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How Zero Percent EMI Scheme is not zero percent


As you might be aware, RBI has raised objection against Zero Percent EMI schemes as many such schemes are effectively not zero percent. 

Let us look at one simple example.

Suppose you wish to buy an LED TV costing Rs.28,000. But you have only Rs.10,000 in your pocket. The dealer, however, offers to give you the TV 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 irr
Zero Percent Scheme IRR

However, we must pause for a moment and think...
...Can a bank afford to give free money? 
...Can it run its business if it doesn't charge any interest?
...Is bank a non-profit charitable organisation?

The answer, of course, is NO. 

So where's the catch?

The catch is in the innocuous looking 'processing fees'. The bank 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.

The above working is based on the assumption that entire 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 IRR calculation in Excel). I am sure now you would agree that the scheme makes economic sense for the bank.  

In short, it is not a zero interest scheme.

By the way...
...this is one of the many ways to recover interest without the customer being aware
...there are a few genuine promotional schemes too where nothing is charged to the customer

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