ronjan

Member • Sep 27, 2006

## The EMI Monster :)

Cross-referenced from BladE's edge

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Hi,

Hehe 😀, a few days back one of my verry good friends The Big K, who runs this fundoo site #-Link-Snipped-# [If you are an engineer and if u r half as crazy as me 😁, u gotta be thr !], asked me to contribute some finance-related articles but since I dinn want to ding his readership 😛, I asked for a raincheck, but today I want to write about something I have seen splayed all over the place, which is one dirty trick banks are using to make truckloads of money !

So its called EMI or Easy Monthly Installments [I hope I got dat one correct 😀], which lures users into believeing they are paying

**by paying small-small amounts each month to finish payment of a large amount per se. But as they say, There is nothing like a free lunch 😁. Its a well-known fact that when buying cars, you pay atleast 15-20 k less if u pay the whole money upfront rather than taking the EMI route. So, as my erstwhile Prof. JR Varma at IIM-A used to say, lets use some numbers to see how deep we are in the soup 😁.**

*at ease*So, currently ICICI credit card offers a scheme wherein you can pay a 1000 Rs. in six monthly installments of Rs. 173 each. So, first of all, lets say how a bank salesman would sell it to a layman...as a class IV kid would know, he would use the simple interest route to say you pay 173 * 6 = 1038, which over a 6-month period gives a rate of 7.6%, and umm, that's not too much, the bank loan rate is upwards of 9% afterall, so its good, ain't it ?

But, since we are not morons really, so 1st of all lets change the simple interest to compound interest, which gives ~7.74% which is still managable, but the trick lies in the fact that with each payment of 173, apart from the interest

**So, the correct way of looking at it would be to look at the Internal rate of return of the transaction, which can be computed easily by the help of MS Excel's IRR function 😁. And a small computation, like the one lined below :**

*you pay a part of the principal away as well !*Month 1 : -1000+173 = -827

Month 2 : 173

Month 3 : 173

Month 4 : 173

Month 5 : 173

Month 6 : 173

gives you a monthly IRR of 1.516% which gives an yearly rate of

**18.2% per annum**!!! Now that's a staggering figure, almost 6% over any kind of personal loan you will ever take in life.

So, next time some salesman calls you up and says, "Sir, EMI 😁", I believe the only thing you should say is,"Go take a hike"...

Lemme know what you think ...

Tk care !

Ranjan