Beware . . .Your 4% furniture loan is actually 12%

So my friend, let’s call him X, decided to go buy furniture and fixtures. He went to HomeTown and bought stuff worth Rs. 76021.

And then there was a Bajaj Finance advertisement that told him, oh, pay only 4% and get this on a loan!

X has to pay one advance installment – Rs. 6589, today. X’s EMI is just Rs. 6589 for 11 months. That’s a total of 72479, which along with the initial payment  adds up to just Rs. 79068.

You think – I’m buying stuff worth 76,021 but it’s only going to cost me another Rs.3,000 or so to take it on a loan! That’s just 4% (3,000 on 76,000)

(Okay, there’s also a processing fee of Rs. 1,100 but that only takes the interest rate to about 5.4% which is still cool?)

Under The Hood: The Actual Rate Is Closer To 9%

But that’s not how it works under the layers. Think of it like this:

  • You get some money as a loan
  • You pay an advance EMI so you actually get a lower amount as a loan (76021 minus the upfront payment of Rs. 6589 = a loan of 69432)
  • This amount is paid back every month through a monthly payment of Rs. 6589 for 11 months.
  • We have calculated that the interest rate is actually about 8.7% a year.
  • We start with an outstanding loan of 69432 in month 1. There’s some interest that applies to it for the month, at 8.7%, it would be Rs. 502.
  • We paid Rs. 6589 at the end of Month 1. That would take care of Rs. 502 of interest and reduce the principal outstanding to by 6087.
  • The new principal for month 2 is 63344.
  • The interest for month 2 is Rs. 458. (At 8.7%) And then you pay 6589, so the interest is paid out and the principal falls to 57,214.
  • And so on till, after month 11, your principal outstanding goes to zero.

Now how did we get to 8.7% as the interest rate?

We tried using 4%. At 4% the loan would be fully paid off just around month 10. In fact, at 4% your monthly EMI would only be Rs. 5,000 – a full Rs. 1589 less!

We increased the rate until the outstanding became exactly zero at the end of 11 months. Which gave us 8.7%. That’s what you pay.

But isn’t 8.7% good? Not if it’s actually 12%.

Sure. But it’s not even 8.7%. It’s actually closer to 12%.

Because X had a processing fee of Rs. 1,100.

To get the loan he had to pay another Rs. 1100. Now let’s compare this to paying cash upfront. You would pay nothing – just the Rs. 76,021. Now you:

  • Pay Rs. 7689 upfront
  • Pay Rs. 6589 for 11 months

Using the same calculation as above, we realize that K actually paid 12% for the loan.

The finance folks here will complain that oh, you’re not ACTUALLY paying 12%, because the processing fee is just a fee and so on.

But it’s 12% really. Here’s why:

If you had Rs. 76021 and instead of taking a loan you kept the money (minus initial EMI etc) in a bank deposit or mutual fund, you would need an interest rate of 11.94% to actually pay this loan back at 6589 per month.

That’s why it’s 12%. The effective cost of capital, to you, is that much.

Note: It’s actually even higher if you have money in fixed deposits – because you’ll pay tax on the interest you earn, and cannot offset it against the interest you pay. It’s a mess and the salaried individual is the worst off in this debate.

Is Bajaj Finance making a killing? Well, they get the money from you. They also get a discount from the folks that sell you the furniture. And they pay out part of the “processing fee” as a commission to the agent. For them, net of everything, they probably rake in 15% or so. Which isn’t too bad, so one might just buy their shares. Also people love to hear 4% because it’s darn difficult to realize it’s 12%.

But What If You Don’t Have The Money?

This might still be useful because there are hardly any easy sources of loans that give you this cash at 12% or less.

We went to a Bankbazaar and put the amount in – for a 1 year loan of Rs. 76,000 you will pay just a little more (at 12.50%) per year. Notice that the numbers here look very close to the Bajaj Finance deal – only that the banks don’t pretend it’s 4%!

(They can’t. The RBI doesn’t allow them to. Bajaj Finance is an NBFC so they get to do these things)

(If you don’t mind the extra interest cost, banks love it when you take loans and repay them – they then give you future loans at 0% processing fees and/or lower interest.)

In reality, the 4% loan isn’t 4% – it’s actually 12%. But it still may be the lowest loan amount you can get if you don’t have the money. If you have the money, unless you’re getting a whopping 12% from it, it’s better to use your credit card, get some points, and pay off the credit card bill with the money.

Disclosure: I own some shares of Bajaj Finance.

Something missing . . . 

Last month was traveling to my hometown in Kerala. Happy feelings when you finally get the annual leaves approved and are heading back home. The journey was in the train and trust me there is no other mode of transportation as memorable than traveling with Indian Railways. My reservation was made for the side upper berth and I had an extraordinary personality as my co-passenger. She was a nun, who was also the principal of a reputed school in the state. 
The journey was beautiful and company of Sister made it indeed an awesome one. During our conversation Sister shared one of her experience, which made me think and thought of sharing the same. 

It was a normal day as any other day and Sister was on her routine rounds of classrooms. As she was walking and came past to this class of grade 2, the class was seen unattended by any teacher and kids were all over the place. Seeing the commotion Sister entered the classroom and asked the kids to be on their seats. When enquired it was understood that the teacher was ill and no substitution was provided. Sister though to keep the kids busy till a substitution was arranged. She asked all the kids to take a plain paper and draw anything that came into their minds. Every one started with the activity and soon the class seemed to be under control. 

After a few minutes Sister had a quick glance on the drawings of the kids. They were all artists, one was drawing a scenery and another a Barbie doll. But one girl caught her attention. She seemed to be drawing her family. In the picture though was only two people. Sister asked the young girl what was she painting. And the reply was her family. But in the painting the girl and her mother were only there. Sister thought she might have lost here father and hence did not ask her anything more. 

Few days later Sister had an opportunity to visit the same class due to the same reason of teachers unavailability. This time again she asked the class to paint a picture. To her surprise this young girl drew the same picture again and that too without her father. Due to the curiosity on finding the real reason Sister went and checked the school database and to her surprise she found the girl had a father and he was a well-known businessman of the town. 

Sister immediately called her father and asked him to be available in the Principals office before the school leaves for the day. The immediate reply from the father, “Sorry, today I am very busy will try to come tomorrow”.  Sister replied , “Then please find the transfer certificate along with your child when she comes home today” and hung the phone. 

Within an hour the father was in principals office. Sister showed him the painting and asked him, “What is missing in the picture? “.  The man could not find anything wrong. He said, “It’s all fine,  nothings missing in this” . Sister replied , “Sir you yourself are missing”. Hearing this the man was shocked. Sister asked the girl why she didn’t draw her father in the family painting, her answer was “I FORGOT, I have not seen him in past six months. He comes after I am asleep and goes out before I am awake”.

That incident actually made a dent in me and made me think are we indeed actually missing somewhere. Family is the only place where we are honored and respected,  no matter who we are in the outside world and getting forgotten there is a disaster in itself. 

The Love of a FAMILY is LIFE’S greatest BLESSING – Anonymous.