The Curious Case of 0% EMI Schemes

You were shopping for the latest sofa designs on a leading furniture website. When you moved to payment page after finalizing the product, you saw 0% EMI option on the payment page. On selecting the option, you saw names of a few finance companies with the offer details. You noticed none of the offers was from a bank. Such schemes intrigued you. What was in it for the finance companies to offer such schemes? Moreover, you wanted to know why none of the banks was offering such scheme.



You are right. Banks won’t miss out on any money making opportunities unless there is a regulatory intervention. Earlier, even banks used to offer zero percent EMI schemes on purchases on their credit cards. However, Reserve Bank of India had banned such schemes from banks in 2013. So, you won’t see such zero percent schemes on offer from credit cards from banks. From banks, you will get an option to convert the purchase amount into EMI. For such EMIs, the interest rate is typically 12-15% p.a. The focus of this post is not such EMI schemes from credit cards.

Here, I want to highlight zero percent EMI schemes from other Non-Banking Financial Companies (NBFCs). Some of the NBFCs you must have heard of are Bajaj Finserv, Mahindra Finance, Shriram Transport etc. In such schemes, the interest rate is actually zero or so you are told. Since the aforesaid RBI notification applied only to banks, it is safe to assume that these NBFCs can continue to offer such 0% percent EMI schemes. These zero percent EMI schemes are likely to puzzle most of us.  What do NBFCs gain by offering such schemes?

Where Is the Catch?

As a customer, this deal sounds too be good to be true. What is in it for the NBFC?  How do they make money in this transaction? Let’s see the reasons.

  1. Discounts from Retailer: Firstly, NBFCs get some discount from the retailer. This is how the agreement between the retailer and the finance company is structured. For instance, if you make a purchase for Rs 50,000 and avail EMI option from the finance company, the finance company will pay only say Rs 47,500 to the retailer i.e. the retailers absorb the cost partly. Now, you can ask why a retailer will agree to such an agreement. Simple, it helps them drive sales albeit for a minor hit on the margins. And you shouldn’t be surprised at this minor hit given the discounts these retailers are offering from their pockets.
  2. Processing Fees: These finance companies typically charge processing fees to the customers. For instance, on a purchase of Rs 25,000, you will be charged a processing fee of say, Rs 749 on the transaction. Hence, you will be paying Rs 25,749 for your purchase of Rs 25,000. The processing fees is paid upfront and hence not included in the loan amount.
  3. Partial Down payment Required: You may be asked to make down payment for a certain percentage of the purchase amount. Hence, the actual loan amount goes down.

Please note the information about the discounts from the retailers is not available in the public domain. However, from what I have learnt by talking to people in the sector, finance companies share the cost with the retailers. Moreover, not all the features mentioned above will be part of every deal. For instance, in some deals, the finance company may not get any discounts from the retailers. Some deals may not ask for any down payment. The extent of discounts, level of processing fees and the down payment requirement will vary across deals.

Illustration

Let’s try to understand what the NBFC stands to make in this entire transaction. Let’s assume you make a purchase of Rs 50,000 on the website. Retailer shares 5% of the purchase amount. You need to make down payment for 20% of the purchase amount. Processing fee of Rs 750 shall be charged for the transaction. Let’s see the return on investment to the NBFC in various scenarios.

Scenario 1: Retailer discount, down payment and processing fees are considered

Purchase Amount (A)50,000
Shared by Retailer (5%) (B)2,500
Down Payment by Customer (C) (20%)10,000
Processing Fees (D)750
Effective Loan Amount (E)= (A)-(B)-(C)-(D)36,750
Loan Tenor (in  months) (F)6
EMI Amount (G) = (A-C)/(F)6,667
Effective Return (Monthly)2.48%
Nominal Annualized Percentage Return (APR)29.72%

The return is huge at 29.72%. Almost in line with what credit card companies/banks make on credit card debt.

Scenario 2: No down payment requirement. Only retailer discount and processing fees

Purchase Amount (A)50,000
Shared by Retailer (5%) (B)2,500
Down Payment by Customer (C)
Processing Fees (D)750
Effective Loan Amount (E)= (A)-(B)-(C)-(D)46,750
Loan Tenor (in  months) (F)6
EMI Amount (G) = (A-C)/(F)8,333
Effective Return (Monthly)1.95%
Nominal Annualized Percentage Return (APR)23.46%

Still very high at 23.46% p.a.

Scenario 3: No retailer discount. Only down payment requirement and processing fees

Purchase Amount (A)50,000
Shared by Retailer (5%) (B)
Down Payment by Customer (C)10,000
Processing Fees (D)750
Effective Loan Amount (E)= (A)-(B)-(C)-(D)39,250
Loan Tenor (in  months) (F)6
EMI Amount (G) = (A-C)/(F)6,667
Effective Return (Monthly)0.54%
Nominal Annualized Percentage Return (APR)6.52%

The return falls to a low 6.52% per annum.

Therefore the key is the sharing arrangement with the retailer. The NBFC will struggle to make money in absence of such an arrangement.

What Is in It for You?

As a customer, you don’t care what the discounting arrangement between the retailer and the financier is. All you need to care about is the cost of borrowing for you. Let’s see what the cost of borrowing is for you in the above example. In fact, the return to the bank when retailer arrangement is ignored is your cost of borrowing.

Customer Scenario

Purchase Amount (A)50,000
Shared by Retailer (5%) (B)
Down Payment by Customer (C)10,000
Processing Fees (D)750
Effective Loan Amount (E)= (A)-(B)-(C)-(D)39,250
Loan Tenor (in  months) (F)6
EMI Amount (G) = (A-C)/(F)6,667
Cost of Borrowing (Monthly)0.54%
Nominal Annualized Percentage Return (APR)6.52%

Hence, it is a good deal from customer perspective. You won’t get such cheap finance elsewhere. Even home loans are more expensive. The reason is that the retailer is sharing the burden of the loan to drive sales.

Please understand these schemes are not exclusive to online shopping. You will find such offers in brick and mortar shops too.

Editor’s Note: It is a good deal for the customer in this example. That may not be the case for all purchases. Also, you could lose out on the discount (which is now transferred to the NBFC instead). You also need to calculate the APR before availing the loan.

What Should You Do?

It is quite clear from the above examples that the cost of borrowing is quite low for the retail customers. However, I would still advise readers to stay from such schemes and make complete payments for the purchase. The reason is more psychological than financial. If you get fond of such schemes, you will be tempted to buy things that you don’t really need. You will start making purchases just because you can afford to. I have seen people do that. If it was so easy to control these urges of entitlement, we wouldn’t see so many people struggling with credit card debt.

The more you participate in such schemes, the higher will be your EMI burden and the less you will be left with to invest for your long term financial goals. So, use these zero percent schemes only in cases of emergency.

Personally, I cannot think of any such emergency situation. They won’t  offer such EMI schemes for your hospital expenses. Can you think of one?