Recently, I got a promotional email from a bank to convert credit card outstanding to EMIs. The EMI amount will be added to the credit card statement every month.
I have discussed such deal structures in much greater detail in an earlier post. However, there have been a few interesting developments in the payments space that such deals require a fresh look. First, let’s go to the basics and assess the real cost (if it is really 18% p.a.). We will consider a few cases to assess the true cost of such offers.
Case 1 (Rs 7000, 6 months)
For an outstanding amount of Rs 7000, you have to pay Rs 1229 for 6 months. In addition, you have to pay 2.5% transaction fee (one-time) subject to a minimum of Rs 300 in the first month. You also have to pay GST on the interest component of the EMI.
| Credit Card outstanding | ₹7,000 | |||||||
| EMI Tenure | 6 | |||||||
| Interest Rate (Assumed) | 18% | |||||||
| EMI Amount | ₹1,229 | |||||||
Loan Schedule | ||||||||
| Month | O/S at the start of the month | EMI | Interest | Loan repaid during the month | O/S at the end of the month | GST on interest | Fee + GST | Total Monthly outgo |
| 1 | ₹7,000 | ₹1,229 | ₹105 | ₹1,124 | ₹5,876 | ₹19 | ₹354 | ₹1,602 |
| 2 | ₹5,876 | ₹1,229 | ₹88 | ₹1,141 | ₹4,736 | ₹16 | ₹0 | ₹1,245 |
| 3 | ₹4,736 | ₹1,229 | ₹71 | ₹1,158 | ₹3,578 | ₹13 | ₹0 | ₹1,241 |
| 4 | ₹3,578 | ₹1,229 | ₹54 | ₹1,175 | ₹2,403 | ₹10 | ₹0 | ₹1,238 |
| 5 | ₹2,403 | ₹1,229 | ₹36 | ₹1,193 | ₹1,211 | ₹6 | ₹0 | ₹1,235 |
| 6 | ₹1,211 | ₹1,229 | ₹18 | ₹1,211 | ₹0 | ₹3 | ₹0 | ₹1,232 |
| Total payment made | ₹7,793 | |||||||
| Excess payment made | ₹793 | |||||||
| APR (Annual Percentage Rate) | 39.30% | |||||||
Case 2 (Rs 7000, 12 months)
| Credit Card outstanding | ₹7,000 | |||||||
| EMI Tenure | 12 | |||||||
| Interest Rate (Assumed) | 18% | |||||||
| EMI Amount | ₹642 | |||||||
Loan Schedule | ||||||||
| Month | O/S at the start of the month | EMI | Interest | Loan repaid during the month | O/S at the end of the month | GST on interest | Fee + GST | Total Monthly outgo |
| 1 | ₹7,000 | ₹642 | ₹105 | ₹537 | ₹6,463 | ₹19 | ₹354 | ₹1,015 |
| 2 | ₹6,463 | ₹642 | ₹97 | ₹545 | ₹5,918 | ₹17 | ₹0 | ₹659 |
| 3 | ₹5,918 | ₹642 | ₹89 | ₹553 | ₹5,365 | ₹16 | ₹0 | ₹658 |
| 4 | ₹5,365 | ₹642 | ₹80 | ₹561 | ₹4,804 | ₹14 | ₹0 | ₹656 |
| 5 | ₹4,804 | ₹642 | ₹72 | ₹570 | ₹4,234 | ₹13 | ₹0 | ₹655 |
| 6 | ₹4,234 | ₹642 | ₹64 | ₹578 | ₹3,656 | ₹11 | ₹0 | ₹653 |
| 7 | ₹3,656 | ₹642 | ₹54.84 | ₹587 | ₹3,069 | ₹10 | ₹0 | ₹652 |
| 8 | ₹3,069 | ₹642 | ₹46.04 | ₹596 | ₹2,474 | ₹8 | ₹0 | ₹650 |
| 9 | ₹2,474 | ₹642 | ₹37.10 | ₹605 | ₹1,869 | ₹7 | ₹0 | ₹648 |
| 10 | ₹1,869 | ₹642 | ₹28.03 | ₹614 | ₹1,255 | ₹5 | ₹0 | ₹647 |
| 11 | ₹1,255 | ₹642 | ₹18.83 | ₹623 | ₹632 | ₹3 | ₹0 | ₹645 |
| 12 | ₹632 | ₹642 | ₹9.48 | ₹632 | ₹-0 | ₹2 | ₹0 | ₹643 |
Total payment made | ₹8,181 | |||||||
| Excess payment made | ₹1,181 | |||||||
| APR (Annual Percentage Rate) | 31.21% | |||||||
Let’s look at the impact if the amount is higher.
Case 3 (Rs 70,000, 6 months)
| Credit Card outstanding | ₹70,000 | |||||||
| EMI Tenure | 6 | |||||||
| Interest Rate (Assumed) | 18% | |||||||
| EMI Amount | ₹12,287 | |||||||
Loan Schedule | ||||||||
| Month | O/S at the start of the month | EMI | Interest | Loan repaid during the month | O/S at the end of the month | GST on interest | Fee + GST | Total Monthly outgo |
| 1 | ₹70,000 | ₹12,287 | ₹1,050 | ₹11,237 | ₹58,763 | ₹189 | ₹2,065 | ₹14,541 |
| 2 | ₹58,763 | ₹12,287 | ₹881 | ₹11,405 | ₹47,358 | ₹159 | ₹0 | ₹12,445 |
| 3 | ₹47,358 | ₹12,287 | ₹710 | ₹11,576 | ₹35,782 | ₹128 | ₹0 | ₹12,415 |
| 4 | ₹35,782 | ₹12,287 | ₹537 | ₹11,750 | ₹24,031 | ₹97 | ₹0 | ₹12,383 |
| 5 | ₹24,031 | ₹12,287 | ₹360 | ₹11,926 | ₹12,105 | ₹65 | ₹0 | ₹12,352 |
| 6 | ₹12,105 | ₹12,287 | ₹182 | ₹12,105 | ₹0 | ₹33 | ₹0 | ₹12,319 |
| Total payment made | ₹76,455 | |||||||
| Excess payment made | ₹6,455 | |||||||
| APR (Annual Percentage Rate) | 31.67% | |||||||
Case 4 (Rs 70,000, 12 months)
| Credit Card outstanding | ₹70,000 | ||||||||
| EMI Tenure | 12 | ||||||||
| Interest Rate (Assumed) | 18% | ||||||||
| EMI Amount | ₹6,418 | ||||||||
| Loan Schedule | |||||||||
| Month | O/S at the start of the month | EMI | Interest | Loan repaid during the month | O/S at the end of the month | GST on interest | Fee + GST | Total Monthly outgo | |
| 1 | ₹70,000 | ₹6,418 | ₹1,050 | ₹5,368 | ₹64,632 | ₹189 | ₹2,065 | ₹8,672 | |
| 2 | ₹64,632 | ₹6,418 | ₹969 | ₹5,448 | ₹59,184 | ₹175 | ₹0 | ₹6,592 | |
| 3 | ₹59,184 | ₹6,418 | ₹888 | ₹5,530 | ₹53,654 | ₹160 | ₹0 | ₹6,577 | |
| 4 | ₹53,654 | ₹6,418 | ₹805 | ₹5,613 | ₹48,042 | ₹145 | ₹0 | ₹6,562 | |
| 5 | ₹48,042 | ₹6,418 | ₹721 | ₹5,697 | ₹42,345 | ₹130 | ₹0 | ₹6,547 | |
| 6 | ₹42,345 | ₹6,418 | ₹635 | ₹5,782 | ₹36,562 | ₹114 | ₹0 | ₹6,532 | |
| 7 | ₹36,562 | ₹6,418 | ₹548 | ₹5,869 | ₹30,693 | ₹99 | ₹0 | ₹6,516 | |
| 8 | ₹30,693 | ₹6,418 | ₹460 | ₹5,957 | ₹24,736 | ₹83 | ₹0 | ₹6,500 | |
| 9 | ₹24,736 | ₹6,418 | ₹371 | ₹6,047 | ₹18,689 | ₹67 | ₹0 | ₹6,484 | |
| 10 | ₹18,689 | ₹6,418 | ₹280 | ₹6,137 | ₹12,552 | ₹50 | ₹0 | ₹6,468 | |
| 11 | ₹12,552 | ₹6,418 | ₹188 | ₹6,229 | ₹6,323 | ₹34 | ₹0 | ₹6,451 | |
| 12 | ₹6,323 | ₹6,418 | ₹94 | ₹6,323 | ₹-0 | ₹17 | ₹0 | ₹6,435 | |
| Total payment made | ₹80,338 | ||||||||
| Excess payment made | ₹10,338 | ||||||||
| APR (Annual Percentage Rate) | 26.99% | ||||||||
And you thought you were paying only 18% p.a. Most of us think only in terms of absolute cost (and not in terms on interest cost). For cases 1 and 2, the excess amount paid is Rs 793 and Rs 1,181. Many of us may be fine with this small excess payment. However, for cases 3 and 4, the excess payments are Rs 6,455 and Rs 10,338. Now, these amounts are quite substantial, and you can’t ignore these. The excess amount will go up as the outstanding amount goes up.
Why Did the Effective Cost of Loan Go Up?
As you can see, in the examples discussed, the effective cost of loan (APR) ranges from 26.99% p.a. to 39.30% p.a. This is nowhere close to 18% p.a. you thought you had to pay. How did the effective cost go up?
There are two culprits.
- Processing fee (and GST on such fee)
- GST on interest component of EMI
GST on the interest component of the EMI took the cost from 18% to 21.24% p.a. Processing fee was responsible for the remainder of the hike in effective cost.
In absence of any processing fee, the cost of loan would have been 21.24% p.a. That’s what an upfront processing fee can add to your cost of loan. Since the loans under consideration are short term, the impact of the processing fee is quite high. It is for this reason you must never ignore processing fee, especially for short term loans. Do note the communication mentioned about the processing fee (but was silent about its impact). The communication was completely silent on the GST on interest part.
What Should You Do?
Depends on where you stand.
#1 If You Have Already Made the Purchase
Do you have an option? If you have already made a purchase and you don’t have enough funds to pay the credit card bill in full, you will have to cough up a much higher rate of interest (if you do not convert outstanding to EMIs). After including penalties and taxes, the net cost can easily be in excess of 40% per annum. Not just that, you lose the privilege of interest-free credit period i.e. for your fresh purchases, you have to pay interest from day 1. Your credit score will also be adversely affected.
In such cases as mentioned above, converting your outstanding into EMIs can be a very good option. This conversion will not only bring down the rate of interest but you continue to enjoy interest-free credit period for fresh purchases. Your credit score will not take a hit either.
If the amount involved is quite large, you can also consider a personal loan. You can subsequently use the loan amount to square off your credit card liability. The rate of interest on a personal loan is likely to be much lower, especially if you have a good credit score. Since there is some effort involved in getting a personal loan, such effort is justified if the amount involved is big. You wouldn’t want to undertake this effort to save Rs 1,000.
#2 If You Have Not yet Made the Purchase
This is where things have got quite interesting over the last couple of years. Now, many e-commerce websites and retailers offer you option of No-cost EMI on both debit cards and credit cards. Therefore, if you foresee cashflow pressure in the coming months, it is better to sign up for such No cost EMI deals (if such deals are available). You will save a good amount by avoiding any interest payments.
Even when No cost EMI deal is not available for a particular purchase, you can sign up for regular EMI deal while making the payment where you may have to pay a much lower interest rate.
By the way, No cost EMI or any EMI is not an option if you have to swipe your card to meet exigencies (say hospitalization). For other cases, as I always maintain, avoid spending money you don’t have or can’t afford. If that’s not possible, explore the EMI options discussed above.
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