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How Zero Percent EMI Scheme Is NOT Zero Percent

I am sure you would have received, not one but many offers, of interest-free loans.

All you have to do is to buy a certain product like a mobile, laptop, TV, washing machine etc. — and repay the cost in easy monthly installments.

However, beware! Many of these so-called 'Zero Interest' EMI schemes may not be interest-free as proclaimed. The logic is simple... it would be very rare indeed when someone is willing to make a 'loss' by lending you 'free' money.

In other words, there are many ways in which the interest cost could be recovered from you.

Let us look at one (very) simple example of this.

Suppose you wish to buy a smartphone costing Rs.28,000. But you have only Rs.10,000 in your pocket. The dealer, however, offers to sell you your desired smartphone for an upfront payment of Rs.10,000.

For the balance Rs.18,000, he arranges a zero percent loan for you with a bank

As per the terms, all you have to do is to return this money in 6 installments of Rs.3,000 each.

Since you can comfortably afford to pay Rs.3,000 every month and it comes with zero cost, the above offer looks simply irresistible.

zero-percent-emi-scheme

However, we must pause for a moment and think — the dealer, the lender, the product seller are all commercial organizations. Hence...
... Can they afford to give away free money?
... Can their businesses survive for long, if they don't charge any interest?
... Are all these companies charitable organizations?
... How are they making such HUGE profits?

So where's the catch?

The catch is in the innocuous looking 'processing fees'. The lender asks you to pay Rs.500 to process your loan application.  

In very simple terms (which technically is wrong; but I am mentioning it as it is very easy to understand and calculate), paying Rs.500 on an amount of Rs.18000 for a 6-months term works out to a cost of 5.56% to you.

Note: The above working is based on the assumption that the entire sum of Rs.18,000 is repaid at the end of six months. Whereas you are paying EMI every month. Hence, the above calculation is technically wrong.

The correct cost is 9.73% (you can do the IRR calculation in Excel). 

zero-percent-irr-calculation

I am sure that NOW you would agree that the scheme makes economic sense for the bank.

In short, it is NOT a zero interest scheme. You are paying almost 10% cost for borrowing Rs.18,000 for a period of six months (instead of calling it 'interest', they are calling it as 'processing fees'... the nomenclature is immaterial, the cost you pay is real.)

By the way...
...this is one of the many ways to recover interest without the customer being aware (you must always look for the hidden costs, if any)
...there are a few genuine promotional schemes too where nothing is charged to the customer (I hope you are one of those lucky ones to get a 'truly' interest free deal)

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