Explained: How lenders make money through no-cost EMI schemes

As the festive season kicks off, numerous online and brick-and-mortar retailers introduce 'No-cost EMI' or 'Zero Cost EMI' options for a range of products, including mobile phones and electronic appliances. While opting for equated monthly installments (EMI) when purchasing a product offers relief from a substantial upfront payment, it's crucial to recognize that there is invariably a cost associated with these seemingly 'no-cost EMI' schemes. Hence, it becomes essential to understand the genuine expenses linked to these 'no-cost EMI' or 'zero-cost EMI' offerings.

In this explainer, we look into how retailers and lenders make money while offering such schemes.

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What are 'No-cost EMI' or 'Zero Cost EMI' schemes?

'No-cost EMI' or 'Zero Cost EMI' schemes are financing options offered by retailers, both online and offline, that allow consumers to purchase products such as mobile phones and electronic appliances in equated monthly installments (EMI) without making an initial lump-sum payment. These schemes are designed to make high-value purchases more affordable by spreading the cost over several months.

How does it work for lenders?

A No-cost EMI, or zero-cost EMI, is a financing option that allows customers to purchase products or services in installments without incurring additional interest or finance charges. For lenders, this option involves partnering with retailers to offer customers the ability to pay for their purchases in equated monthly installments (EMIs) without paying any interest on the loan amount. Here's how it works for lenders:

Are 'No-cost EMI' schemes truly without any cost?

No, despite their name, 'No-cost EMI' schemes are not entirely free. While they eliminate the need for an upfront payment or interest charges, there is often a hidden cost associated with these schemes.

How do 'No-cost EMI' schemes work, and what is the hidden cost?

There are two primary ways these schemes operate:

a) Foregoing discounts: Some retailers, especially online platforms, may forgo the discounts they would typically offer for upfront payments and, instead, use that amount to cover the interest cost of the EMI. The interest cost is thus passed on to the customer indirectly, making the purchase costlier in the long run.

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b) Adding interest to the product price: In this approach, the interest cost is added to the original product price. For example, if a product originally costs Rs 15,000, it might be offered under a 'No-cost EMI' plan for Rs 17,250. The additional Rs 2,250 represents the interest amount, which the customer pays back over the EMI tenure.

What does the Reserve Bank of India (RBI) say about 'zero percent interest' schemes?

The RBI has clarified that the concept of 'zero percent interest' is non-existent. In its 2013 circular, the RBI pointed out that the interest element is often camouflaged and passed on to the customer through processing fees or by loading expenses into the applicable interest rate. Such schemes are considered marketing gimmicks that may exploit customers.

How do lenders benefit from offering No-cost EMI schemes?

By offering No-cost EMI options, lenders can boost sales for their partner retailers, as customers are more willing to make high-value purchases when they can pay in affordable installments.

Competitive Advantage: Retailers that offer No-cost EMIs gain a competitive edge, attracting more customers looking for flexible payment options. Offering attractive financing options can foster customer loyalty and repeat business, as customers may choose the same lender for future purchases.

These schemes often involve credit cards or digital wallets, encouraging card usage and higher transaction volumes, which benefits lenders. Since there's no interest involved, customers are less likely to default on payments, reducing the risk for lenders. Lenders can charge processing fees or commissions to retailers for providing the financing option, generating additional revenue. By offering No-cost EMI options, lenders can enhance their brand reputation, as customers perceive them as facilitators of affordable purchases. Lenders can build long-term customer relationships, leading to repeat business and referrals, which is beneficial for the lending institution. These schemes provide valuable customer data, which can be used for marketing strategies and product development. Lenders must ensure regulatory compliance to maintain a positive reputation and legal compliance. This includes transparency in terms and conditions and adherence to financial regulations.

Should customers be cautious when opting for 'No-cost EMI' schemes?

Yes, customers should exercise caution. While these schemes offer the convenience of spreading payments, it's essential to be aware that there's a cost involved, and the actual interest may not be explicitly disclosed. Consumers should carefully examine the terms and conditions, especially regarding the final purchase price and any foregone discounts.