Business has evolved since the ancient times from barter, business, commercial venture, general manufacturing to specialized manufacturing today. Initially, only the seller and buyer were parties to a business transaction. The title to the asset is given by bill or invoice. Bill is used for consumables or low value assets that are usually purchased in cash. Invoice is used to specify durables or high value assets that are purchased on credit. Sales can be in either cash or credit. The two tasks for the seller are to sell and to monitor credit.
Credit/ loan were evolved to bridge the gap between the purchasing power and demand. Over time credit organizations differentiated into sales and finance organizations. Today, three parties are involved in business transactions: seller, buyer and financier.
Hire purchase originated in England and is now unique to former British colonies. The financier purchases the asset and lets it on hire to the user. The user exercises an option to purchase the asset at the end of the contract after paying all the dues. HP is a transaction in which the purchaser of goods pays an initial deposit and takes possession. Subsequent installments are made over a specified time after which ownership passes to the purchaser. The parties to the contract are Owner (financier) and Hirer (purchaser / user). The installments are called Hire Money. If there is a default in the payment of any installment, the financier retains the right to repossess the asset from the purchaser without any refund.
Sundaram Finance is one of the first hire purchase companies in India. In fact, they were instrumental in the creation of the Hire Purchase Act of 1972.
ELEMENTS OF HIRE PURCHASE AGREEMENT
To be a valid hire purchase agreement, the following elements must be clearly specified in writing and signed by the hirer as well as the financier:
Identifying attributes of the asset, such as chassis number, engine number etc.
Cash price of the goods i.e. price at which the goods may be purchased
Hire purchase price, which is the amount payable by the hirer under the agreement
Down payment or initial hire payable by the hirer
Number, amount and date of each installment payable by the hirer
Date of commencement of hire purchase agreement
Rate of interest charged by financier
COMPARISON OF LOAN, HIRE PURCHASE AND LEASE
Table 2.1 Comparison of Loan, Hire Purchase and Lease
Criteria
Hypothecation
Hire Purchase
Lease
Sale of asset
Sold to borrower, hypothecated to financier
Sold to financier, financier hires to buyer (hirer)
Sold to financier (lessor), financier leases to lessee
Initial payment
Margin money
Initial hire
Lease deposit
Ownership
Title is with borrower from the beginning
At the end of the contract, title transfer to buyer is done
Title remains with lessor throughout the life of the asset
Cash flow to seller
Loan value of the asset is paid by financier, balance amount by borrower
100% of asset cost is paid by financier
100% of asset cost is paid by lessor
In case of default
Money is the consideration
Court intervention is necessary
POA* is obtained to bypass court intervention
Asset can be taken away by financier
Court intervention is not necessary since the financier is the owner of the asset
Asset can be taken away by lessee
Court intervention is not necessary since the lessee is the owner of the asset
*- POA is Power of Attorney. The lender/financier reserves the right to repossess the asset without court intervention, to save time and resources.
PROCESS OF A HIRE PURCHASE TRANSACTION
Eligibility to avail hire purchase
The field officers approach a prospective client and explain the terms of the hire purchase deal. Generally, assets with a high rate of depreciation are financed through hire purchase. The following entities can avail finance:
Persons of contractual capacity i.e. of age greater than 18 years (as verified by birth certificate), sound mind
Partnership firms
Proprietary organizations
Companies
Public limited companies
Quasi- Governments
Governments
POA holders
Natural Guardians
Under Hindu Law, the party's father is preferred as natural guardian. Only by way of practice/ convenience the mother is accepted as guardian. Under Christian Law, either father or mother can be accepted as guardian. Under Muslim Law, there is no guardianship. Further, ladies behind purdah cannot be signatories to a hire-purchase agreement.
Proposal Analysis
Before entering into a contract with an applicant for a hire-purchase financing, field investigation is a must. The following aspects of a client are verified through field analysis:
Place of residence (applicant should have resided in the place for a minimum of 2 years)
Standard of life
Character of applicant (determining willingness to pay)
Income details
Source of income
Property owned by applicant
Expenses
Credit rating of the individual
This is a strictly subjective judgment performed by the branch office and sent to the head office for verification. At Sundaram Finance, the applicant's income and monthly commitment alone are considered.
In case of salaried professionals, latest salary slip and annual tax returns or Form 16 have to be submitted. This is used to determine the gross salary, from which statutory deductions and total borrowings are reduced, arriving at net salary. This is the basis for capacity determination.
In case of businesspeople, the company's balance sheet and P&L account are scrutinized to determine the cash profit i.e. net profit after tax plus depreciation from P&L account.
Net annual income should be equal to or greater than twice the annual commitment of the contract. This is called cash flow cover. Amount Commitment is the sum of all the Equal Monthly Installments paid in a year i.e. [EMI] x 12.
Calculation of EMI
The total amount repayable is the sum of the principal (cost price of the asset) and interest (cost of funds).
EMI = Amount repayable / Number of installments
The interest component is given by
Interest = Principal * Flat rate of interest * Number of years
Flat Rate of Interest
Simple Rate of Interest
This is generally used for computing the EMI manually, easily and easy understanding of a monthly commitment.
This rate of interest is used for the purpose of accounting and banking.
The EMI is initially fixed and the hirer has to pay this fixed amount for all the installments.
The EMI charges payable by the consumers vary for every installment when calculated using simple rate of interest and hence it is confusing.
The amount contributed towards the interest and principle varies with installments.
Interest amount is calculated for every month with respect to the principal remaining.
At Sundaram Finance, hire purchase contracts normally exist for a period of between 12 months and 60 months, in multiples of 6 months.
Operations
The asset is purchased according to the hirer's specifications. The engine number and chassis number specified in the invoice are noted in the contract. These details should be identical in the RC book, contract and invoice for the agreement to be legal. The date of the agreement and the invoice should be identical in a hire purchase contract, since the asset comes into existence on that date. However, this is not mandatory in hypothecation.
The following documents are collected to process a hire purchase application:
1. Income proof
Salary slip
Form 16
Latest IT return
P&L A/C, balance sheet (audited)
2. Identity proof
Passport
Photo credit card
Pan card
Driving license
Voter id
Ration card
Partnership deed
Trust deed
Certificate of incorporation
3. Location proof
Ration card
Telephone bill
House tax challan
Driving license
Electricity bill
4. Asset proof
House tax challan
Copy of sale deed
Wealth tax assessment
Housing cooperation society bill
5. Signature verification
Passport
Photo credit card
Pan card
Driving license
Voter ID card
Signature verification from bank
6. Bank statement
7. Photograph
Serving debt
In hire purchase, debt need not be served in full. The buyer or renter is free to return the asset at any period in the agreement, and no further installments need to be paid. This is why 100% financing is never performed in a hire purchase transaction. At Sundaram Finance, the dates of payment are fixed as 3rd, 10th, 17th and 22nd of every month. Post dated cheques are collected.
In event of default
Default or non-payment of installments is defined as
For car - 2 months lapse in payment.
For commercial vehicle - 90 days lapse in payment.
The following procedure is followed by the financier for repossession of asset in the event of payment default:
Figure 2.1 Procedure to deal with payment default
Contract termination
At the end of the hire purchase contract
Re. 1 is collected as option money to terminate the contract.
Form 35 is issued.
Financier endorses the RC book with "no dues" enabling title transfer to the hirer / purchaser.
In a hypothecation, Form 35 is issued to terminate the contract.
OTHER ASPECTS PERTAINING TO HIRE PURCHASE
Motor Vehicles Act
Any vehicle plying on a public road must be registered.
Form 20 - application to register a new vehicle
Form 34 - to register a new vehicle
Form 29 & 30 - transfer of ownership (If there is an endorsement in the RC book by a financier, title cannot be transferred unless a NOC - No Objection Certificate is gained.)
Form 35 - termination or extension of contract
Insurance
Insurance can be defined as "a lot of people sharing the burden of one deprived man".
Motor Vehicle insurance does not specify a limit on the value of claims that can be made. It can be differentiated into comprehensive and third-party insurance.
Third-party insurance merely compensates damages caused to third party by the actions of the vehicle user provided valid driver's license is present. Any vehicle plying on the road must have third party insurance.
Comprehensive insurance also compensates for damage to the vehicle and owner, in addition to third party damage. Any vehicle under finance must compulsorily have comprehensive insurance.
Insurance does not cover war & war-like activities, nuclear reactions and acts of terrorism.
CREDIT POLICY
Credit policy aids the financier in preparing the terms of a hire purchase contract. It is merely a guideline for conducting the business. At Sundaram Finance the first written credit policy was established in 2000 when the volume of business crossed Rs. 2 crore. It is now reviewed every year, and is subject to change based on economic and other market conditions.
Credit policy has an effect on three main variables:
Percentage of funding
Repayment period
Interest rate
Percentage of funding
In hire purchase, 100% of asset value is never financed. The loan to value ratio varies according to the type of asset and the credit risk. The ratio is always calculated on the ex-invoice price less discount. Loan to Value ratio, or LTV, can increase if market expands or delinquencies decrease. Higher LTV means that a higher portion of the asset price is funded by the financier, with lesser initial hire amount. This is fixed according to the company policy and reviewed periodically.
Interest rate
The interest rate is inclusive of the internal return rate or profit margin for the financier. This is variable based on
Return on Investment
RBI regulations
Economic reforms
Market conditions
Presently, the IRR cannot vary during the term of a contract. It has to be fixed at the time of drawing up the contract.
Repayment Period
This is almost always constant for a given type of asset and class of customer, owing to the depreciation of asset with time.
ASSETS FINANCED THROUGH HIRE PURCHASE
Sundaram Finance extends finance through hire purchase for
Cars
Commercial vehicles
Cars are an expense, while commercial vehicles are an income generating asset. For financing a car, past income is considered, while for commercial vehicle, predicted future income flows are considered. Presently the market share of Sundaram Finance in hire purchase finance of cars is about 7 - 16%, with up to 24% in some pockets such as Vellore district.
Credit Classification of Cars
Table 2.2 Classification of Cars
CLASSIFICATION
NAME
VALUE OF ASSET (in Rs. lakhs)
A
Small Car
3-4
B
Medium Car
4-7.5
C
Large Car
7.5-15
D
Luxury Car
>15
Table 2.3 LTV Funded for Cars and Jeeps
SALARIED
BUSINESS
Small
90%
85%
Medium
85%
85%
luxury
80%
75%
Repayment period for A & B class cars, for salaried class, is 60 months. For others, it is 48 months.
In the event of gifting a car acquired through hire purchase, third party guarantee with evidence must be present.
Credit Classification of Commercial Vehicle
Any vehicle that runs on the road for remuneration is a Commercial Vehicle. They can be classified as
load carrying or passenger carrying vehicles
stage carriage or contract carriage vehicles
LCV, MCV, HCV or multi-axle vehicles
Stage carriage is on a fixed route, with fixed timings and fixed fare. Ex. Public buses.
Contract carriage is where every aspect - route, timings and fare is customized according to individual customer needs. Ex. Autorickshaw.
Table 2.4 Classification of Commercial Vehicles
ABBREVIATION
CLASSIFICATION
GROSS LOAD WEIGHT (in tons)
LCV
Light Commercial Vehicle
<5
MCV
Medium Commercial Vehicle
5-10
HCV
Heavy Commercial Vehicle
10-15
Multi - Axle Vehicle
>15
Table 2.5 LTV Funded for Commercial Vehicles
TRUCK
BUS
LCV
Experience (in years)
3
3
3
Tenure (in months)
48
48
36
LTV of total chassis cost
95%
90%
85%
LTV of total body cost
90%
90%
85%
Repayment period for LCVs alone is 36 months as they depreciate faster and earn less revenue. For other classes the period is 60 months.
For used commercial vehicles, the following are the credit norms applicable at Sundaram Finance:
Table 2.6 Credit Policy for Hire Purchase Finance of Used Commercial Vehicles
CREDIT POLICY
NEW CUSTOMER
EXISTING CUSTOMER
Age of vehicle at closure of contract
=< 8 years
=< 8 years
Maximum tenure (in months)
36
36
LTV (on basis of market value)
60%
60%
Paper cash cover (times net income)
1.5
1.5
Assessed cash cover (times net income)
2.0
2.0
Exposure limit (in Rs. Lakhs)
10
10(if not fixed by HO/RO)
Age (in years) at the closure of contract
65
65
Years in business
2
2
Years in location
3
3
Eligibility criteria
Should own one free and road-worthy vehicle
Previous closed contract to be not greater than 12 months ago
