Have you ever tried to under the mathematics behind No cost EMI schemes? As I see, the schemes are quite popular on e-commerce websites such as Flipkart and Amazon.
Do you know RBI prohibits banks from offering zero interest EMI schemes? How do banks offer such schemes then?
Well, e-commerce websites and banks have figured out a way around this.
Here is an excerpt from Amazon website with respect to No-cost EMI schemes.
The bank will continue to charge interest on EMI as per existing rates. However, the interest to be charged by the bank will be passed on to you as an upfront discount at the time of your purchase, effectively giving you the benefit of a No Cost EMI. This discount excludes GST on interest amount that will be charged by your bank.
Flipkart also explains in a similar way through an example.
Let’s see what this means.
- Let’s assume the item costs you Rs X.
- You will have to pay an EMI of Rs X/6 per month (if you opt for 6 month No cost EMI scheme)
- The money that you would have paid as interest is offered to you as the upfront discount. Let’s assume that the upfront discount is Rs D.
- Your credit card will be charged Rs Y = Rs X- Rs D
- If you work back the numbers, on a loan of Rs Y at a certain rate of interest (R% p.a.), EMI for 6 months will be Rs X/6.
- A few days, the bank will convert Y into EMI.
- You will have to pay GST on the interest amount. Now, the GST paid is an extra cost to you.
Let’s try to understand with the help of an example.
The cost of the product is Rs 1,01,999.
You can see No-cost EMI options for 3-month and 6 month EMI. For longer tenure repayment, the no-cost EMI option is not available. We will see later why that’s the case.
I don’t know the rate of interest that we should consider. All I know that the rate of interest can’t be zero because that’s not acceptable to the RBI. As you can see, for the other EMI schemes, the rate of interest is 15% p.a. It is fair to assume R=15% p.a.
For the 3 months No-cost EMI, you pay Rs 34,000 per month. That makes it 1,02,000. You don’t anything extra. The difference of Rs 1 is to rounding off.
Ditto for 6-month No-cost EMI. 17,000 X 6 = 1,02,000.
So, if you purchase the item for 1,02,000, you will have to pay Rs 17,000 per month for 6 months.
Where is the upfront discount?
As we have discussed before, banks can’t offer any loan without interest.
It is another matter if you do not return the principal. 😊 Everything has to be right on paper.
Coming back to the topic, we need to figure out the amount Y, that would result in EMI of Rs 17,000 per month for 6 months at an interest rate of 15% p.a.
You can simply use PV function on excel to find that out. You can also try out Loan calculator to figure out the same.
Y = PV(15%/12,6,17000,0,0) = Rs 97,682
Your credit card will be charged Rs 97,682.
Therefore, the discount (D) becomes 1,01,999 – 97, 682 = Rs 4,318
This discount is borne by the retailer/brand/seller.
Had you opted for 3 month No-cost EMI, your credit card would have been charged Rs 99,502. The upfront discount would have been Rs 2,497.
If you had an option of going for 9 month No-cost EMI, the upfront discount would have been Rs 6,093. For a 12 month No-cost EMI, the upfront discount will be Rs 7,825.
Since the discount is borne by the seller/retailer/brand, the cost (discount amount) goes up if the repayment tenure is longer. That is why No-cost EMI schemes are limited to shorter repayment tenures.
As you can see, the scheme is No cost for you. However, it is not Zero interest for the bank (which RBI wouldn’t be happy with). The upfront discount from the seller keeps you, bank and the seller happy.
You do not have to pay an extra penny. The bank avoids regulatory glare and the seller has sold the product.
Is the No cost EMI scheme really No-cost?
Not really. GST plays spoilsport.
GST is charged on the interest portion of the EMI.
Let’s see how it affects your payment.
As you can see, you are paying something extra every month due to GST on the interest cost.
In the first month, you pay Rs 17,220 (instead of Rs 17,000). This is because of 18% GST on interest amount of Rs 1,221. 1,221*18% = Rs 220
The total extra payment in this case will be Rs 777 i.e. you will pay Rs 1,02,776 (instead of Rs 1,01,999).
Therefore, not really a Zero cost EMI for you.
If you were to compare the upfront payment of Rs 1,01,999 with six EMI of Rs 17,000 each (plus GST), the rate of interest is 2.6% p.a. Without GST, the effective cost of the loan would have been 0%.
Considering your savings account balance earns you 4% p.a., a No cost EMI scheme is still a good deal (unless such deals make you spend more).
Looking just at the numbers, these schemes are a good deal in isolation. Sometimes, you may get cash back offers too over and above no-cost EMI. This would make such offers even more attractive.
With these schemes, there may be a tendency to spend more. If you can’t control your spending, reckless behaviour can put in financial trouble.
Disclaimer: The nature of the EMI schemes may change over a period of time. This is the structure that is prevalent on the date of writing of this post (August 9, 2018). The structure may be different across e-commerce websites. Before signing up for any no-cost EMI scheme, please understand the terms and conditions completely.
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