There are no free lunches and contrary to the common perception, all the parties involved benefit from 0% EMI schemes.
By Sanjeev Sinha, ECONOMICTIMES.COM | 24 Sep, 2013, 01.08PM IST | Economic Times
The Reserve Bank of India has come down heavily on zero per cent or discounted interest rate schemes, and wants them stopped as it feels that consumers have been fooled by such schemes into believing that bank funding comes for free. “Such schemes only serve the purpose of (luring) and exploiting vulnerable customers,” it said in a confidential note to banks just a few days ago.
The central bank has also barred banks from charging discriminatory interest rates on loans for all product categories that don’t attract the zero per cent facility. It wants to stop the current practice where financing takes place on the maximum retail price of the product and not the market price, and wants banks to pass on benefits they get from retailers and brands to consumers.
Industry experts have welcomed the RBI move, but some of them have started questioning the timing of these measures as they believe that such schemes were driving the sales of consumer durables even in a dull economy, but sales may take an instant blow following the central bank’s move, particularly when the festive season is just round the corner.
Surprisingly, even consumers looking to buy consumer goods on easy monthly installments seem to be enjoying such schemes. After all, where else could they find a chance to stagger their payment without paying any interest on the loan amount?
However, before going overboard, you need to know the real cost of such schemes and also how do these schemes work.
“Zero percent finance schemes are quite popular with consumers, and companies use them in an efficient way to attract customers to make purchases, especially for consumer durables, during the festive season,” says Anil Sahgal, director, MAGI Research and Consultants, and co-founder of personal finance consulting portal ‘i-save’.
He says the festive season is a critical sales period for most consumer durable companies and the zero percent schemes play an important role in effective sales promotions. Since most customers do not understand the total cost of the scheme, they happily go for it as it seems like a genuine discount.
“You should, however, always remember that there is no free lunch in life. Therefore, contrary to the common perception, all the parties involved benefit out of such schemes. There is nothing like ‘zero’ or ‘free’ in anything you buy. Similarly, zero interest is nothing but higher discounts that the concerned company or manufacturer offers to the bank or the lender or the financier who in turn passes it on to the end buyer,” says a Mumbai-based financial planner.
These schemes are typically offered by finance companies or NBFCs in conjunction with a manufacturer or dealer network. The schemes basically offer a ‘zero percent’ finance, where a customer typically pays for the financing cost in an indirect manner. The indirect cost will include, for example, paying a processing fee and a significant amount as advance EMIs in addition to the minimum cash down payment. The biggest cost, however, is forfeiting a cash discount which might be available on a cash purchase.
For example, suppose Gopal wants to buy an LCD TV for Rs 36,000. At a major retail store, there is a cash discount of Rs 2000 available on the LCD. However, Gopal does not wish to pay the whole amount cash down and also does not want to spend on his credit card where the interest cost would be high. To avail of the scheme, Gopal will need to pay a processing fee of about Rs 1,000 to the NBFC. He will also have to forfeit the cash discount of Rs 2,000 since the discount is not available on a finance deal. Now, on a loan of 12 months, Gopal will have to pay 4 EMIs in advance, i.e. 36,000 / 12 X 4 = Rs 12,000. So, effectively Gopal has got a loan for Rs 24,000 only. His total cost of taking the loan was Rs 3,000 (processing fee + forfeiting the cash discount). So for 8 months, Gopal paid Rs 3,000 on a loan of Rs 24,000, paying an effective interest rate of 18.75% annualised.
Thus, it goes without saying that “there is more than what is being communicated. It is more of a marketing activity with attractive packaging, rather than providing any real service to the customer,” says Kavi Arora, MD & CEO, Religare Finvest Ltd.
Therefore, buyers who can afford to buy with their own resources should not get lured by such schemes simply because they appear attractive. However, if you must go for any zero finance scheme, you need to take some precautions. For instance, you must check the amount of processing fee to be paid besides checking the advance EMIs required. Also, compare the total cost of the zero finance scheme with the interest cost if any other loan was taken to finance your purchase, e.g. a personal loan by your bank or on your credit card.
“Customers must be aware of the details of the scheme and make an effort to compare these with other options for borrowing. If a customer has a good credit history and is able to establish a personal loan with his or her bank, it may be available at a much lower cost than the effective cost of a zero finance scheme. Also, with a personal loan, a customer has no restrictions on the choice of the product,” says Mr Sahgal.
Thus, you should zero in on any zero percent finance scheme only if you are not being charged extra in the name of fees and charges, and if the cost of the product is the same without finance options. If not, it is better to look for some other options!