A no-cost EMI works like a regular loan where the bank or lender charges an interest. But, the interest is not passed on to the customer. It is rather borne by the merchant selling the product. The total interest on the loan is given as an upfront discount to the customer at the time of purchase, which makes the purchase cost of the item the net amount that the customer has to pay.

The cost in no-cost EMI

When you make monthly instalments, the interest component is built into it along with the principal to ensure that the full cost is recovered. This is where this financing scheme gets interesting. No-cost EMIs are typically offered through credit cards. Interest payments on credit cards carry 18% GST. So, your monthly instalments are not made up of just principal and interest but also carry 18% GST charged on the interest component built into the instalment.

Let's understand this with an example. Say, you buy a television worth ₹62,000 in a no-cost EMI scheme. You have to pay ₹6,889 in monthly instalments for nine months. The interest rate is 16%. In the first month, of ₹6,889, the principal is ₹6,115 and interest is ₹774. However, in your credit statement, you will see the interest component to be ₹913 as it includes 18% GST (goods and services tax). So, the total amount you pay in the first month is ₹7,028 instead of ₹6,889. Over eight months, you pay ₹709 extra in GST (see graphic) on the interest amount that is technically not even borne by you.

This is a hidden cost to such no-cost EMI purchases that you are not told upfront. Banks also charge a processing fee of ₹99-250 which, in most cases, is disclosed upfront. The GST on interest payments and the processing fee is the cost that you pay for availing the interest-free loan. In the above example, you would have paid about 1.5% extra on a 'no-cost' loan. Also, credit card purchases turned into EMIs are exempted from earning rewards. This means you lose out on an additional 1-3% that you would have earned in the form of rewards or cashback.

When you take a loan from a non-banking finance company (NBFC), there could be a host of other charges like convenience fee, network fee, annual fee, etc., that may add to this cost. Do note that taking a loan from an NBFC or a bank doesn't attract 18% GST on the interest. However, GST is applicable on other fees and penalties.

It can be argued that it is still a sweeter deal than actually paying 16% interest rate on loan to get the convenience of staggered payments when you don't have enough liquid cash. While it is true, since the instalments work like loan EMIs, consumers should take it up only if they can manage to pay the instalments on time.

Sellers' stake

One may wonder what's in it for the seller or merchant who is willing to foot a loan on behalf of the consumer. The no-cost EMI scheme has been worked out in a fashion that benefits all the stakeholders involved–the merchant or seller, financier (bank or NBFC) and the customer.

The customer is lured with the convenience of easy, staggered payments at no extra cost. When a sale is guaranteed through the no-cost EMI scheme, the manufacturer offers 'EMI discount' on the product. EMI discount is essentially the interest on the loan, which the customer won't get if they don't take the loan.

A former banker who runs a fintech company explained to Mint that the discount offered by manufacturers or merchants becomes part of their marketing cost. "Merchants in the electronic business have bigger margins of about 10% and hence, bigger marketing budgets. They absorb the subvention (interest on loan) as part of their marketing costs," he said.

The financier, or lender, earns from the interest, while the customer gets a product immediately for a small cost. If there are sellers in between (like Croma, for instance), they get commission for driving the sale and may even get a commission from the financier if the interest rate on the loan is high.