Personal Finance: The 0% Resolution

Zero isn't always equal to zero--at least when it comes to financing. Blasting the latest myth on the loan turf...

All his life, Arup Ghosh, a middle-level official in a huge government department, had held on steadfastly to the belief that there was no such thing as a free lunch. Which was the only thing that could explain his seeming bad manners and total intransigence one Saturday evening, when his neighbour's (just-married) daughter and son-in-law dropped in to visit him. Actually, they'd dropped in to say hello to Mrs Ghosh, a fact that didn't bother him at all; Baywatch, and a certain Carmen Electra kept him occupied. But his ears perked up when they caught the term zero per cent interest. It turned out that the young couple had just picked up a television set the previous day, availing a 12-month zero interest finance scheme.

Why Concessional Consumer Loans are Costlier

ť All-cash transactions fetch handsome discounts; other transactions do not
ť Advance-EMIs ensure that the actual loan is much lower than that availed
ť Advance-EMIs mean the tenure of the loan is shorter than that used in interest tabulations
ť Hidden costs like processing and hypothecation fees mean cost isn't really zero-cost

''Zero per cent interest,'' scoffed Mr Ghosh, Carmen Electra forgotten. He then launched into a scathing attack on the intellectual level of Gen-nex, and how easy it was to gull them. Mrs Ghosh tried to downplay the issue by suggesting that her husband was probably out-of-touch with new-fangled things like zero per cent finance schemes, and the neighbour's daughter offered him a way out by suggesting that the schemes weren't really free, as the manufacturer, and, in some cases the dealer, bore the cost of the loan. But Mr Ghosh wasn't having any of that. ''I have an honours degree in economics from Presidency,'' he said. ''That means I know something about economics. And zero per cent does not make economic sense.'' The visitors left after a while, but, on the way out, the son-in-law suggested that Mr Ghosh take the trouble of going through a few advertisements in The Hindustan Times if he wished to learn more about zero per cent financial schemes.

The following Monday, Mr Ghosh, whose newspaper-reading was restricted to the Delhi-edition of a Calcutta-based newspaper (which didn't sport too many ads), asked his office-boy to get a copy of the day's The Hindustan Times from the reading room. Much to his chagrin, he found out that his visitors were right after all. There were zero per cent schemes; 7 per cent ones; and 9 per cent ones. He scanned the advertisements for details; they were sketchy. And so it was that a miffed Mr Ghosh set out to uncover the truth about the 'something for nothing' schemes as he called them.

Time wasn't a constraint for Mr Ghosh. Middle-level officials in the government enjoy the benefit of anonymity. So, Tuesday afternoon found him in a consumer durables outlet near his office. He'd decided to play the part of a prospective washing machine buyer to understand the economics of the zero per cent scheme.

The machine he picked was a high-end front-loading model with a marked price of Rs 30,000. Mr Ghosh started off, as was his habit whenever he went shopping, by asking for a discount. The salesperson was obviously used to customers like Mr Ghosh: he offered a 10 per cent discount on an all-cash transaction; 5 per cent on a credit card one. Mr Ghosh picked neither. Instead, he pointed to a display card on the machine that advertised a zero per cent financing scheme from GE Countrywide.

The salesperson knew his stuff and rattled off the details: zero per cent loans were available for a year, no more; of the 12 equated monthly installments (EMI) of Rs 2,500 (for complete financing), Mr Ghosh would have to pay four (Rs 10,000) at the time of purchase, and the rest through post-dated cheques; and he would have to pay 2 per cent of the loan amount as processing charges (that worked out to Rs 600).

Mr Ghosh crunched some numbers: the opportunity cost associated with the four EMI-advance, at an interest rate of 10 per cent, for a period of eight months, worked out to Rs 666 (the amount he would have got if he had invested the Rs 10,000 in a bank's fixed-deposit scheme with a 10 per cent rate of return for eight months). With the processing cost, his total cost on a loan of Rs 20,000 (Rs 30,000 less the advance), for a eight month period, came to Rs 1,266. And the annualised cost to 9.50 per cent, and not the advertised zero per cent.

Mr Ghosh, a honours graduate in economics, crunched some more numbers. If he included the Rs 3,000 discount that he lost out on by not paying cash, his cost amounted to a whopping 32 per cent. True, he could earn a 10 per cent rate of return by investing the money he would otherwise have to pay up-front for the washing machine in a bank's fixed-deposit scheme, but his net cost would still remain high at 22 per cent.

The game was afoot. Mr Ghosh's plans to expose the 6.65 per cent scheme on offer for buying a two-wheeler on Wednesday were scotched by some unexpected work that came his way. By late morning on Friday, though, he'd pushed all the files he had to and headed for a two-wheeler showroom near his office again. He'd decided on a premium scooterette priced at Rs 41,936 (like the washing machine, he'd opted for the best). ''Finance,'' he muttered to the bored salesperson attending to him.

And this salesperson, too, knew his shallots. The finance company would fund between 70 and 85 per cent of the scooterette, but the duration of the loan would be between 18 and 24 months. Then emerged the other details: an advance of six EMIs; a processing charge of Rs 800, and a hypothecation charge of Rs 400. And the interest rate? A mere 6.65 per cent.

Mr Ghosh returned to the number-crunch mode. If he wished to finance 70 per cent of the scooterette, he would have to borrow Rs 29,355. And at a 6.65 per cent rate, the interest worked out to Rs 3,904 (Rs 1,952 a year); the EMI to Rs 1,386 a month (Rs 29,355 + Rs 3,904, apportioned over 24 months). Factoring in the six-EMI advance, Mr Ghosh realised that he would be paying an interest of Rs 3,904, on a loan of Rs 21,039 (the loan amount minus the six EMIs), for a period of 18 months. The effective interest rate? 12.36 per cent. And that was the figure without the processing and hypothecation charges.

Now, Mr Ghosh had irrefutable proof that there was really no such thing as a free lunch. He couldn't wait for his neighbour's daughter and son-in-law to drop in again, but hoped that they wouldn't do so on a Saturday evening. There was something about Carmen...