24

INSTALLMENT CREDIT AND RETAIL SALES PRACTICES

Despite the fact that more than 90 percent of sales by low-income market retailers was on an installment basis, this group assigned only 20 percent of their contracts. These typically were the largest contracts. Whereas the average value of unassigned contracts was $124 in 1966, the average for contracts assigned was $298 (table III-1).

In all, of the 65 retailers reporting sales on an installment contract basis, 49 assigned all or part of these contracts to finance companies or banks (table III-7). Twenty-one of 22 appliance retailers and 18 of 22 furniture retailers assigned contracts. Four low-income market retailers assigned all and six others assigned some of their installment contracts to finance companies. Only department stores assigned no contracts arising from installment sales.

Finance companies are most actively engaged in the purchase of installment contracts arising from retail sales transactions (table III-3). Seventy-five percent of the total value of contracts assigned was assigned to finance companies, principally by general market appliance stores and low-income market retailers. Banks supplied 25 percent of all installment contract assignment financing, principally for general market furniture retailers. Nearly all of this business was done by four banks. For other retailers, most contracts were assigned to finance companies, four of which supplied 77 percent of the funding. General market appliance stores assigned virtually all of their contracts. Four finance companies took 90 percent of this paper. The pattern of assignments by low-income market retailers (who assigned only one-fifth of their paper) was less concentrated, with the top four finance companies accounting for only 65 percent of reported assignments.

TABLE III-3.-Distribution of total installment contracts assigned to finance companies and banks

1 The total number of finance companies to which contracts were assigned by retailers surveyed was 21. The total number of banks to which contracts were assigned by retailers surveyed was 10.

Source: FTC Survey.

CHARACTERISTICS OF INSTALLMENT CONTRACT ARRANGEMENTS 25

INSTALLMENT CONTRACTS UNASSIGNED

Of the $45.3 million in installment contracts reported for 1966 in the Commission's survey, $29.4 million or 65 percent was unassignedheld by the retailers themselves. The extent to which contracts were unassigned varied considerably by type of retailer. Department stores surveyed held all of their contracts; low-income market retailers held four-fifths (80 percent); and general market furniture stores held over two-fifths (43 percent) of the total value of their installment contracts. General market appliance retailers, however, held practically none (2 percent) of their installment paper (table III-2). In total, of 65 retailers reporting installment sales, 16 held all of their own contracts. They included 3 department stores, 8 of the 18 low-income market retailers, and only 5 of the 44 appliance and furniture stores.

FINANCE CHARGES ON INSTALLMENT CONTRACTS

With one exception, the stated finance charges were calculated on an "add-on" basis by both low-income and general market retailers. This exception was a low-income market retailer who made no separate finance charges in calculating payments due on installment contracts. All of its sales were on a time basis and the price for these goods on the average was three times the cost of goods sold. This markup was somewhat higher than the average for low-income market retailers as a group, who, as a matter of course, added to their selling price additional charges for installment credit.

Other retailers used "add-on" rate charts to determine customers' monthly payments. No account is taken of diminishing balances over the period and, consequently, the "add-on" is not a true or effective annual rate. Table III-4 indicates that the average add-on rate for contracts assigned to finance companies and banks was 11.7 percent of the initial balance, and the average add-on rate for unassigned contracts was 10.7 percent of the initial unpaid balance.

The true or effective annual rate that consumers were paying on these installment contracts was approximately twice the add-on rate. This is because with each payment the amount borrowed was reduced, making the average balance borrowed about half the original unpaid balance. If it is assumed that equal payments are made at equal times (usually monthly) throughout the total period of the contract, the

The new Maryland "Retail Credit Accounts Law," which went into effect June 1, 1967. establishes a maximum of $12 per $100 per annum that may be added to the principal balance on installment contracts that do not exceed $1,000. This is equivalent to a 22 percent effective annual rate of finance charge.

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INSTALLMENT CREDIT AND RETAIL SALES PRACTICES

TABLE III-4.-Finance charges on installment contracts assigned and unassigned by District of Columbia retailers, 1966

One low-income market retailer has been omitted, because it made no separate charges for installment financing.

2 Weighted averages.

Source: FTC Survey.

true or effective annual rate can be calculated by a relatively simple formula called the constant ratio method. This formula was applied and checked with actuarial rate tables to obtain the equivalent effective. annual rates shown in table III-4 and subsequent figure and tables.* For installment contracts entered into by the retailers surveyed, in 1966 the average effective annual rate of finance charges was 21 percent on those assigned to finance companies and banks and 20 percent on those held by the retailers themselves.

3 The constant ratio method assumes that the allocation of the charge is proportional to the number of periodic payments. The formula is as follows:

In this formula i is the effective rate of finance charge per annum; m is the number of payments per year; P is the amount borrowed on principal; D is the financing charge in dollars; and n is the number of payments to discharge the debt. Neifeld, M. R., Neifeld's Guide to Installment Computations, Mack Publishing Co., Easton, Pa., 1951, ch. XI, pp. 193-195; and Board of Governors of the Federal Reserve System, Consumer Installment Credit, vol. I, pt. I (1957), p. 54.

The United States Rule prescribes the actuarial method of computation for finance charges. The use of the actuarial method is proposed in the pending "Truth in Lending" bill and the pending installment sales bill for the District of Columbia. The principle of the United States Rule is that "interest is to be computed on the amount due to the time of the first payment, then the payment applied, if it exceeds the interest up to that time, and a computation made of the interest on the balance to the time of the second payment, and so on." Neifeld, op. cit., p. 317. The effective annual rates shown in Table III-4 and subsequent figure and tables were calculated from "add-on" rates by the constant ratio method and then checked against actuarial tables. Installment contracts for appliances and furniture seldom exceed 24 months. For this time period (under 36 months), the constant ratio method formula provides substantially the same results in effective annual rates as the actuarial method (United States Rule). Effective annual rates in table III-4 and subsequent figure and tables have been rounded to the nearest whole number.

CHARACTERISTICS OF INSTALLMENT CONTRACT ARRANGEMENTS

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Table III-5 shows the distribution of all installment contracts by effective annual rate of finance charge for those retailers reporting charges on installment credit sales. The bulk of installment credit sales by low-income market retailers were at effective annual financing rates of 22 percent or more. Nearly half (47.9 percent) was at rates ranging from 26 to 33 percent.

Contracts arising from sales by general market retailers rarely entailed such high charges. Three-fourths were at finance rates of 20 percent or less. This figure is heavily weighted by department store installment credit sales. Less than one percent of general market retailer contracts had finance charges exceeding 24 percent.

Among general market retailers, only appliance stores had rates consistently exceeding 20 percent. These retailers assigned most of their contracts at effective annual rates of 23 to 24 percent. Thus, virtually all of the contracts involving rates exceeding 24 percent were written by low-income market retailers.

Figure III-1 summarizes the distribution of effective annual rates of finance charges on installment contracts of low-income market and general market retailers for all installment contracts, as well as for assigned and unassigned contracts.

TABLE III-5.—Installment contracts distributed by effective annual rate of finance charge (assigned and unassigned) 1

1

1 Includes all installment contracts for which seaprate finance charges were specified.

Source: FTC Survey.

FIGURE III-1.-Distribution of Effective Annual Rates of Finance Charges on Installment Contracts of Low-Income and General Market Retailers, 1966.

CONTRACTUAL ARRANGEMENTS FOR ASSIGNMENT OF INSTALLMENT CREDIT

To better understand the factors determining finance charges, contracts were analyzed on the basis of whether they were assigned to finance companies and banks or held by the retailers themselves. As