Personal Finance

Zero-interest need not be zero-cost

Anand Kalyanaraman | Updated on October 15, 2011 Published on October 15, 2011


With Diwali just ten days away, marketers of all hues will soon step on the gas. Discount sales, easy repayment options and a host of special offers will be unleashed to entice customers to loosen their purse strings.

The time-tested (but frowned upon by the RBI) ‘zero per cent interest schemes' may also make a comeback.

This sales promotion technique allows customers to pay for their big-ticket purchases in instalments, with no interest being charged for the staggered payments.

For instance, a customer buying a consumer durable costing Rs 24,000 may be allowed to settle dues in 6 instalments of Rs 4,000 each. Sounds good, right?

Pay easy with no additional interest cost. This unique selling proposition of zero-interest schemes has for long managed to draw crowds to the stores.

With good reason. At face value, such schemes do seem quite attractive from the perspective of potential customers. For one, there is no need to pay the entire amount upfront. This makes the purchase seem within reach of even those who otherwise can't afford it.

Besides, unlike normal financing schemes, there is (supposedly) no extra cost charged to the customer in ‘zero per cent' interest schemes. But should customers bite the bait, without testing the waters?

Hidden Costs

As the cliché goes, if it's too good to be true, it probably is. And like many seemingly good things in life, ‘zero-interest schemes' too may have their stings in the tails. Sure, interest cost may be ‘zero'. However, there is often a ‘processing fee' to be borne by customers, which puts to naught the hard-sell of ‘no additional cost'.

Let's assume a processing fee of Rs 1,000 in the case above. This works out to 4.2 per cent on the financed amount of Rs 24,000 for 6 months and 8.4 per cent on an annualised basis.

That's not all. Those choosing zero-interest schemes are often not allowed other discounts offered by sellers.

Suppose, in the case above, customers making an up-front payment are allowed a discount of Rs 1,500, which is not extended to those going in for zero-interest schemes.

Foregoing the discount is in effect an additional cost, which on Rs 24,000 works out to 6.25 per cent for six months, and 12.5 per cent on an annualised basis. Combined, the processing fee and the discount foregone would have added a cost of around 21 per cent (annualised) for those choosing the zero-interest scheme. Not such a ‘great deal' anymore?

The picture could get even more discouraging, if customers are required to pay some instalments upfront.

Say, in the case above, two instalments adding up to Rs 8,000 need to be paid at the time of signing up for the zero-interest scheme.

The customer is effectively being financed only for the balance amount (Rs 16,000). Now, the processing fee of Rs 1,000 and discount foregone of Rs 1,500 add up to a total cost of 15.6 per cent on a six-month basis and 31.3 per cent on an annualised basis.

Do the math

Given that zero per cent interest schemes may lack transparency and may distort pricing, the RBI had, in as early as 2002, issued a circular advising banks to refrain from offering such schemes for consumer durables.

So, over the last few years, the incidence of banks offering zero-interest schemes has declined.

However, many non-banking finance companies (NBFCs) continue to tie up with manufacturers and dealers to provide such offers, especially in the festival season.

Before signing up, customers would do well to read the fine print, and do the math (processing fees and their reasonableness, discounts foregone and effective amount of financing) to ensure that they are indeed getting a good deal.

Finally, it's advisable not give in to impulsive buying urges in the festival season, merely because there are ‘discounts' and ‘schemes' to boot.

Remember, you finally need to settle the bill, even under the best offer.

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