A Walk Down Loan Street!
Should You Shop With Borrowed Money?
It is that time of the year. Big sales all around. Ecommerce companies are enticing you with great discounts. So are offline retailers. From now to the end of Diwali it is going to be one long spending opportunity.
Best time for a personal finance blogger to remind you to be frugal and spend only as much as you can afford. Yes, we are talking about loans.
Let us look at one interesting development you might have noticed.
Payment options have increase manifold
The number of payment options have gone up compared to just a few years ago. Earlier you had Cash on Delivery, Netbanking and Credit/Debit card as options. Now, you can add Wallets & UPI to it.
Then you have many pay later options. You can convert your payment to an easy EMI with whichever card you use. You can take a loan at the drop of a hat from so many lenders. Apps like Money Tap and Cred might be sending you regular messages. These, enticingly call out how much money is available for instant withdrawal. You can download an app like Lazypay or Zest and use that to Buy Now Pay Later.
So, point made, I guess. It is easier than ever before to borrow money and spend it on stuff.
If you are in the shopping mood, it is much harder to step back and think. You can swipe, scan, whatever and be done with the transaction.
All well and good right. Why should it be a problem if it is easier for a person to borrow money quickly?
This is true. It is always good to have the facility to borrow money whenever you need it.
But! There is always a But!
You should be able to pay back the amount you have borrowed. If not then you will pay interest. An important point to note, you should be aware of the interest you are paying.
What are the interest charges for these options
I am looking at 4 basic ways in which a customer is able to borrow money.
- Credit Card
- Credit Card EMI
- Personal Loan
- Buy Now Pay Later
Credit Card:
We have a separate article covering the cost of borrowing on credit cards. To note here, that cost can be between 30% to 44% per year. You do get free credit for a few days if you pay it off in full.
Credit Card EMIs:
Cards charge you ~ 15% – 18% per annum for converting card purchases to EMI. There is also a processing fee of ~2%.
Note: This is different from the No Cost EMI that ecommerce sites offer. Those are similar to purchasing on the card. As a customer, you don’t pay extra for the No Cost EMIs.
Personal Loans:
You can borrow from banks and from the new age apps. If you go to a bank then rates can range from 14% to 26%. An app like Money Tap shows a rate of – 13% to 24%.
Also, banks usually charge you a fee to close the loan early, ~2% of the outstanding capital, but this varies across banks. The new-age apps don’t currently charge a penalty for early closure.
Buy Now Pay Later:
Technically there is no charge here, if you pay within the stipulated days. If you convert these to an EMI then you are looking at ~15% to 28% interest.
HDFC’s Flexi Pay rate is 70 per month per 3000 rupees. That converts to 28% per annum. Other BNPL apps are very cagey about the interest rates on EMI. You will need to dig to find out the rates. They are in the range of 15% to 26% per annum.
Here too, the banks will charge you a penalty for paying early, the BNPL apps currently don’t.
There are also distinctions around your credit score. Some of these lending apps use your credit score and some don’t. Of course, if you miss payments or default then all of them will report it to the credit bureau.
Where does that leave you as a consumer.
It boils down to discipline. For the person who does not miss payments and manages their finances well, this is a very good thing.
Great to have options and optimise your spending.
But if you have issues with managing your money. If you have a likelihood of falling into a debt trap then this makes it worse.
It is now so easy to borrow money and think of a 100,000 rupee spend as nothing more than an EMI of 9,000. The ease of use, less than a few seconds to complete the purchase, makes it harder to reflect and reconsider.
This allure can easily lead you into a debt spiral. The issue is, most of the BNPL and Personal Finance apps don’t make the interest rates clear. They all sell the point about how easy it is to buy something that you always wanted (but couldn’t afford).
They also talk about the number of days you have in which to pay it back.
The actual charges are mentioned as absolute numbers ex. 11 rupees fine for late payment. These absolute numbers make it sound like a low charge – ex. 70 rupees per month interest for 3000 rupees. The % however is well into the 20s which makes it a very expensive way to borrow.
How do the BNPL companies make money?
They charge the merchants. Similar to credit card companies, BNPL companies charge the merchants a fee. The other revenue stream is interest.
Currently, there aren’t too many records in the public domain of the split between these two streams of revenue.
Klarna (one of the largest in this space) has an annual report. There you can see that 30% of the revenue comes from interest. A service that is free for consumers to use, still gets 1/3rd of its revenue from interest paid by the same consumer. Late fees and penalties haven’t been called out separately.
This article on Forbes mentions that 43% of the BNPL customers paid a late fee. It also states that more than 50% had their credit card limits decreased in the last year. Both of these indicate that these are customers who are not on top of their personal finances. You can read more about BNPL here or watch here.
The BNPL companies solve a genuine customer need. They also reduce the amount of friction in the process. Also, they are making it easier for consumers to pay back the borrowed money. Regulators have not yet solved the gap between rules applicable to banks and BNPL providing essentially the same service.
Bottomline:
The issue actually is not BNPL providers but the borrowers.
As a savvy customer, you should use every facility available to you and use it cleverly. However, be aware of your own limitations and don’t overstretch yourself. Easy options will always make it easy to get trapped.
Festive time is to enjoy yourselves and have a good time. Do it with a little financial prudence.
Key takeaways:
- It is a great time to be a consumer.
- Festive season is here and there are plenty of exciting deals being offered.
- There are numerous easy payment options that did not exist till recently
- As a customer, you should be aware of the interest costs of each option.
- It is very easy to fall prey to the allure of cheap loans.
- Be financially prudent and enjoy the festivities
