On a lazy Sunday afternoon Mr Damodar an IT programmer aged 35 years visited a top retail store in Bangalore with the intention of purchasing a newly launched version of a smart phone manufactured by a top Company costing INR 48,000.
What added to his excitement was what he had seen in the newspaper the advertisement stated that this smart phone was available with attractive financing under an offer called 0% interest Consumer Durables Finance with no hidden charges.
This advertisement ran like this: “No interest needs to be paid on the loan amount taken. All that is needed is to divide the loan amount with the loan tenor opted for, pay a few installments upfront and a nominal processing fee and the latest smart phone belongs to you”.
Just like thousands of youth in our nation Mr Damodar too was hooked by this advertisement. Even though Mr Damodar could afford to pay for the smart phone outright he opted for this route as this was an interest free purchase. He opted for the purchase amount of INR 48,000 paid back in 12 months at an EMI of INR 4,000 per month. A processing fee of INR 1000 was to be paid and 4 EMI’s totaling INR 16,000 immediately. Was it the right decision that Mr Damodar made?
The retail store offered a cash discount of INR 2,000 on the outright purchase of the smart phone. Since Mr Damodar did not pay the full amount for the smart phone immediately he was not eligible for this discount. He landed up paying an additional INR 2,000 for the smart phone .In addition he also paid INR 1,000 as a processing fee for the offer. In addition 4 EMI’s totaling INR 16,000 were paid .In effect Mr Damodar took a loan for only INR 32000.The total cost of the loan was INR 3,000 (Processing fee + loss of the cash discount).Thus for 8 months Mr Damodar paid INR 3,000 on a loan amount of INR 32,000. Even though the advertisement stated that there was no interest on the loan Mr Damodar paid an effective interest rate annualized at 14.06%.
So Mr Damodar paid INR 49,000 for the smart phone which he could have obtained for INR 46,000 by making an outright purchase. Not so smart after all.