Here's truth behind zero percent loan

In an interview to CNBC-TV18, Pankaj Mathpal of Optima Money Managers shared his reading and outlook on zero percent loans.

Below is the verbatim transcript of an interview aired on CNBC-TV18.

Q: Anywhere you look you are bound to see a shop offering zero percent loans on consumer durables and the likes but are zero percent loans really all that they promise to be?

A: No. Zero percent cannot be zero percent. There is no free lunch especially in financial sector. One has to remember two things. One is processing fee; when one buys a consumer durable at zero percent interest, they recover some processing fee upfront. Usually when one goes for a loan, one pay interest on monthly reducing balance basis, which means one is paying interest only on the outstanding balance but when one pays upfront, for example if someone pay 5 percent upfront processing fee, it is equivalent to 10 percent monthly reducing balance interest for one year. So, indirectly he or she is paying an interest and that also in advance.

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Second, these schemes are available on the selected products. If one checks the rate of these products without this benefit, it will be 5-10 percent less. Therefore, one losing bargaining power when is going for zero percent equated monthly installments (EMI). However, if one calculates the internal rate of return (IRR) considering these benefits, it is much higher. So, zero percent is for sake of saying but somehow indirectly one is paying that.

Third, when one converts his or her purchase on credit card in EMI, this EMI is added to monthly balance amount, which is due. So, what happens if one do not pay credit card balance on time then whatever interest is applicable, usually that is 3 percent per month or 40 percent effectively per annum that one has to pay. So, it maybe zero percent only, the processing fee, which one will be paying but if one do not pay on credit card that amount of a monthly basis then one is paying the charges, which are applicable to credit card.

However, when he or she is using the credit card, means he or she is converting purchase on credit card in EMI option. In such case credit limit is reduced to the extent of outstanding balance. So, that is one thing, which one has to keep in mind. So, basically with these things I will say that zero percent will depend that processing fee is 3 percent, 5 percent whatever, but definitely it will be more than 10 percent effectively.

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Caller Q: Should I opt for personal loan versus credit card loan?

A: Credit card loan and personal loans are almost same. In case of credit loan, it is a pre-sanctioned limit. So, you do not need to submit any document for that. However, if you compare the interest rate, it is comparatively higher. Though interest rate varies from card to card and bank to bank and also depends on the personal profile of the borrower but usually if you compare with the personal loan it is a bit higher.

Second, as I said earlier when you take loan or you use equated monthly installments (EMI) facility on a credit card that amount is added to your monthly bill. So, if you do not pay that bill then you are paying additional interest on that. It is not only the interest, which is applicable on your personal loan but also what is applicable on your credit card so it maybe interest-on-interest. So, I will suggest that you should avoid taking loan on the credit card. If it is possible to avail personal loan, you should go for that. The only problem is with the documentation etc. or you want the quick disbursal, in such case only you should go for loan on credit card.

Q: Just wanted one clarification. You said the rate of interest will be dependent on the type of card. So say on an average you have one of these normal credit cards. What is the difference between the interest that you would pay when you take a loan on a credit card versus when you take a personal loan from the bank?

A: Use of credit card is a different thing and taking loan is a different thing on credit card. When one swipes card for some purchase and one is paying within the limit, on the due date, before due date one do not pay any interest. After due date they charge around 3 percent per month, which effectively comes to 40 percent but when one is applying for loan it will not be 3 percent, it will be somewhere 16 percent to 24 percent per annum.

If one does not pay that in time then he or she pays the interest, which is applicable on credit card. So, usually if one is paying in time, personal loan or loan on credit card then one is paying 16-24 percent or if profile is not so good it maybe 36 percent per annum also. It varies right from the 16 percent to 36-40 percent. So, I cannot say how much will be applicable but when one do not pay on time then the charges are very high.