The great Indian festive season (that started in August) just got over with Diwali. Be it a house, vehicle or a gadget, you can get good deals on all the products that you have been planning to buy for a long time during festive seasons. The sellers and the banks/finance companies can provide you relief in one of the ways:
- Discount/Waiver on the processing fee
- A lower interest rate
- Better flexibility on loan repayment. In some cases, you may get a moratorium on principal repayment or pre-payment penalty waiver.
- Upfront discount on the purchase. This happens if there is an arrangement between the seller and the lender. A No-cost EMI works on this concept only. The seller provides an upfront discount to you (only if you opt for No-cost EMI) and rest of the loan works in the same fashion. The loan processing fee is waived too but there is a minor GST impact.
- Some cashback or gifts on the purchase. Since these are upfront benefits, these are akin to discount on the processing fee.
I have written about festive loans in an earlier post. In this post, let’s look at what types of concessions are likely to be best for you.
Which Type of Discount Is Better?
In my opinion, there cannot be a fixed answer. There can be a different answer for each case involved.
One of the ways to compare is to calculate the impact of the discount on your overall cost of your loan. The intent is to bring down each loan to the same currency and we can compare various offers on the effective cost. If the effective cost is 12% with Offer A and is 13% with Offer B, we know that the Offer A is better.
Discount on the Processing Fee
The impact of the discount on the processing fee on the loan amount is higher for the short-term loans. We have discussed this in an earlier post.
- The effective cost of Rs 1 lac loan (10% p.a., 1 year) is 12.25% p.a. if you include 1% processing fee.
- The effective cost of Rs 1 lac loan (10% p.a., 3 years) is 10.82% p.a. if you include 1% processing fee.
- The effective cost of Rs 1 lac loan (10% p.a., 20 years) is 10.17% p.a. if you include 1% processing fee.
The impact goes down for the long-term loans. Why? The processing fee is spread over the long term. Clearly, the impact will be much higher for both long term and short-term loans if the processing fee is higher. However, if the loan is short-term, you need to be more mindful of the processing fee. A discount on the processing fee will be very beneficial for a short-term loan.
From a borrower’s point of view, you need to be sure that you are not indulging in a simple give and take. For instance, the effective cost of a Rs 1 lac (10% p.a., 1 year, 1% processing fee) loan is same as Rs 1 lac loan (12.25%, 1 year) with no processing fee. For a short-term loan, lender A can reduce interest rate and more than make up for it by subtly hiking the processing fee. As borrowers, we usually focus on the interest rate. And this may be a mistake.
A Lower Interest Rate
For long term loans, a lower interest rate is better. However, there are limits to what lenders (especially banks) can do. Long term loans are not usually offered at fixed rates. Floating rate loans are given at a credit spread over an external benchmark and the banks can’t change spread just like that. RBI does not take kind view of teaser loans (low interest rates initially and higher rates later). Even if they did, it is likely to be a tricky choice. For more on this topic, refer to this post.
However, just to give an idea, for a Rs 50 lacs loan for 20 years, you save Rs 3.94 lacs over 20 years if the interest rate was 9.5% p.a. (compared to 10% p.a.).
Flexibility in Repayment
There may be offerings with moratorium on principal repayments for a few years (Step-up loans). This results in higher loan eligibility and perhaps better affordability too. There are issues though. Firstly, now such products are available round the year and not just in the festive season. Secondly, the total interest that you pay over the long term is higher.
Floating rate loans don’t have any prepayment penalty. Fixed rate loans may have. A waiver of pre-payment penalty can be useful if you want to close the loan soon.
Upfront discounts are extremely attractive for both short-term and long-term loans. And that’s a no brainer too. Discounts on the purchase amounts translates into relief on loan payments.
Everything else being same (10% p.a., 20 year loan tenure), you need to pay Rs 11.58 lacs less over 20 years on a Rs 45 lacs loan (as compared to Rs 50 lac loan).
You would pay Rs 7.63 lacs less on a Rs 45 lacs loan (10%p.a., 20 years) as compared to a Rs 50 lacs loan (9.5% p.a., 20 years).
Therefore, your energy is better spent on getting the product deal right.
What would you prefer, a 5% upfront discount or a 1% waiver on the processing fee? You can see upfront discounts of 5-10% for online sales or consumer durable sales. If you are negotiating on real estate purchases, the discounts can be even bigger from the initial quoted price. Processing fees are never in that range. Hence, upfront discounts will almost always win.
Learning: If possible, negotiate the product deal and the loan deal separately.
No-cost EMIs are regular loans with upfront discount and NIL processing fee. And we can see the impact. The effective cost for you is 0% (Barring some GST impact on interest payments). Therefore, these deals can be attractive too.
As a buyer and a borrower, you would need to look at all the aspects — Upfront discounts, lower interest and concessions on processing fee. If you can salvage a big upfront discount, it will almost always win. Between interest rates and processing fee, a lot will depend on loan tenure, along with rate and processing fee differential.
Here is a case for you to figure out.
- Flipkart offers you 10% discount. Nil Processing Fee. Credit Card EMI at 15% p.a. EMI for 6 months.
- Amazon offers no discount. No cost EMI. EMI for 6 months
- Local showroom offers 15% discount. 0.5% processing fees. 15%. EMI for 6 months.
Which one is a better deal?