# Why did RBI ban 0% EMI schemes?

I recently met my long-time friend at his home for a tea. This childhood friend of mine is a geek and eventually the conversation drifted to his new purchase, a Mac Mini. He was very enthusiastic about his new purchase and was thrilled about getting it under the zero percent EMI scheme. The conversation went something like this:

Friend – It was a great deal. Instead of lump sum ₹40,000, I can now pay an EMI of ₹6,667 per month for 6 months under the 0% interest scheme.

Me – But why didn’t you pay upfront? Maybe there was a discount if you paid the full price upfront at the time of purchase.

Friend – Not in this case. So, I would have appeared stupid to pay the entire amount upfront when they were offering it at 0% interest rate.

Me – 0% interest rate? What about the processing fees?

Friend – That was nominal. Only ₹1,600. I know its only 4% of the purchase price. Its no big deal.

Me – But you have to pay it back in 6 months, not one year.

Friend – Umm…in that case its 8% interest rate then. Still not that bad.

My geek friend’s father, a retired banker, had tuned into our conversation by then.

Friend’s father – Its 8% flat rate.

Friend – What do you mean?

Friend’s father – In flat rate, interest is calculated on the full amount borrowed for the entire loan tenure irrespective of monthly payments. In reducing balance method, the interest is calculated on outstanding amount and not on the entire amount borrowed. So you are effectively paying 14.15% interest rate on your computer purchase. Who is dumb now?

My geek friend sulked for the rest of that evening. But you don’t have to…because RBI banned the 0% EMI schemes few weeks ago. The next time you purchase a car, a gadget or a household item on an attractive EMI scheme, use our loan calculator to check the loan APR before the purchase. Loan APR, which is expressed as a yearly percentage rate, represents the true cost of your loan after taking into account the loan interest rate plus the fees & charges that you pay when getting a loan.

## So why did RBI ban 0% EMI schemes?

Pricing disparity – Many a times, the same product is priced differently depending on whether you pay using a) cash b) debit card OR c) opt to finance the product. Typically, you get a discount only if you pay the full amount in cash whereas you lose the discount if you purchase it under the EMI scheme. There are also instances where merchants levy a percentage of the transaction value as charges on customers who make payments through debit cards. Banks either turn a blind eye to such practices or collude with merchants to make this happen.

Hidden interest rate – The interest element is often camouflaged and passed on to customer in the form of processing fee. The very concept of zero percent interest is non-existent. Such schemes only serve the purpose of alluring and exploiting the vulnerable customers. Except in a few cases, banks aren’t allowed to provide loans below their base rate.

Artificial demand – About 20-30 percent of consumer goods sales happen via such zero percent EMI schemes. Such schemes result in sentiment-driven purchases and artificially inflate demand. This leads to low-growth, high-inflation scenario. Ex: Sales of ultra-expensive iPhone rose 400% in just a few months after it introduced the EMI and cash back schemes. It changed the consumer perception from iPhone being a high-end product to an affordable one. As an immediate after effect of ban on 0% EMI schemes, sales of consumer goods sank to a 10-year low during the festival season. No wonder, big retailers aren’t happy.

## The big question

The bigger question is: When should you opt to pay lump sum vs. EMI, irrespective of the whether its 0% interest rate or not? Like we wrote earlier, EMI can be a boon or bane depending on the purpose.

It makes financial sense to pay EMI on a loan (with reasonable interest rate) that is used to build or pay for an appreciating asset (ex: well-timed purchase of an affordable home or a college education). It gets better when its coupled with tax benefits.

On the other hand, the highway to uncontrolled debts is to pay EMI for fast-depreciating assets (ex: expensive technology gadgets, home appliances or even a car). It gets worse if you lose sales discount with this option.

“Easy EMI schemes” are anything but easy when its time to pay them every month. Today’s youth is slowly being led to think along the lines of “Can I afford the monthly payment?” instead of “Can I really afford this item? Or will that cheaper item satisfy my needs?” EMIs tend to make you purchase a much more expensive gadget or car than you need. In this regard, RBI’s directive to ban misleading 0% EMI schemes is a step in the right direction.