Tuesday, December 6, 2011

Beware of zero percent finance schemes

Having remained in a lull for some time, zero percent finance schemes are back with a bang.

And consumers looking to buy consumer goods on easy monthly installments seem to be a happy lot today.

After all, where else can they find a chance to stagger their payment without paying any interest on the loan amount?

However, before going overboard, you need to know the real cost of such schemes and also how these schemes work.

“Zero percent finance schemes are quite popular with consumers, and companies use them in an efficient way to attract customers to make purchases, especially for consumer durables, during the festive season,” says Anil Sahgal, founder of financial advisory portal ‘i-save’ .

He says the festive season is a critical sales period for most consumer durable companies and the zero percent schemes play an important role in effective sales promotions .

Since most customers do not understand the total cost of the scheme, they happily go for it as it seems like a genuine discount.

“You should, however, always remember that there is no free lunch in life. Similarly, zero interest is nothing but higher discounts that the company or manufacturer offers to the bank or the lender or the financier who in turn passes it on to the end buyer,” says Lokesh Nathany, head of sales & distribution, Motilal Oswal Asset Management . The schemes offer a ‘zero percent’ finance, where a customer typically pays for the financing cost in an indirect manner. The indirect cost will include, for example, paying a processing fee and a significant amount as advance EMIs in addition to the minimum cash down payment. The biggest cost, however, is forfeiting a cash discount which might be available on a cash purchase.

For instance, suppose Nand Gopal wants to buy an LCD TV for Rs 36,000. At a major retail store, there is a cash discount of Rs 2,000 available on the LCD. However , Gopal does not wish to pay the whole amount cash down. To avail of the scheme, Gopal will need to pay a processing fee of about Rs 1,000 to the NBFC. He will also have to forfeit the cash discount of Rs 2,000 since the discount is not available on a finance deal. Now, on a loan of twelve months, Gopal will have to pay four EMIs in advance, ie, 36,000 / 12 X 4 = Rs 12,000. So, effectively Gopal has got a loan for Rs 24,000 only. His total cost of taking the loan was Rs 3,000 (processing fee + forfeiting the cash discount). So for eight months, Gopal paid Rs 3,000 on a loan of Rs 24,000, paying an effective interest rate of 18.75% annualised. So, buyers who can afford to buy with their own resources should not get lured by such schemes simply because they appear attractive.

However, if you must go in for a zero finance scheme, you need to take some precautions.

For instance, “you must check the amount of processing fee to be paid besides checking the advance EMIs required. Also, compare the total cost of the zero finance scheme with the interest cost if any other loan was taken to finance your purchase.

Customers must be aware of the details of the scheme and make an effort to compare these with other options for borrowing,” says Mr Sahgal.

Source: Economic Times

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