Is rent to own really cheaper than buying?

You've had a lousy year. First, you lost your job. Then, when the interest rate adjusted on your subprime mortgage, you couldn't make the monthly payments, so the bank foreclosed on your house. You started putting everything on credit cards until the collection agencies started calling. Then, without any other choice, you declared bankruptcy.

Welcome to the no-credit economy, an alternate financial universe inhabited by the 28 million Americans who don't have a bank account and the 23 percent of American families who don't own a credit card [sources: Aversa and Pulliam Weston].

The people in this growing segment of the population cash their paychecks at corner stores that charge a steep fee. If they need some quick cash, they might pawn something or get a high-interest payday loan. And if they need a refrigerator or a new couch, they shop at the local rent-to-own (RTO) store.

For many working poor, it simply isn't possible to purchase big-ticket household merchandise without a credit card or a bank loan. RTO stores like Rent-A-Center and Colortyme are small department store chains that cater to clients with credit problems.

Instead of buying a refrigerator on credit or taking out a loan from a conventional department store, you pay the RTO business a fixed cash amount every week -- let's say $30 -- to rent the refrigerator. If you want to eventually buy the refrigerator, you'll need to complete a set amount of weekly payments, usually around 90.

On the surface, RTO seems like a good option for people without access to credit, but some critics of RTO business practices say it's just another example of predatory lending [source: CoPIRG].

So our question is: Is RTO a good deal, or is it just another way that the poor and creditless get the short end of the stick? Can you actually end up paying less with RTO than other purchasing plans? Keep reading to learn more about RTO and how it all adds up.

How Rent to Own Works

Rent to own (RTO) is a payment plan by which you can buy brand-new merchandise -- furniture, appliances, electronics, computers -- through weekly cash installments.

According to the Association of Progressive Rental Organizations (APRO), a nonprofit group that lobbies on behalf of RTO businesses, there are some distinct advantages to making purchases using the RTO model:

You can own new, name-brand products without a large upfront cash payment or taking out credit.
Renters can return an item at any time. There is no obligation to make the next payment.
People using RTO services won't face a credit check. Bankruptcies and bad credit histories don't matter.
Renters who fail to make a payment will not have a stain on their credit history, since this is a no-credit transaction. However, the merchandise will be repossessed.
You can enjoy lifetime reinstatement at many RTO businesses. This means that if you decide that you can't continue paying for an item right now, the money you have already spent will be credited toward that same item in the future. So if you have to return the refrigerator, you can pick it back up when your next paycheck arrives and you won't have to start back at week one.
Renters who make on-time RTO payments can build a positive credit history. [source: APRO]

The APRO also says that the RTO payment model suits a wide range of potential customers, not just people with credit problems:

Football fans who want to rent a widescreen plasma TV and an extra couch for the big game
Seasonal workers or travelers who want new, high-quality merchandise to use for a few months at a time
Parents who may not want to invest in expensive items like musical instruments or electronics that their child might not like in six months.
People who need to temporarily replace an appliance while it's being repaired [source: APRO]

While these types of RTO customers undoubtedly exist, the main client of an RTO business is what one RTO franchise calls the "moderate-income consumer" [source: Aaron Rents]. These are people with bad or no credit, no savings and few options for purchasing expensive household merchandise.

The RTO model is different from other purchasing options like in-store credit or layaway. In-store credit is a loan financed by the store that incurs interest. RTO is not technically a loan, but a payment plan.

With layaway, a customer makes weekly cash payments toward the purchase of an item, much like RTO. The difference is that the store holds the item -- literally "lays it away" -- until the customer has paid the full amount. Layaway contracts are generally for short periods, like 30 to 60 days, and incur no interest.

The RTO model allows the customer to use the item while making weekly payments, but that comes at a cost. Even though weekly RTO payments seem reasonable -- $30 for a refrigerator or $40 for a nice computer -- they can add up fast.

While RTO businesses claim they don't charge interest (this isn't a loan, remember), there is steep interest built into the payment structure. After all, if you pay $30 a week for 91 weeks for that refrigerator, you've just bought yourself a $2,730 fridge.

Keep reading to learn why RTO purchases might make sense for short-term rentals, but not for long-term purchases.

Cheap to Rent, Expensive to Own

If you want a giant plasma TV for the big game and know that you will return it promptly on Monday morning, then shopping at a RTO store makes perfect sense. For $30, you can enjoy a new, high-quality piece of equipment with no strings attached.

But if your intent is to buy that giant plasma TV and use it for years, then RTO is one of the worst deals around. According to a report by the Federal Trade Commission, 70 percent of RTO merchandise is eventually purchased [source: FTC].

To understand why RTO is a raw deal, let's take a look at the numbers. The RTO store Colortyme advertises a 42-inch (106.7-centimeter) Hitachi plasma TV for 91 payments of $28.99 a week. So if you want to own that TV, you'll pay a grand total of $2,638.09. For comparison, the same TV sells for $949 on Amazon.com plus $113 for shipping.

Here's another example. To buy a Dell Inspiron 530s computer with a 22-inch (55.9-centimeter) monitor from Colortyme, you'll pay $33.99 a week for 91 weeks, a total of $3,093.09. If you bought the same computer directly from Dell.com, it would cost you $799.

Now it's true that few people would pay cash for these items, so let's look at how RTO compares to buying with a credit card. Let's say you have a credit card that carries a relatively high 18 percent interest rate (APR). And let's say that you take 91 weeks to pay off the balance on that $799 computer. You would still only pay a total of $937.44 for the computer. When you break it down by monthly payments, you'd spend $44.64 each month with a credit card and $135.96 a month with the RTO plan.

Back to our question: Is rent to own cheaper than buying? Absolutely not. In the long run, you can end up paying upwards of three times more than retail by using a RTO payment plan.

The RTO industry has come under fire in recent years for violating state usury laws. In 2006, the New Jersey Supreme Court ruled that Rent-A-Center was breaking the law by charging more -- in many cases far more -- than 30 percent interest on its merchandise [source: Burtka]. The court disagreed with Rent-A-Center's argument that its payment plans did not constitute a credit sale [source: FTC].

Even though the RTO industry has been accused of profiting on financial ignorance and gauging the poor, others argue that RTO plays a valuable role for a marginalized segment of the population. If somebody doesn't have any credit, but really wants a nice computer, then he or she should be free to choose RTO as a payment option, knowing that it might cost significantly more in the long run.

Ron Burley of AARP magazine has some advice for people who choose to shop at RTO stores:

Read the contracts carefully. Understand the payment structure and the total price of the merchandise.
Some RTO stores now offer biweekly or monthly payments that may carry lower interest rates. Ask about them.
Ask about an early purchase option in which you agree to pay a set price for the item if you can come up with the cash in 60 to 90 days.
Insist on a lifetime-reinstatement clause, so that even if your item is repossessed, the money you've already spent is credited toward future rental of the same item. [source: Burley]

For more information on credit, debt and personal finances, follow the helpful links on the next page.

Rent-to-own Homes

RTO homes are different than RTO department stores. With RTO homes, a portion of the monthly rent is credited toward the future purchase of the house. The buyer is also required to pay an upfront option fee, which is also credited to the purchase of the house. If the buyer decides not to buy the house, then he loses both the rent credits and the option fee.

Unlike RTO department stores, the eventual purchase of a RTO home does involve credit checks and a conventional mortgage. Learn more at How Rent-to-own Homes Work.

Lots More Information

Sources

Aaron Rents, Inc. (Jan. 20, 2009)http://www.aaronrents.com/
Association of Progressive Rental Organizations. "Rent-to-Own: Cost vs. Value" (Jan. 20, 2009)http://www.rtohq.org/apro-rent-to-own-cost-vs-value.html
Association of Progressive Rental Organizations. "The Rent-to-Own Customer" (Jan. 20, 2009)http://www.rtohq.org/apro-rent-to-own-customer.html
Burley, Ron. AARP Magazine. "Out Bug Bucks and a Bed." Jan. and Feb. 2009. (Jan. 23, 2009)http://www.aarpmagazine.org/money/on_your_side_JF09_rent_to_own_furniture.html
Burtka, Allison Torres. Trial. "N.J. high court restricts interest in rent-to-own contracts." June 1, 2006. (Jan. 23, 2009)http://www.accessmylibrary.com/coms2/summary_0286-15802402_ITM
CoPIRG (Colorado Public Interest Research Group). "Predatory Lending Fact Sheet" (Jan. 23, 2009)http://www.copirg.org/financial-privacy-security/stop-predatory-lenders/predatory-lending-fact-sheet
Lack, James M., Signe-Mary McKernan and Manoj Hastak. Federal Trade Commission. "Survey of Rent-to-Own Customers" (January 27, 2009)http://www.ftc.gov/reports/renttoown/rtosummary.shtm
Shin, Annys. The Washington Post. "Rent-A-Center Settles with California." November 28, 2006 (January 23, 2009)http://voices.washingtonpost.com/thecheckout/2006/11/rentacenter_settles_with_calif.html