Hire-purchase is a convenient way of purchasing an item, if you cannot afford to pay cash upfront.
The down side is that like any other loan, you must pay interest on the amount borrowed. Interest escalates the total price of the good as compared to when buying the same item for cash.
There are normally three types of consumers:
1. One who will faithfully make all payments and will try his/her best to free the good bought on hire purchase before the contracted term ends;
2. One who takes his/her time and pays only what is due when it is due and utilises all the time allocated; and
3. One who frequently defaults and goes in arrears.
The Hire Purchase Act gives customers the right to complete the contract early. For those of you who are keen to free the good before the end of the contracted term, are entitled to claim rebate from the hire-purchase company.
This refund refers to the HP interest amount added together on to your monthly payments.
For instance if you opted to make full payment over 12 months but you cleared the loan in just 4 months, then you should not pay interest for the remaining eight months.
As a smart consumer, you must ask for this rebate when clearing the debt earlier than the contracted term. In this case, eight months interest must be refunded to you.
When a good is bought on hire-purchase, the total interest is added to the amount you owe to the hire-purchase company. The total amount (cash price of the goods plus the total interest) is then divided into your monthly or weekly payments as agreed between you and your hire-purchase company.
Now how often do consumers demand for rebate if they complete their debt before the contracted period? Majority of the consumers are unaware of this and thus do not enquire with their hire-purchase companies on rebate. They lose this money, which becomes an added income for the trader.
Deepti wants to buy a sewing machine around Christmas time. She can buy it for $400 cash, or on hire-purchase for $30 down payment or deposit and 12 monthly installments of $37.28 per month. Her added interest will be $77.33 for 12 months.
Deepti who is a single working mother could not afford cash price and hence opted to buy the item on hire purchase.
After meeting three payments, Deepti was happy to receive her Income Tax Return. Although she still has nine months to clear the remaining balance, she decided to pay the entire amount in the fourth month.
While the debt burden was off her shoulders, little did Deepti realise that she has actually ended up paying more by clearing her debt early and not claiming for the rebate?
Let's take a look at the total amount Deepti had to clear in a year and the rebate she was entitled to.
Total Cash Price of the Item: $400
Total Monthly Installments:
12months x $37.28=$447.36
The rebate is calculated using a mathematical formula called the Rule of 78. The rule gets its name from adding 12+11+10+9+8+7+6+5+4+3+2+1=78.
Using the Rule of 78 means that more of the cost of credit is applied to the beginning of the contract than towards the end.
Since Deepti cleared all her payments in the fourth month, she should receive rebate or refund for eight months.
Calculation of rebate on interest:
Interest for completed term =
t x (1+2+3+k - 1+2+3+4+n)
* = remaining repayment period (in months) ie eight months
k = original repayment period (in months) ie 12 months
t= is the total interest charges for the whole agreement period
= $77.33x(1+2..+12)- (1+2+3+...+8)
= $77.33 x (78-36)
Interest for four months = $41.64
Rebate for eight months =
Hence Deepti could have claimed $35.69 from her hire-purchase company as the rebate. Since Deepti was unaware of the rebate entitlement, her credit provider benefitted with extra $35.69.
It is important to know how much interest was charged when buying goods on hire-purchase. You will feel better when getting out of debt but you will definitely feel happier if you get out of debt with more cash in your hand due to early payout.
* This is a weekly contribution from the Consumer Council of Fiji