HIRE PURCHASE II

I received some interesting responses to last week’s article on hire purchase.?One reader noted that his parents bought the majority of their stuff using Hire Purchase.?Another suggested that hire purchase is popular because many banks do not lend the small amounts shown in the article.?He also noted that sales staff are very effective in encouraging the use of hire purchase—they respond quickly and you do not need an appointment.?They make it easier to buy those appliances and furniture.

He also suggested that the “typical middle-class customer is more interested in the affordability of the payment, being uneducated to understand the interest rate that is often quoted as add-on.”?He concluded with the hope that my article encourages consumers to make correct financial decisions.

First I want to point out that it is not true that banks don’t lend the small amounts shown.?My first loan with a bank was for $500.?Now that was about 40 years ago.?However, that first loan allowed me to build up a relationship with the bank.?The bank and the bank officer then had a basis for assessing my credit worthiness.?They had evidence in the form of the consistent monthly payments I made towards my loan and the deposits of my monthly salary to support my credit application.?I had established a track record.?I demonstrated that I could be trusted.

A young security officer I know was considering hire-purchase to buy a much needed appliance for his mother.?He made enough to pay the monthly instalment.?I advised him to apply for a loan at one of our local banks and to deposit the difference between instalments payable on the hire purchase and bank loans in his savings account.?At the end of the two-year loan period he not only had the appliance for his mother, he had savings in the bank.?Note that in addition to the bank you should consider credit unions as a source of loan finance.

So what kind of savings are we talking about.?Let’s look at one of the examples I shared last week.

Stainless Steel Refrigerator

You will recall that one of the examples was the purchase of a 21 Cu. Ft. Stainless Steel Refrigerator.?The cash price was $13,398.37 and the down payment required was $3,350.42.?Therefore the loan amount was $10,047.95.?The very ‘affordable’ monthly payment was only $1,193.58.?As the reader noted, this was so very easy to obtain.?No appointments were necessary and the sales clerk was super friendly.

I understand, I too have considered buying on hire purchase.?However, let’s look at the alternative.?Yes, I know, banks can be very intimidating, they can seem unapproachable.?Maybe, just maybe, they want to be sure that you can pay back the loan so that they won’t have to provide for, and eventually write-off, bad debts.?They want to make sure that they protect the hard earned savings of their depositors—the source of most of the funds used to make loans.

Why should you do the hard work to prove to the bank that you are credit worthy??As the example below shows, the monthly payment on a one-year bank loan of $10,047.95 at an interest rate of 12% is $892.75.?This is $300.83 or 33.7% lower than the ‘affordable’ hire-purchase instalment of $1,193.58, which adds up to $3,609.98 over the one-year term of this loan.?In other words, at the end of twelve months you would have paid off for the fridge and have $3,609.98 in the bank, excluding any interest you may earn on the savings.?This is why you should build your banking relationship.

LG Refrigerator

Let’s look at another example.?This is based on the research I did over two years ago for an LG Refrigerator.?The cash price then was $17,336.25 and the down payment required was $4,070.00.?Therefore the ‘loan’ amount was $13,266.25.?The very ‘affordable’ monthly payment for this two-year ‘hire-purchase loan’ was ‘only’ $1,204.25.?The monthly payment on an equivalent two-year bank loan at an interest rate of 12% is $624.49, $579.76 or 48% less than the hire-purchase instalment, saving $13,914.28 over the two-year term of this loan.?At the end of the two years you would have paid off for the fridge and still have $13,914.28 in the bank, $688.03 more than the amount borrowed to buy it.

Therefore, hire-purchase has apparently become ‘more affordable’ with interest rates dropping from 89.58% to 71.10%, but this is still astronomically high.?I hope that these examples clearly demonstrate that investing in building a relationship with your bank or credit union makes sense.?It is time to deal with your fear of banks.?They don’t bite and the interest expense incurred will be much lower than the amount you will pay on a hire purchase transaction.?If you really want to borrow to buy that piece of furniture or that mega TV find the lender with the lowest interest costs—your bank or credit union.

Let me repeat what I said last week, fear of banks causes most of you to have very superficial relationships with them.?Those superficial relationships result in you being underbanked and, as a result, you leave your ‘dumb money’ sitting in bank accounts earning very little.?There is nothing to be ashamed about here.?Most of us are underbanked.?We do not take the time to understand and make wise investment decisions.

Any debt incurred to pay for stuff you really don’t need is BAD DEBT

As I also noted, you should avoid the trap of instant gratification and the desire to borrow to pay for stuff you really don’t need.?Let me also repeat, any debt incurred to pay for stuff you really don’t need is BAD DEBT, and bad debt is usually debt that won’t make money for you.?In other words, if you used debt for consumer purchases, it’s bad debt.?If you use debt to buy an asset that does not help you to earn a living and that depreciates in value, that’s bad debt.

However, if you must, if you cannot wait and must have that appliance or piece of household furniture, please do not use hire purchase.?You may think it’s ‘affordable’ but it’s usually the most expensive option available.?I urge you instead to do the hard work, save and buy later, failing that use your bank or credit union.

As usual, I look forward to your questions and comments.?Be safe.?Take good care.

Cheers, Nigel

Nigel Romano, Partner, Moore Trinidad & Tobago, Chartered Accountants