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Rental-purchase agreements: a preliminary investigation of consumer attitudes and behaviors.

Rental-Purchase Agreements: A Preliminary Investigation of Consumer Attitudes and Behaviors

Rental-purchase agreements, so-called "rent-to-own" programs, are becoming increasingly common throughout the United States. Unlike traditional rental agencies, such programs offer both extended rentals and the possibility of ownership at the end of the rental agreement. Over 5,000 stores nationwide offer merchandise through rental-purchase agreements, with total volume over $1.5 billion a year (Consumer Reports 1986); the latter represents a 50 percent increase since 1982 (Lee 1983).

These developments can be linked to changes in operations of traditional financial institutions, changes that themselves are related in part to deregulation. Most institutions no longer make small installment loans, and finance companies have moved away from the small unsecured loans that had been their mainstay (Brown 1986). The growth of rental-purchase agreements may be viewed as a response to such changes, and, as such, they deserve the same attention given to conventional credit arrangements.

Attention must be directed first toward the paradox inherent in rental-purchase plans. Conceptually and legally, fundamental differences exist between rentals and purchases; yet, in practice, renting-to-own is similar to buying on credit. In both cases, the consumer is making a periodic payment for the product. The resulting confusion is compounded by advertisements that stress low periodic payments and that treat ownership as a costless bonus to the consumer. In fact, neither emphasis is warranted.

THE COST OF RENTING-TO-OWN

Acquiring ownership through a rent-to-own program generally requires customers to rent for 18 months. Contracts, however, are extended on a weekly or monthly basis. The rental agreement is renewed automatically when the customer makes the next payment; otherwise, the merchandise is returned at the end of the week or month. Thus, eventual ownership may always be an option, but it is never a requirement. The consumer has no long-term obligation, and the rental agent has no long-term responsibility (i.e., beyond the rental period).

Payments appear low only because billing periods are short. Nine rental agencies selected randomly from different parts of the greater Atlanta area were surveyed in 1985. Weekly rental rates for identical 19-inch portable color television sets ranged from $11.25 to $15.55, with monthly rates from $40.00 to $54.20. Table 1 provides a summary of weekly, monthly, and total costs.(1) Although rates are clustered, considerable variation is evident.

(1)The four unreported stores all had rates either identical to or within a few cents of those given for stores four and five.

The most notable feature of Table 1, however, is that total costs are high for all agencies sampled. A search of five retail outlets revealed a price range of $325-399 for the same set. Thus, a customer of the lowest priced rental agency would still pay twice the average retail price.

For the purpose of illustration, suppose that rental fees are treated as installment payments; one can then calculate an implicit annual percentage rate (APR) using the standard formula for such purchases (Gitman 1984, p. 287).(2) Calculations are based on an average retail price of $362. The resulting APRs are startling (Table 2). The highest rates range above 190 percent for weekly payments and reach 150 percent for monthly payments.3 In contrast, the customer charging the set on a revolving credit plan and then making minimum monthly payments would pay a rate of less than 20 percent.

(2)APR was calculated as follows: M(95N + 9) F/12N (N + 1)(4P + F), where M = number of payments in a year ( = 12 monthly or 52 weekly), N = number of loan payments scheduled over life of loan ( = 18m or 78w), F = total finance charges ( = total cost - $325), and P = the principal amount of the loan ( = $325). This formula is an approximation of the true APR, but it is used to facilitate comparisons.

(3)Calculations in Consumer Reports give implicit interest rates on rental-purchase agreements. ranging from 115 percent to 152 percent (Consumer Reports 1986).

The figures in Table 2 are merely hypothetical. Because the consumer is technically a renter, no credit is extended, and no APR is involved. This critical point exempts rental agencies from truth-in-lending requirements and state usury laws. During the rental period, rental agencies do provide service at no additional cost. However, most items are new and covered by the manufacturer's warranty. It seems unlikely that service costs would represent a significant portion of the total cost.(4) One must conclude, then, that rent-to-own programs represent a very expensive option to the consumer.

(4)(Officials for the Association of Progressive Rental Organizations, a trade organization, justify higher prices on the basis of greater risk that products will be damaged or lost. Product-loss writeoffs are claimed to be six to eight times above the average for all retailers (Johnson 1985, p. 35).

PURPOSE

This paper deals with consumers' involvement in rental-purchase agreements. The focus is on consumers' knowledge and attitudes as reflected by a sample of participants in rent-to-own programs. Insights into participants' knowledge of rental-purchase agreements, their motivations, and their satisfaction should lead to a fuller understanding of the situation and may provide the basis for evaluating alternative public policy responses.

As a preliminary exploration of participation in rental-purchase agreements, the study was aimed at identifying general issues and overall patterns. However, because the issue involves payments over time and is linked to developments in financial markets, the study was structured around three research questions relating to these topics. 1. Credit Availability--To what extent is participation in rent-to-own programs associated with a lack of access to credit? 2. Limited Information--In light of potential confusion, are participants unclear about the nature of rental-purchase agreements and unaware of costs and long-term consequences? 3. Time Horizon--Do participants focus on having the product now to the point that they heavily discount the high costs involved?

AN INVESTIGATION OF CONSUMER MOTIVATION

The Need to Know

Information about the rental-purchase market is limited. Although increasing numbers of individuals are opting for rental-purchase agreements, little is known about participants' motivations or understanding of the programs. It is possible that consumers remain uninformed or misguided; in these cases, additional disclosure could be effective. If, however, consumers are participating in rent-to-own programs in spite of the high costs, disclosure would have a more limited impact.

One issue obviously concerns alternatives. Question #1 above relates to participants' access to credit and their use of rental-purchase agreements. Questions #2 and #3 are also involved, contrasting the role of information and time horizon (or internal rate of discount). The two are not mutually exclusive, but understanding their relative importance is essential to any assessment of the situation.

This study offers a preliminary assessment by surveying a group of consumers who had participated in rental-purchase programs. Questions were grouped into five categories: (1) socioeconomic background, (2) experience with rent-to-own programs, (3) reasons for selecting the rent-to-own approach, (4) knowledge of the program, and (5) satisfaction with the program.

Procedures

The sample consisted of 61 individuals in the West Palm Beach, Florida area who had participated in rental-purchase agreements. Individuals were selected from those attending educational programs offered by the Consumer Credit Counseling Service (CCCS) of West Palm Beach, but who had not received credit counseling from the Service. People were asked if they had taken part in rent-to-own programs; those who said yes were then asked to take part in the survey.(5) 5Consent was obtained following procedures approved by the University of Georgia's Institutional Review Board for research involving human participants.

A pilot test of the questionnaire was conducted in West Palm Beach. Based on those results modifications were made, and the final instrument was developed.(6) The instrument was administered by CCCS staff members, who read the questions to the participants and recorded their responses. Participants were also given the opportunity to make individual comments. Data were collected during the fall and winter, 1986-1987.

(6)A copy of the instrument is available from the authors upon request.

Results

Overview. As indicated in Table 3, consumers in the sample were predominantly female and tended to have lower incomes, with less than high school educations. Most respondents had taken part in rent-to-own programs only once and rented on a weekly basis for a relatively short time (and thus did not rent-to-own). Nearly three out of five persons in the sample reported that they had been denied credit.

Consumer knowledge and satisfaction. The rationale for additional disclosure is that consumers are inadequately informed. Answers to the questions posed reflected a pattern in which about one-third of the respondents reported having problems or not understanding the contract (Table 4). In most cases, those who misunderstood the contract had problems as a result; the confused consumers who escaped problems, however, were still at risk. One cannot assume that additional disclosure would have helped these individuals (Tybejee 1979), but it is evident that a sizable group within the sample reported having difficulties with the contract.

Experience with rental-purchase agreements, however, seemed to give respondents a better grasp of the costs involved. Over 70 percent of the sample correctly identified that rental-purchase agreements are "much more expensive than buying on credit" (Table 4). Over half the respondents identified the correct range for total price of a $325 television purchased through a rent-to-own plan.

Responses to the question about overall satisfaction with rent-to-own programs mirror the pattern noted above; just over one-third of respondents indicated that they were not satisfied at all (Table 5). The largest group fell into the middle category, while less than one-fifth of the respondents said that they were generally satisfied. These responses are consistent with and may help explain the fact that most individuals in the sample rented for less than four months (Table 3). Overall, the distribution suggests that participants did not come away from their experiences with generally favorable impressions.

The low level of satisfaction is demonstrated by the question on respondents' willingness to take part in rent-to-own programs again. Over half the sample indicated that they would not take part again (Table 6). This percentage--55.7 percent--is well above the one-third that had expressed negative attitudes in earlier questions. The most frequent comment added to this question was that rent-to-own programs were too expensive.

Motivation. One of the key questions with respect to rental-purchase agreements is: why do consumers take part? Respondents were given seven choices, with the option of adding others. A clear pattern emerged: nearly seven out of ten respondents indicated that being able to get the product right away was one of the two most important reasons for participation (Table 7). The fact that no credit check was involved was listed first or second by over 45 percent of respondents, with nearly a third listing it first. Low payments were most attractive to just over a quarter of the sample, followed by the ability to quit at any time.

These results are not surprising, because nearly 60 percent of the sample had been denied credit (Table 3). Similarly, being able to get the product immediately would be appealing to those who might otherwise face uncertain prospects. Both of these features tend to be heavily advertised.

Patterns among multiple users. It was noted earlier that about 40 percent of the sample had participated in rental-purchase programs more than once. It is logical, then, to inquire into possible differences between that group of 24 and the 37 respondents who participated only once. Income and educational levels for the two groups were similar, but there were important differences in terms of attitudes and experiences. The most notable difference had to do with the denial of credit; among repeat users, 70.8 percent reported having been denied credit, as compared with only 51.4 percent of those who had participated just once (Table 8).

Two out of five one-time users indicated they were not sure what they were getting into when they signed the contract, and in nearly all cases these individuals felt they were hurt as a result (Table 8). Only about one in five of the repeaters were not sure what they were getting into, barely half the rate of the other group. A much larger proportion of one-time renters correctly indicated that rent-to-own programs are "much more expensive than buying on credit."

Overall satisfaction with rental-purchase programs was remarkably similar for the two groups (Table 9). A greater proportion of one-time renters fell in the "not satisfied at all" category, but the difference disappears when the two lowest categories are grouped. Furthermore, the proportion of one-time renters falling into the two highest satisfaction levels was greater than that for repeaters.

As shown in Table 10, however, similarities in the level of satisfaction are not reflected by intentions to participate in additional rental-purchase agreements. A minority among repeaters said they would not participate further, but the overwhelming majority of one-time renters indicated that they would not participate in such programs in the future. The chi-square statistic indicates that these differences are significant at the .01 level.

Overall, the reasons for renting-to-own were similar for the two groups (Table 11), but there was one interesting difference. Among one-time renters, getting the product immediately was most important; for repeaters, the lack of a credit check was most important. When the two most important reasons were grouped, immediate availability was first for both groups, with no credit check second. However, well over half the repeaters listed credit first or second, as compared with just over 40 percent of the one-time renters. The results are consistent with the higher proportion of credit denials among the repeaters.

SUMMARY AND CONCLUSIONS

Limitations

Before the implications of these findings are explored, the limitations of the study should be noted explicitly. Because it was drawn from a single area, the sample is not necessarily representative of the population at large. Furthermore, respondents had some association with the Consumer Credit Counseling Service, which may correlate with or have influenced patterns of behavior or attitudes. Sample size is also a consideration, especially in comparing subsets within the sample.

Finally, a possible response bias is inherent in all such studies. Although questions were tested and then presented in as neutral a manner as possible, respondents still may have geared their answers to what they thought the investigator wanted to hear or the respondent may have been reluctant to admit to potential embarrassments, such as having been denied credit or having signed a contract he or she didn't understand.

Summary

The findings provide support for the three research questions stated above. The underlying issue is credit availability (Question 1). Most respondents had been denied credit; the rate of denial was higher for those who rented more than once. This point is recognized within the industry, though it is cast in positive terms by trade publications that report successes in renting to "credit-needy buyers" (Marini 1983, p. 48).

As a credit substitute, most respondents found rental-purchase agreements wanting. Indeed, one of the most obvious features emerging from the responses is the low overall level of customer satisfaction. A message must exist in the fact that nearly three-fourths of first-time customers indicated that they would not patronize rent-to-own programs again. That point is consistent with the respondents' apparent awareness of the high cost involved.

Initially, however, many consumers seemed confused (Question 2). Recall that about one-third of all respondents said they weren't sure what they were getting into when they signed the contract; most of them felt that they had problems as a result. It would be difficult to argue that a market is working well when one-third of the consumers involved are confused or face problems.

The four features of the rental-purchase option that respondents indicated were most attractive all relate to time horizon. Despite having been denied credit, the consumer still can get the product immediately, with low periodic payments. If the consumer has a change of heart, he or she simply can return the product at the end of the rental period. All of this is consistent with a short term horizon (or high rate of discount), as suggested in Question 3 (Andreason 1975).

For most participants, the attractiveness of the program wanes as the realities of the high cost become more apparent. However, some consumers--about 40 percent of this sample--participated in additional rental-purchase programs. The striking feature of consumers in this group is their credit histories; nearly three-fourths had been denied credit. They may be patronizing rent-to-own programs simply because they have no alternatives.

These points outline a preliminary assessment of the rent-to-own market. Rental-purchase agreements appeal to consumers with a history of credit problems. With inadequate information, some participants are confused, and many are disappointed with the arrangement. Those who continue renting may not perceive that they have any other alternative or may simply discount heavily the costs, focusing instead on short-run benefits.

The Structure of Consumer Protection

The preceding section does not provide a basis for definitive judgments, but the evidence of consumer vulnerability suggests the need to examine the adequacy of consumer protection in rental-purchase markets. No Federal legislation covers rent-to-own programs. The Consumer Leasing Act (1976), which promotes "meaningful disclosure" on the terms of leases, applies only to leases of over four months in duration (Consumer Leasing Act 1976, Sec. 102 (2b)). Rent-to-own programs extend contracts only for a week or a month at a time and are, therefore, not covered by the Federal law. Some states require disclosure of rental-purchase terms; the contracts reviewed in conjunction with the cost survey (Tables 1 and 2), for example, provide full disclosure because the Georgia law follows the provisions of the 1976 Act (Official Code of Georgia Annotated 1985, Sec. 10-1-680).

Efforts have been made to amend the Consumer Leasing Act to include rent-to-own programs. Congressional hearings in 1983 documented abuse nationwide (U.S. Senate 1983). At this writing, no action has been taken on Senate Bill 1152. The proposed Consumer Lease and Rental-Purchase Act would extend coverage to rent-to-own programs by abolishing the four month limitation in the 1976 Consumer Leasing Act (U.S. Senate 1983, Sec. 104, p. 6).

The major innovation in the bill concerns advertising. The amendments would require that any advertisement that mentioned the possibility of ownership also would have to state the total cost involved (U.S. Senate 1983, Sec. 117, p. 17). Enacting this provision of the legislation would alter the character of advertising for rent-to-own programs significantly. Advertisements typically refer to "easy terms," with no mention of total cost. There is also an emphasis on avoiding "credit hassles," thus preying on the fears of persons who may have had credit problems or are concerned about applying for credit.

Similar legislation has been considered in a number of states. New York implemented one of the most sweeping laws in 1987. A tag attached to the merchandise must list: 1) the value of the product, 2) the amount of weekly or monthly payments, 3) the number of payments required for ownership, and 4) total cost (New York State Legislature 1986, Sec. 501). The law also requires that costs be mentioned in advertisements under terms similar to those discussed in the proposed amendments to the Consumer Leasing Law above (New York State Legislature 1986, Sec. 505).

All the legislation discussed thus far is geared to improving information flows through disclosure of costs and terms. The New York law, however, contains an additional provision limiting total payments to twice the item's value. This limit on total cost affords protection to consumers even when they fail to assimilate the information that the agency is required to disclose.

Conclusions and Implications

The findings summarized above provide the basis for a preliminary assessment of consumer protection in the rent-to-own market. Lacking access to credit, lower income consumers are induced to try rental-purchase agreements and, in some cases, continue their patronage. The credit problem appears to be associated with the movement of traditional lenders away from small consumer loans. Rent-to-own programs may become the poor's substitute for credit, just as money orders have become their substitute for checking accounts. In that case, consumers should have the same protection that they enjoyed previously.

More complete disclosure is a need that is supported by this research. Some participants indicated confusion about rental-purchase agreements, and as they learned more through experience, many expressed low levels of satisfaction and dropped out. The initial confusion coupled with the capacity to learn suggest that better information before the fact might have altered consumers' behavior.

One cannot conclude, of course, that more complete disclosure of contract terms would be sufficient to induce such a change. However, the probability of change would improve if information on total cost was displayed with the merchandise (as required by the New York law) and included in advertisements. Also, the additional information would provide consumer groups an opportunity to educate consumers about the true cost of renting-to-own.

At the same time, many participants seem to lack alternatives; for that group, additional disclosure would have limited impact (Brandt and Day 1974). Thus, there is also a basis for the kind of protection embodied in the New York law that limits total charges. In effect, the ceiling prohibits what might otherwise be considered an oppressive sales contract (Horvitz 1980, pp. 55-57).

Unconscionable sales are currently illegal under the Uniform Commercial Code (2-302), but definitions are imprecise and case law in this area does not offer clear guidance (Smith and Roberson 1971). State-to-state variations complicate the issue further. A Connecticut court, for example, found in favor of the consumer--a welfare recipient--in a rental-purchase case (based on unequal bargaining power); in a nearly identical case, a Kansas court ruled against the consumer (Pridgen 1986, pp. 3, 21, 22). At the very minimum, however, the concept of unconscionability indicates that "The law is beginning to fight back against those who once took advantage of the poor and illiterate without risk of either exposure or interference" (Smith and Roberson 1971, p. 418).

Industry officials argue that rent-to-own programs simply represent a market response to consumer needs that would not be met otherwise.(7) However, the high costs involved, the dissatisfaction rate, and the high drop-out rate indicated in this sample suggest that the response is flawed. Market change has outpaced consumers' abilities to cope, which suggests the need for public policy initiatives. Those initiatives have been undertaken at the state level, but protection remains uneven. Thus, action should be taken at the Federal level. (7)An industry lawyer was quoted as saying: "We haven't created a market, we've seen a market and provided what people wnat" (Johnson 1985, p. 35).

The preliminary nature of this study means that these are only tentative conclusions. The consistency of the pattern, however, provides direction for additional inquiry. A need exists to explore the question with a larger, more diverse sample, while monitoring the impact of recent policy developments (such as the legislation in New York). Any such investigation should not treat the emergence of rental-purchase agreements as an isolated event but as part of the market for consumer credit. When that is done, it will be possible to provide both a more complete evaluation of rental-purchase agreements and a more balanced assessment of the impact of changes underway in financial institutions.

Table : 1 Cost of Purchasing Identical 19-inch Color Televisions Through Selected Rental-Purchase Agreements*

Table : 2 Imputed Annual Percentage Rates for Television Purchased Through Selected Rental-Purchase Agreements*

Table : 3 Profile of Rent-to-Own Sample: Medians and Percentages, Selected Variables

Table : 4 Participants' Experiences with Rental-Purchase Agreements and Understanding of Contract and Cost

Table : 5 Participants' Satisfaction With Rental-Purchase Programs

Table : 6 Participants' Willingness to Take Part in Rental-Purchase Agreements Again

Table : 7 Most Important Reasons for Participating in Rental-Purchase Programs

Table : 8 Participants' Experiences with and Understanding of Rental-Purchase Agreements, by Participation

Table : 9 Participants' Satisfaction With Rental-Purchase Programs by Participation Rates

Table : 10 Participants' Willingness to Take Part in Rental-Purchase Agreements Again, by Participation Rates*

Table : 11 Most Important Reasons for Participating in Rental-Purchase Programs by Participation Rates
COPYRIGHT 1989 American Council on Consumer Interests
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Author:Swagler, Roger M.; Wheeler, Paula
Publication:Journal of Consumer Affairs
Date:Jun 22, 1989
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