InjuNo cost EMI, the evil I didn’t see coming. I never thought that I would be calling this evil when I first came across this scheme. But after getting involved in just three transactions, I’m convinced about its evil nature. Skeptical? Worry not, I’ll provide all the clarity you need.
What Is No Cost EMI?
To understand No Cost EMI, we need to understand EMI first. EMI is simply equated monthly installments.
“But Installments of what, Inju?“, you may ask.
Okay, let’s rewind back a little. Alex is a fresh graduate, just joined his first job. Alex’s office is on the outskirts of the city and he is too lazy to catch the company bus at 6:30 AM in the morning. So he plans to buy a brand new CBR 250r for the daily commute. He approaches a Honda showroom, they tie him up with their banking/lending partner. The banking partner pays the money to the showroom, all at once. And recollects the total amount from Alex at regular intervals.
Now because he is doing Alex a favor by paying the money upfront, it’s only fair that the lender gets something extra in return. This “extra” is called the interest amount. The interest rate is usually dependent on the lender’s perception of Alex’s ability to pay back the amount and the operational costs and profits margin expectations of the company (read “the lender should be able to give a life for its owners and employees”).
Now the total amount pays back is
Amount Alex Owes (AAO)= Bike Cost+Interest Amount.
Now, let’s say Alex commits to a timeline of 6 months for paying back the entire amount. So the lender divides the amount he owes by 6 months to derive the monthly amount Alex has to pay.
So, Alex’s monthly repayment amount becomes= AAO/6.
This monthly repayment amount is called Equated Monthly Installment or EMI.
“Okay, understood. But what’s the deal about No-Cost?“
Remember when I said, the lender needs to make profits and also give salaries to employees. Now if the lender is just paying money for the bike and collecting the same amount from Alex, how can the lender make profits for owners and pay salaries to employees? It doesn’t take a scientist to establish that employees need money to survive, right? and the company needs money to run. And you pay the extra interest amount so that the company can run, which is the cost you pay for choosing to not pay for the bike in full.
Now, no-cost EMI is simply the case where you don’t pay that extra cost (read interest). Which begs to ask a question.
What’s In It For The Lender?
Now, what’s the incentive for the lender if he is not getting the interest amount? How will he run his lending business when he is not earning any money?
That’s where things start to get interesting. The answer lies in the nature of the No Cost EMI. There are primarily two strategies that companies employ. Let’s go back to Alex’s new bike purchase to understand this better. Alex is clever and observed that showrooms usually gave discounts during festive seasons. So he waited for one such festive sale to start. ($AMZN Great Indian Sale or $FK Big Billion Days in the context of Indian e-commerce).
Strategy #1: So the showroom is probably offering the product at a discount but it won’t pass it on to Alex. Instead, it lets Alex opt for the No-Cost EMI option and pays the discounted amount to the lender. Showroom sells the bike, Alex gets to wake up late and the lender’s owner and employees are happy. WIN-WIN-WIN. The only drawback for Alex is he forgoes the discount that he would’ve got had he paid the amount in full.
Strategy #2: So another strategy is to add the EMI amount on the product price itself. So, if the bike costs INR 1.98 Lakh and for the sake of simplicity, the interest cost is INR 2000. So, the showroom would price the bike at INR 2 Lakhs and offer a No Cost EMI option. Not that attractive right? That’s why this strategy isn’t used as much as the first one.
The word discount is the “magic word” for the genie(brain) in the lamp(body) to spend mindlessly.
-Mostly Inju
Now, you may say, “Inju, that sounds like a great scheme“
Of course. There are a lot of advantages of availing the No Cost EMI option. I’ll discuss a few.
Advantages Of No Cost EMI
Let’s circle back to Alex and his bike purchase. Alex is very disciplined when it comes to managing his money. He earns well and spends responsibly. He is very rational when it comes to buying something. So, it is safe to say that an impulse purchase is an unlikely entry in his money trail.
For someone like Alex, No-Cost EMI is a really good option. Alex buys something he really needs and opts for the No Cost EMI option. It saves Alex the pain of draining all the cash he has. Instead, he can break the expense down into as many smaller chunks as he wants(within the available limits).
This enables him to hold onto the cash he has and plan his expenses better. In Corporate Finance terms, it’s called working capital management. Managing the cash efficiently by optimizing income and expenses. In simple terms, Alex knows what he is spending on and has a good idea of his “debt servicing” capability.
Alex can even choose his credit card for the purchase. Because Alex is already sure about his debt-servicing capability, He can put this expense on his credit card and keep paying the EMIs. Regular and timely repayments of EMIs maintains/improves your credit score. Maintaining a good credit score comes handy when you’re opting for bigger loans for house or car etc.
Let’s say, Alex has enough money to pay for the bike upfront. But he instead chooses the No-Cost EMI option and invests the money or even keeps it in his savings bank. Whichever option he chooses, he is earning some interest on the money. So, in totality, he is making very good use of the No-Cost EMI scheme.
Inju, with so many advantages, why would you call this Evil?
Why Do I Call It Evil?
Okay, so if you read the story about Alex and thought it’s very easy to use this scheme to your advantage, then you need to continue reading. Whatever I mentioned above is very attractive and advantageous to a financially disciplined person like Alex. But ask this question to yourself and answer honestly.
“How financially disciplined are you in comparison to Alex?”
“How often do you do Impulse purchases?”
Let’s now hear about a friend of Alex, Bhargav. Bhargav is a strong believer in things like, Live the Moment, YOLO and is not very serious about where he is spending his money and how much is leftover. Fortunately, he makes a decent sum which pulls him through the month. But not all of us are in such a similar situation.
Gone With A Bite
So, on a Sunday afternoon, while having a bite of the freshly baked pizza he ordered, Amazon sends a notification about a certain noise cancellation headphones. He clicks on the notification, goes to the product page. Looks at the product image. His eyes move to the price and Amazon carefully places the No Cost EMI option right below it.
A very convenient INR 1624 against a total price of INR 34,500.
Bhargav clicks the “buy now” button, selects the “pre-filled” address, clicks on his select mode of payment with the No-Cost EMI option, and boom. Within 1 minute and a couple of clicks, Bhargav buys a product that he wasn’t even thinking a minute ago.
Now, this isn’t the first time Bhargav has fallen for push notifications. And Bhargav isn’t alone. We all at one point or the other made such purchases. The blazing fast internet today places pretty much the entire world at our fingertips. With that,
The time gap between an impulse to buy something and actually buying it has been narrowing down.
Let me show the impact of such impulse purchases over a period of time. Look at the difference between the cash left with and without the EMI expenses.
The Big Picture
But Inju, if Bhargav can afford those items, albeit with No Cost EMI, then what’s wrong.
There is absolutely nothing wrong if you’re making as much money and in spite of Bhargav’s frivolous spending, he still has a decent amount of cash left at the end of every month.
But according to the data from salaryexplorer.com, the median salary in India is INR 29,400. This means about 50% of the salaried population earn less than INR 29,400 which is INR 20,000 less than what Bhargav makes. Imagine what impact such impulsive behavior has on those people? Take a look at the cash balance after EMI expenses for this income group.
Most people don’t look at that bigger picture when they decide to buy something on No-Cost EMI. And with repeated purchases, there will come a point where you no longer can repay the amount or have to take additional loans for meeting emergencies.
And why do they end up in that situation? Three words. Impulse, oversight, and No-Cost EMI. Are you convinced enough about this evil scheme now?
Yes, Inju. So, what do we do now?
Precautions To Take Before Your Next No-Cost EMI Purchase
The basic check you should do before any No-Cost EMI purchase is to be aware of your current expenses. You can use concept like the Money Trail to determine your current expenses.
Once you get hold of your expenses, calculate how much money you have left after the expenses. This will determine your debt servicing capability.
If you can pay for the EMI and still meet any emergency obligations, then go ahead and buy whatever you want. I suggest you do a similar exercise and map the EMI expenses over the tenure of the repayment.
Why?
Because you may not forget about the EMI expense today, or tomorrow or maybe even a month for now. But when you are 2-3 months into the purchase and if you don’t look at your expenses regularly, chances are plenty that you just forgot about it, all thanks to the Auto-debit features.
So taking a mental note of the cash left at the end of the month after accounting for EMI expenses is necessary and important before making the next purchase.
To Summarize, what you should do before your next No-Cost EMI or EMI purchase:
- Check your current expenses
- Calculate the cash leftover per month
- Evaluate if you can pay for the EMI and still meet emergency obligations.
- Get a long term view of the expenses.
I hope this post helped you to get a good understanding of No-Cost EMI, it’s advantages and disadvantages, and the things you should watch out for your next purchase.
If you have additional tips for the readers, feel free to add them in the comments. I’ll edit the post to include the suggestions 🙂
Thanks a lot for sticking with me and reading till the end.
If you liked this blog post, feel free to drop your email ID below to get all the latest blog posts directly to your inbox. If you’re reading my blog for the first time, feel free to read about Money Trail ( A framework to Understand expenses), How to reduce expenses, and how to increase income. In case you’re into investing, you may like my summary of Buffet’s Share Holder letter (2019), Dhandho Investor, and Little Book That Beats The Market.
This is Inju,
Signing off until next time.
Cheers!