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Monday, October 17, 2011

Layaway Plans, Personal Finance and Consumer Behavior

There was an op-ed by Louis Hyman (author of Debtor Nation: The History of America in Red Ink)in last week's NYTimes about the reappearance of the layaway plan. A layaway plan is where a shopper pays a small fee (about $5-$10) and a down payment (usually 10%) in order to make payments toward an item. The shopper can't take the item until the payments are made. The payments typically must be made within 2-3 months. If the shopper is unable to make all the payments, the store returns the money that has been paid, less the plan fee. Some plans, like Walmart's, will also charge a cancellation fee (of $10). Hyman notes that:

"...as a financing option, layaway is decidedly worse than most credit cards. Imagine a mother going to Wal-Mart on Oct. 17 and buying $100 worth of Christmas toys. She makes a down payment of $10 and pays a $5 service fee. Over the next two months she pays off the rest. In effect, she is paying $5 in interest for a $90 loan for two months: the equivalent of a credit card with a 44 percent annual percentage rate, a level most of us would consider predatory.

In comparison, even a card with an 18 percent A.P.R. would charge only half as much interest — and she could take those presents home the same day.

Then consider what would happen if she couldn’t finish all the payments. Wal-Mart would give her the money back, less $10. If she borrowed that $90 and paid $15 in interest for two months, she would have the equivalent of a jaw-dropping interest rate of 131 percent."

These are all very good points, but there are also good reasons why layaway plans may be a better option for some consumers. Unlike with credit cards, a consumer can't charge astronomical sums without being aware of it. It's easy to do that when you use credit --$20 bucks here, $5 bucks here -- the numbers add up, and it's the rare consumer who keeps a running, cumulative tally of their various credit purchases. While the interest rate might be high using Hyman's hypothetical, there is a limit on the hurt a consumer feels.  That's not necessarily the case with credit cards. A consumer who fails to pay the entire balance on a credit card gets charged a penalty. That, plus the balance on the credit card, plus interest on that new bigger balance, gets carried over until the following month. The consumer feels okay about it as long as minimum payments are being made -- even though the size of the debt may be growing.  And the size of the debt is likely to be growing because, even if the entire balance hasn't been paid off, additional purchases are likely being made, adding to the outstanding balance (upon which interest and fees are being added)....You get the picture. This is the debt rabbit hole that a layaway plan helps a consumer avoid.

The fact that the shopper can't take the item home that day is probably the biggest benefit to a layaway plan. Shoppers like shiny new things. They see them and want them now. If they pay for something knowing they don't get it right then, they might be less impulsive about their purchases. In addition, a layaway plan protects a shopper against his or her own cognitive limitations (and who doesn't have them?) You may not really need that new flat screen t.v., but you just won't listen to reason. You come to your senses a week later, but rather than being out a thousand dollars and stuck with an item you no longer want, you're out the service fee and the cancellation fee ($10-15 dollars usually). You haven't fallen into the rabbit hole of consumer debt over that bad purchase.

This is not an endorsement of layaway plans, just an acknowledgment that the reality of personal finance is not as simple as the numbers on the page. Personalities and circumstances affect whether a certain strategy is for you. Some people can't control their drinking, so they abstain. Some people know they can't control their spending, and so they cancel their credit cards and pay in cash if they have it, or put their items away on layaway. It's not just a financial plan, it's a financial and behavioral strategy.

Now for the contract's angle:

Read the fine print. Credit card companies nabbed many customers with their fine print. Customers interested in layaway plans should read and understand the terms of the plan. They should read the fine print. The cancellation fee for the WalMart plan is in very small letters and easy to miss.

Get the specifics. In writing. Information about layaway plans that are available on retailer websites are big on touting things you can buy but skimpy on the specifics of the plan. The Best Buy plan, for example, doesn't explain how much of your money is refunded in the event of cancellation. The consumer may expect all of it, but does that include the down payment? I think it does and hopefully if the retailer tries to argue that it doesn't, a court will interpret the provision against the drafter. But a consumer never wants to get involved in litigation over something like this. Anyway, there's probably a mandatory arbitration clause in the layaway contract so a consumer would be out of luck....The confusing nature of layaway plans is especially troubling where the consumer is not a native English speaker. Terms that deviate from the "standard" terms of a layaway plan (i.e. where the downpayment and all payments are not returned in the event of cancellation) should be scrutinized very carefully. (Language issues in consumer contracts require a standalone post, there's so much to say on that topic!)

Layaway plans make me think of Williams v. Walker Thomas, the famous unconscionability case. Although that case involved a payment installment - and not a layaway - plan, it raised the same issues regarding consumer wants and needs, behavior, fine print, bargaining power, and alternatives. Funny, whenever I bring up layaway plans in discussing the case in class, most of my students have no idea what they are. I wonder if that will change.

[Nancy Kim]

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Comments

Part of the issue is not just the high effective interest rate, but the low risk faced by the store relative to a traditional consumer lender.

The enforcing lender in a layaway has collateral whose fair market value is ipso facto the retail price of the goods. They will suffer no loss as they would had they hypothetically had a purchase money security interest and repossessed (the situation of atypical rent-to-own store), nor will they have any repossession costs.

Indeed, the layaway store, upon default, loses not money lent or property, but a potential sale, and barring the rare sold out product that can't be restocked, it is a sale that they would not otherwise have made. In the case of a rare sold out product that can't be restocked, it will surely be promptly sold at full retail price, so the store has lost only its cost of capital for three months or so, perhaps 1-2% of the wholesale price and a tiny fraction of the rental cost of the space it takes to keep the layaway good - $10 probably overstates this cost even for an expensive item.

Basically, this is a zero risk loan to the extent that it is a loan, in which there is no unjust enrichment from possession for the buyer.

The better argument in support of such fees is that more often than not the item on layaway will be an expensive one (e.g. a $2,000 plasma TV or set of appliances), driving down the APR considerably, and that the fees charged approximately the actual retail employee salaries incurred to process the transaction. The materiality of the $5 or $15 fee may also be influenced is the layaway buyer is allowed to lock in a price for a short term sale that may be a better deal (although that situation makes the fee charged for not completing the sale seem even more abusive).

Posted by: ohwilleke | Oct 17, 2011 4:10:44 PM

You raise good points. Again, my post wasn't to argue in favor of layaway plans generally - but to point out that sometimes seemingly irrational financial decisions are not that irrational in light of human behavior. Thanks for commenting.

Posted by: Nancy | Oct 19, 2011 2:12:19 PM

I completely agree Nancy, sometimes what is better on paper just doesn't make the most sense in reality. I can definitely understand shoppers opting for a layaway option with the right circumstances. There are plenty of people who are plain afraid of credit, and the idea of unsecured debt really bothers them. The piece of mind that comes from layaway seems to be a good solution for many.

Posted by: Benjamin Skinner | Jan 31, 2012 9:06:36 AM

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