Investors Beware : Conman around |
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Want to be a smart investor or purchaser? Then just remember this principle- "there are no free lunches in this world, and there's got to be a catch somewhere. " You'll never go wrong! In today's world, where we, due to the kind presence of credit cards and easy to get loans, spend tomorrows income today, we are sitting ducks. Big glossy advertisements, TV Ads, window displays - all seem to lure. What clinches the deal is the screaming line - Zero Interest Loans! But hang on before you blindly reach for your purse STOP-LOOK and DISCERN and most of all remember your principle (stated above)!
There is no such thing as a zero interest loan. I mean be realistic, nobody is that foolish and that too guys like banks and finance companies. No way! They take their pound of flesh and that to in a way that you will not catch on if you aren't careful!
Along with the zero interest cookie is a seemingly innocent looking advance EMI-or equated monthly installment, i.e. the amount of principle plus interest that you have to pay every month to get out of the clutches of these blood sucking benevolent companies. These advance EMI's are paid up front by you. They are not in the form of post dated cheques. They are ready to cash cheques. You are giving a down payment, thereby reducing the lending amount and the risk along with it. Also, the bank or finance company stands to gain on the amount of interest that it gets. Firstly, it does not give the 100% loan it had promised. Secondly, the interest that it charges on the amount that it has lent is in actuality greater. This is because, it calculates the interest rate on what it has lent, but forgets about the sum it has already taken in advance. Very simply put, if the bank lent you Rs. 2000 and collected Rs. 1000 as advance EMI, it will get its 16% on the Rs. 1000 that it has actually lent, by telling you that it is lending to you at 8% on the Rs. 2000 that you (ostensibly) borrowed. So actually what you have done is to loan yourself some money and are paying interest to the finance company.
The next tool in their arsenal is the processing fee. This is the most innocuous-seeming (and popular) Charge. Before disbursing a loan, most loan givers require you to pay 2%-4% (typically) of the loan amount as "processing" fees. Now if you have paid advance EMI's then in effect, the bank is lending you lesser than it had promised which increases the effective rate that you are paying. For example, a company might offer a loan at a price of 5.9% for a 12-month tenure, with four EMI's payable in advance, and a processing fee of 2%. The effective rate - a whopping 21.5%! And you thought you were paying 5.9%!
Interest on the reducing balance is another brilliant piece of conman marketing which should be understood. The EMI can be calculated with the interest on annual reducing balance or monthly reducing balance. But remember, these guys have the upper hand from the beginning-because they are lending you less than what you asked for. Also, if you ask for a break-up of the EMI's, you will find that in percentage terms(and actual terms) a higher amount of the EMI goes for covering the interest component and lesser towards the principal for the initial installments. For example-If the EMI is Rs 100 per month, then only say Rs 20/- go towards the principal and Rs 80 towards the interest. This ratio keeps changing as with every installment you are covering more of the interest component. There are two effects of this. Firstly, because in the initial EMI's you are paying off less of the principal, therefore your interest whether - on reducing balance or otherwise - is higher than what it would have been, had you been paying off the interest and principal at fifty fifty of the EMI. Secondly, by agreeing to this, you are ensuring that you first pay off your interest to the finance company and later pay off the principal. In any case, the bargain with the lowest period of reduced balance (mostly monthly) is cheaper. Most lending schemes are a combination of these base versions.
So next time remember before you leap for your wallet-take a look at the advance EMI's, to actually ascertain how much money is being lent to you by the company, then take a look at the processing fee and see what amount is charged on. Post that, work out total outflow taking into account the EMI's and advance EMI's and processing charges and voila! You will see that the Rs 2000 mixer grinder you were planning to buy because you've got to use it NOW! (otherwise you may die), is actually costing you close to Rs 3000, or some such ridiculous figure. So is it worth getting conned?!
EXAMPLE- You want a loan of Rs 10,000. The interest rate specified is 15% p.a. with 4 EMI's paid in advance and the processing fee is 2% of loan amount sanctioned.
Loan asked for Rs 10,000
Interest rate @15% p.a. Rs 1500
*EMI Rs 958(10,000+1500/12)
Processing Fee Rs 200(2% of loan sanctioned)
Advance EMI's Rs 3832(958*4)
Total money given to you Rs 5968(Rs 10,000-3832-200)
Total interest given to Bank/company Rs 1500(1500)
*Actual interest rate charged 25%(1500/5968)
*we have not assumed EMI calculation on reducing balance. In case we do so,then the rate will be slightly lower, between-21%-23%.
Aru Srivastava