Liebrary: How companies hide excessive interest rates on loans

One of the tell-tale signs of a rip-off is an extortionate interest rate. You don't need to look as far as the £9 billion British banks put aside to compensate consumers for their infamous Payment Protection Insurance rip-off. Britain's high-street banks charging up to 800,000% interest on unauthorised overdrafts provides a clear sign of what they are up to.


But it is not enough to simply look for ludicrous interest rates to spot a rip-off. Being wicked doesn't make a chap stupid. And anyone who paid attention in that maths lesson about percentages back when they were teenagers would be able to come up with this scam. If the inclination, or rather the incentivisation, took them.


A report by Barnardo's, the childrens' charity, highlights how poor families are ripped off by extortionate credit charges. The report, "A vicious cycle: The heavy burden of credit on low income families" states:


"Barnardo’s has found that an individual could pay £780 more when buying through rent-to-own companies than through the high street. 


In this example the person would face a premium of over £150 on the list price of a washing machine when purchased through rent-to-own. This is before interest of around £215 paid over three years. 


Perhaps more shocking is the premium paid on service cover. Two additional years service cover (on top of the statutory one year guarantee) costs £382 through the rent-to-own scheme. Three additional years taken from a high street retailer costs around a third of the price, at £130. There appears to be no clear rationale for this premium paid by low income families on service cover. 


The total cost through rent-to-own credit comes in at over £1,250 compared to £470 when bought from a high street retailer. "

Part of the rip-off in the above example involves two additional years service cover costing £382 on top of the statutory one year guarantee. The rent-to-buy company enforcing this claim that as the item is only being 'rented' they need to know it is being properly maintained. However their price is nearly three times higher than the cost of £130 for the same cover bought in the high street. Nasty and brutish.


Putting aside the brutish scam on the extended guarantee, the more elegant though equally nasty mathematical part of the scheme works like this:


You want a fridge-freezer, and decide on this one.


This fridge was available in Sainsbury's for a cash price of £575.


The "rent to own" company would charge you £1,043.64 to pay for this over 156 weeks (3 years).


Their stated interest rate is 29.9% - which as an interest rate sounds within the bounds of reasonableness.


However, the rip-off is they keep the interest rate low by putting the 'cash price' up to £724.97.


By putting up the 'cash price', the effect is to make the 'cost of credit' lower. 


By making the 'cash price' £150 more than Sainsbury's, the cost of credit is magically reduced by £150.


Rent to Buy price is £1,043.64.
If this was based on the Sainsbury's price of £575, then the cost of credit is £468.64  (£1,043.64 - £575 = £468.64)


By putting the "basic price" up to £724.97, the cost of credit has "dropped" to £318.67 (£1,043.64 - £724.97 = £318.67)

The result, the 'rent to buy' company can claim to be charging 29.9% interest. When the true interest, based on the far better Sainsbury's price, would be more like 54%. 


At its most cynical extreme, a vendor could set the "basic price" to £1,043.64, and then advertise the fridge, quite mathematically truthfully, at Zero Percent!  What a bargain rip-off!!


And that's one way to hide an excessive interest rate.