A Reconsideration of Rent-to-Own

Rent-to-own agreements (RTO) are traditionally seen as disguised installment contracts imposed on uninformed consumers at usurious interest rates. After the flaws and omissions in these interest rate calculations arc addressed, the implied annual percentage rates (APRs) remain extraordinarily high. It is shown that alternatives to RTO, such as layaway and long-term rental, yield comparable APRs. The appeal of rent-to-own is then attributed to its structure that includes an initial pure rental phase of high value to persons in volatile financial and/or personal situations followed by an installment phase. Should these situations he resolved, the consumer exercises an imbedded option to acquire a perhaps otherwise unobtainable installment agreement at a competitive interest rate. Recent economic studies have portrayed rent-to-own (RTO) agreements as disguised installment contracts detrimental to consumers by their imposition of undisclosed, usurious interest rates (Hill, Ramp, and Silver 1998, Renuart and Keest 1999, Swagler and Wheeler 1989). Correspondingly, RTO agreements are also purported to yield startlingly high rates of return to the dealer-owner even after deducting reasonable business expenses (Walden 1990). It is asserted that firms in the industry are able to prey on the fears of those who have had credit problems and to exploit their customers' short-term time horizon and lack of understanding of the true cost of rent-to-own. This paper suggests that a straightforward casting of a rent-to-own agreement into the mold of an installment sales contract obscures the actual benefits and costs to the consumer and yields misleading public policy recommendations. In reality, a rent-to-own contract offers consumers a series of valuable services and options unavailable in an installment purchase agreement. Implied interest rate calculations that discredit or simply ignore these services and options distort the nature or rent-to-own agreements while underestimating consumers' ability to make efficient utility maximizing decisions. The first section examines important omissions in the traditional Swagler and Wheeler (1989) consumer analysis and discusses critical theoretical and empirical flaws in Walden's (1990) widely cited economic model of dealer-owner yields. The second section examines market alternatives to rent-to-own and is followed by a section that examines a rent-to-own contract from the perspective of the consumer. The consumer's perspective views the monthly or weekly rental payment as a fee for service, the purchase of a number of options including the option to cancel and, eventually, a payment toward building equity. TRADITIONAL ANALYSIS OF RENT-TO-OWN The traditional view of rent-to-own is that RTO contracts are fundamentally installment credit contracts with the desperate or uninformed consumer vulnerable to exploitation. The resulting implied interest rates imposed on the consumer from these calculations are truly excessive. Renuart and Keest (1999) refer to an apparently hypothetical case where the RTO agreement on a television set yields an APR of 254 percent. Swagler and Wheeler (1989) use a sample of five actual RTO contracts on a 19-inch portable color television set with a retail value of $362 to generate APRs as high as 150 percent for monthly payments and 193 percent for weekly payments. Zikmund-Fisher and Parker (1999) calculate the rent-to-own APR on a 31-inch television at 229.7 percent compared to a credit card rate of 19.8 percent. In this negative perception of RTO, services provided by the rental agency during the term of the contract are given little weight. For example, Swagler and Wheeler (1988) claim the repair service included in an RTO agreement is of minimal value because most items are new and covered by the manufacturer's warranty. Consumers following this advice on the length of the manufacturer's warranty regarding the portable television set would be misled. …