In the festive season, many offline and online retailers are offering deals like Zero Cost EMI or No-cost EMI on different products such as electronic appliances, smart phones, etc.
Purchasing any product on EMI or equated monthly installments helps avoid the difficult burden of coming up with a large lump sum amount upfront. However, we also need to remember that such no-cost EMI deals always have an associated cost that has to be borne by customers. Hence, it is vital for us to know the real cost of such zero cost EMI or no-cost EMI schemes.
A large percentage of online and offline retailers have tie-ups with different banks and financial companies that offer consumer durable loans for the purchase of gadgets, electronic items, etc. Such loans are generally publicized as zero cost loans by these financial lenders. But, the fact of the matter is that the real rate of interest that is charged on these loans is generally quite high and ranges from 15 percent to 25 percent.
What is the law about zero cost EMI or no-cost EMI loans in India?
In September 2013, the RBI or the Reserve Bank of India had issued a circular which stated that the idea of zero percent interest did not exist. The circular clarified that in schemes like zero percent EMI provided on the outstanding amount on credit cards, the interest factor is typically disguised and transferred to the customer as processing fee.
In a similar vein, there were certain banks which were adding the costs acquired while supplying the loan, like the DSA commission, to the relevant RoI (rate of interest) levied on the financial product. As the very basis of zero percent interest does not exist and since fair practice laws require the RoI and processing fees to remain consistent across segments and products, regardless of the supply channel, such deals just served the cause of attracting and taking advantage of susceptible customers.
The only element which can substantiate varied rate of interest for the same financial product, tenure remaining unchanged, is the customer’s credit risk rating. It may however be noted that the risk element may not be valid for retail items where the interest rate is usually kept flat and is unmoved by the risk profile of the customer.
How do zero interest EMI schemes work?
As stated above in the RBI circular, zero percent interest EMI offers are nothing more than a marketing strategy and the cost of interest is always transferred to the customers in some way or the other.
The two main ways in which zero interest schemes work are listed below:
- One of the approaches used is to add the cost of interest to the final price of the item being sold.
- The second approach, often employed by online retailers, is to remove the discount that may have been offered to the customer by the online retailer (in case of upfront payment of the product cost) and then use that discount amount to pay as interest cost to the bank or the financial company.
Presented below is a description of how zero interest EMI schemes work.
- When a discount offered is equal to the cost of interest
This approach is most popular with e-commerce websites that offer no-cost EMI schemes. The online retailers offer discounts that are equal to the total interest which has to be paid to the bank.
For example, if the price of a smartphone on the e-commerce site is INR 20,000. For an EMI plan with 6-month tenure and an interest rate of 15 percent, the total cost of interest would come to INR 3000.
This is how a no-cost EMI scheme offered on online e-commerce sites work:
- The cost of the smartphone is INR 20,000. The discount offered by the online retailer for an upfront payment is INR 3000, thereby making the cost of the phone INR 17,000 with an upfront payment. The interest cost on the EMI plan totals to INR 3000, thereby making the price of the phone under the no-cost EMI scheme to be INR 20,000.
- This essentially means that customers who opt for the no-cost EMI plan end up paying the original cost of the smartphone as installments. The online retailer pockets the price with the discount (INR 17,000) and the remaining amount (INR 3000, issued as discount to the customer and charged as interest under EMI scheme) is paid as interest to the bank. Thus, in reality, the total money paid by a customer for the gadget gets divided into the cost of phone paid to the retailer and the interest paid to the bank. This breakup is however not shown to the customer. If the full discounted price of the phone is paid upfront by the customer to the retailer, then the price of the phone will be INR 17,000 and not INR 20,000 which would be the case in case the customer opts for the EMI scheme.
Thus, in the above example when the customer opts for the 6 months no-cost EMI plan, the EMI per month, after subtracting the discount offered by retailer and adding the interest charged by the bank, comes to INR 2,833.
- When the cost of interest is added to the price of the product
In this method, the zero percent interest EMI plan works via the addition of the interest charge to the cost of the product.
For example, the price of a smartphone that you want to purchase is INR 17,000. Under the no-cost EMI scheme the retailer will sell the phone at a price of INR 20,000. Thus, the interest cost of INR 3000 is already added to the price of the phone that you want to buy. This additional amount (INR 3000) is paid as interest for financing the EMI loan.
We should know that no-cost EMIs are actually a misnomer since the loan cost or interest cost is already a part of the EMI with the exception that the break-up between the cost of the product and the interest cost may not be made available upfront to the customer. The details of the deal/offer can be found if you have a thorough read of the fine print in the terms and conditions.