Rent to Own
by Gary Foreman
Dear Dollar Stretcher,
I work with single moms who are often strapped for cash. They are sometimes suckered into "Rent To Own" where the interest is enormous. Is there any readily available, easily understood information out there to help me to teach them understand how expensive these loans are? How do I show them the true interest rate, or is there a mathematical formula to figure those interest rates? I know that these are sucker loans, but how do I show them in real dollars what they are in for? Thanks for any help you can give me.
Jan has asked about a type of business that, unfortunately, is growing and taking advantage of more people every day. And, as more of us struggle financially, you can expect to hear more about "rent to own" stores.
Many of you have probably never heard of "rent to own," so we'll start with a brief explanation. "Rent to own" is really pretty simple. You'll find a storefront, just like any other retailer. One company in our area has 19 locations spread over a two-county area. They even have an insert in the Sunday paper. You'll find electronics, appliances and furniture, but you can also find jewelry and some other items. The merchandise is typically new.
Sometimes people want something now, but can't afford to pay for it until later. That's nothing new. Virtually every mortgage ever issued depended on that. Same thing for car loans. What's different with "rent to own" is that the people loaning the money are charging very high interest rates. Here's the deal. Customers "rent" an item at a weekly rate. If they rent it for a set number of weeks, they will own the item. The trick is that the total of the weekly rental fees is much, much more than the customer would pay if they bought the same item in a regular store. Even if a customer used a credit card with a very high interest rate, he would pay less than a rent-to-own arrangement.
Let's look at a couple of examples. We compared items using inserts from the Sunday paper. We'll start with a common item: the Sony PlayStation. For simplicity's sake, let's call our "rent to own" merchant "R2O." They're offering the PlayStation for $13.99 a week. If you rent it for 52 weeks, it's yours for only $727.48. Seem a little expensive? Yes, when you consider that a national chain advertises the same PlayStation for $129.99.
That's outrageous! But is it possible to calculate the interest rate? If you want an exact rate, you'll need a financial function calculator. But we can come up with a reasonable estimate just using a simple calculator. The first step is to subtract the normal price from the R2O price. In this case that's $597.49 ($727.48 minus $129.99). So we're paying nearly $600 more at R2O. We'll consider that the interest charged.
Now the simple (but incorrect) way to calculate interest would be to divide the interest charged ($597.49) by the amount borrowed ($129.99). That works out to a 459% interest rate for the one-year loan! The correct way would show that it's actually higher, because we didn't borrow the whole $129.99 for all 52 weeks-- part of it was paid down each week as the year went on. The actual rate is about 557%.
How about another one? This time we'll compare a Sharp video camera. Looks like a nice one, too. Has a 4" screen and even a remote control. The flyer from R2O offers it for "only $21.99 a week." If you rent it for 91 weeks it's yours for only $2,001.09. Or, if you prefer to pay cash, you can have it for $1,100.60. What about the competitors? A national catalog-type showroom is offering the same camera for $449.99.
If we follow our formula we'll find that the interest charges are $1,551.10 ($2,001.09 minus $449.99). This time we'll need to adjust the charges to an annual amount. The "rental" period runs 91 weeks. That's 1.75 years (91 weeks divided by 52 weeks). So we'll divide the interest charges by 1.75 to get the annual interest paid ($886.34). Now we can divide the annual interest charged by the retail price of $449.99 to get an estimated interest rate of 197%. Again, remember this is a method that's designed to be simple but only estimates the interest rate. The actual rate is 250%.
How can you convince people to avoid "rent to own?" Perhaps by showing them the total price they'll pay versus the price at a regular retail outlet. The two items we highlighted here are typical of what you'll find. Perhaps keeping sale flyers for comparison would be a good idea.
Calculator: How much mortgage can I afford?
Is there a solution for the consumer? Sure! We're not talking about being unable to afford an item. It's a question of being willing to wait a short time. Take the PlayStation. If the customer will take the $13.99 they were willing to pay in rental fees and save that for ten weeks, they can go into any store and pay cash for a PlayStation. And if they keep making weekly "rental payments" of $13.99 to themselves they'll end up with nearly $600 at the end of the year.
The lesson is one that needs to be learned by anyone who wants to accumulate savings. When you have to have something right now it's going to cost you. One of the most important keys to money management is patience. We hope that Jan is able to demonstrate that to the people she advises.
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. Gary is available for audio, video or print interviews. For more info see his media page.
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