The Secret behind No Cost EMI!

Lately, you might be seeing a lot of “No Cost EMI” schemes and wonder why they would provide you a “No Cost EMI” which will bring your price after making all the payments the same as the price you pay right now i.e., EMI x Tenure = Cost

Yes, that is an actual 0 cost EMI; No Interest, No Processing Fees, No other charges. And, You always wonder who bears the cost.

We will understand this case by taking an example, read the example carefully as it will follow until the end –

You go to Amazon to purchase a mobile phone, let’s say a Samsung Galaxy S20. The cost of the phone is INR 60,000. Either you can pay the full amount or Amazon gives you some No Cost EMI options on paying via any Credit Card/(or even Debit Cards of select banks). Let’s say there’s a SIX month No Cost EMI option which will mean that you need to pay INR 10,000 per month.

You obviously decide to opt for a No Cost EMI because it saves you some interest on your money. So, happily, you went for a No Cost EMI with your HDFC Bank Credit Card.

Now, we will understand how this whole process works and why they offer you a No Cost EMI in the first place.

There are a total of 4 parties involved in this transaction.

1. The Manufacturer – Samsung
2. The Seller – Amazon
3. The Financer – HDFC Bank
4. The Customer – You

The first 3 parties work together to sell the product to the 4th party. AND each party benefits. I will get back to this statement at the end of an article.

It all starts with the Manufacturer offering an upfront discount to the Financer. It is generally 4-8% depending upon the product and the profit margin. Let’s say that Samsung Offers a 5% discount to HDFC Bank. i.e., HDFC Bank pays Samsung an amount of INR 57,000 (60000 less 5%) on your behalf. Now, HDFC Bank will recover INR 60,000 from you over 6 months.

Now, you wonder for a meagre 5%; why does HDFC Bank take the risk!?

Here’s where the game begins.

First of all, this 5% is for 6 months, so if we annualize it, it will be a 10% gain for HDFC Bank.

Now here’s the REAL game.

You don’t pay HDFC Bank INR 60,000 after 6 months, you keep paying 10,000 every month. In that 10,000 you are paying some of your Principal Amount too. Had you paid 60,000 at the end of 6 months, then it would be a 10% interest, but NO. You are paying EVERY month.

The actual Principal Amount decreases every month, but your EMI remains the same, it means that the effective interest you are paying is definitely more than the original 10%.  

Let’s see the actual interest rate or what we call IRR (Internal Rate of Return) on an excel spreadsheet.

It’s a whopping 19% interest rate for the Financer i.e., HDFC Bank!…. But are we still done from the Financer’s point of view? NO.

Here’s the REAL REAL game.

In some cases, the Financer asks for the payment of the first EMI upfront, it is popularly known as “Down Payment.”

“Ok, that’s just one payment upfront, what is so ‘REAL REAL’ about it?”

Now, we will again calculate the IRR on excel. This time HDFC’s first payment to Samsung will be INR 47,000 instead of INR 57,000 because INR 10,000 is paid by you. There will only be 6 periods in this calculation.

Let’s again go to our spreadsheet.

Now, this is the REAL REAL game. It is an interest rate of a WHOPPING 28% for the HDFC Bank.

Earlier I said, it is a win-win for each party. This is how – 

Samsung doesn’t want to discount unless you are absolutely willing to buy the product. By providing a 5% discount, the sale is increased manifold. 

Amazon will get a commission from both Samsung and HDFC Bank. A sweet deal for Amazon just for letting them use the platform and obviously an increased GMV, which it can boast on Wall Street.

HDFC Bank is already the daddy here, making an interest income between a whopping 19-28%.

“But, Hey, HDFC Bank is taking all the risk?”

The Bank has already assigned you a credit limit on your credit card, the Mobile Phone purchase amount will be blocked on your Credit Card limit until your payments are fully settled. So, the Bank already has certain exposure on you whether you buy this phone or not. Also, there will be only a tiny percent of the population who would want to default on a Mobile Phone payment, and degrade their Credit Rating (CIBIL, Experian, etc. in this case). That tiny amount of default can easily be absorbed when you are earning a GIANT 28%

And for YOU, you get to earn some interest on the funds which otherwise you have paid up front; also the affordability increases.

Overall, this is a WIN-WIN for each party involved.