21.3 time payments (hire purchase)

Hire – purchase A hire-purchase agreement is an option used in place of saving for an item to purchase. The purchaser agrees to hire the item from the vendor and make regular payments towards an agreed rate of interest. The purchaser is able to take the item/goods at the beginning of the agreement but the vendor can repossess the goods if a payment is not made. The goods are owned by the purchaser at the end of the period agreement.

Types of interest rates The interest rate being charged in these contracts is not always explicitly stated (up front). It is important to distinguish between them so we can judge how much we are paying for an item. There are two different types of interest rates that can be charged.

Flat rate of interest The interest paid given as a percentage of the original amount owed is called the flat rate of interest. It is the same as the simple interest rate but referred to as flat rate of interest in the hire-purchase context.

Flat interest rate per annum rf = 100 x I _ P x t Where I = total interest paid P = principal owing after the deposit has been deducted t = the number of years Important: If a deposit has been paid, this must be deducted first so that P = original price – deposit

 

Effective interest rate The flat rate of interest implied by a hire-purchase contract can be misleading. Even though periodic payments are being made, the interest is still being calculated on the original amount owed rather than the average amount owed per period.

Effective interest rate Effective interest rate per annum, re = 100 x I_ x 2n___ P x t (n + 1) Where I = total interest paid P = principal owing after deposit has been deducted t = number of years n = number of payments in total Refer to Example 9 page 566

Effective interest rate from flat interest rate