purchase plan and payment terms may be flexible.
During this period, a hire purchase lender will not change your interest rate. So budgeting is easy and there are no surprises — you know exactly how much money you will pay back each month for the rest of your term.
Lower interest rates
Interest rates on installment purchases are often lower than overdrafts, credit cards and other forms of financing. In addition, the payments are likely to be lower than with a leasing contract, as there is no VAT on rental purchase. If you have the necessary funds, you can repay the loan at any time and in this way you may receive a significant interest refund.
Unlike overdrafts, credit cards and other forms of financing which require higher interest rates, hire purchase interest rates are generally cheaper. There is no VAT to pay with a hire purchase agreement, so monthly payments are likely to be lower than with a leasing agreement.
Flexibility in repayment
You may be able to arrange a slightly different repayment arrangement that further reduces your monthly repayments. Your agreement may require you to pay a larger final payment (called a balloon payment) to compensate for the fact that you have made lower repayments throughout the term. If you are unable to make the final payment, the lender will repossess the item, but you will have benefited from the use of the asset throughout the term.
To further minimize your monthly payments, you may be able to negotiate a new repayment agreement. Because of your reduced monthly payments, you may have the option to make a larger final payment to compensate.
Credit management
Using an installment purchase can help your business build a positive credit history.
As long as you are able to consistently make the agreed payments over time, an installment purchase agreement can improve your business’s creditworthiness.
This will help you improve your credit score over time and make it easier to secure future financing at more favorable terms, including lower interest rates and better repayment terms.
They can also add diversity to your credit portfolio, improve your overall credit profile, and demonstrate that your business can responsibly manage various forms of debt.
In the long term, this leads to greater bargaining power when dealing with lenders as well as greater stability in times of financial uncertainty.
Tax benefits
Another interesting benefit of rent-to-own is the ability to claim depreciation in the value of the asset.
Depreciation is a non-cash expense that reduces taxable income and therefore your tax liability. By spreading the cost of the asset over its useful life, companies can achieve tax savings each year.
Comparing the cost of the asset with the revenue it generates will also give you a more accurate picture of your business’s profitability. This principle aligns with accepted accounting standards and provides a clearer view of your financial health.
This can also lead to improved pricing and cost management strategies.
Increased asset base
A larger asset base can improve your company’s financial stability and strength, making it more attractive to investors and lenders.
This is particularly important when looking for further financing options.
Banks and financial institutions prefer lending to companies with a solid asset base as it reduces their risk. This leverage can result in more favorable loan terms such as lower interest rates, longer repayment terms and lower collateral requirements.
Ultimately, a larger asset base gives your business a greater ability to invest in your chosen growth opportunities by providing you with the necessary financial foundation.
Future planning
Because lease purchase agreements contain clear, predictable terms, your business can more accurately predict and plan for future expenses, tax liabilities and cash flow requirements.
This foresight contributes significantly to setting strategic goals, securing financing and maintaining long-term financial stability.
Additionally, it provides companies with a more cost-effective and flexible way to upgrade to new devices as technology evolves, ensuring they remain competitive and keep pace with ever-evolving industry standards.
However, there may be reasons why installment purchase is not a suitable solution for your business circumstances:
- The asset in question serves as security for the loan and can therefore be withdrawn at any time if you fail to make your payments
- The lender is the legal owner of the asset until all repayments have been made
- Failure to make repayments will affect your credit rating
- Given the total amount you are likely to pay in repayments over the life of the agreement, this can be an expensive way to acquire an asset
- By the end of the redemption period and once you become the legal owner of the asset, the value of the asset may have decreased or it may have become obsolete. This is likely to be particularly true given the term of most hire purchase agreements
How does installment purchasing work?
With lease purchase, you enter into a contract to purchase an asset. Instead of paying the purchase price as a lump sum, you pay the purchase price plus interest in equal monthly installments over a set term. Typically, you’ll pay a deposit at the start of the contract, perhaps 10% of the purchase price.
A typical repayment period can be two to six years — the longer the term, the lower your monthly repayments will be.
Sometimes the final repayment is for a larger amount, called a “balloon payment.”
Fixed and variable interest rates are available for rent-to-own agreements.
Throughout the repayment period, the lender is the legal owner of the asset. Once all repayments have been made, your business becomes the legal owner. Typically, you will be responsible for insuring and maintaining the asset during the repayment period.
Please contact our team at Funding Bay for a free consultation to learn more about the benefits for your business!
