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Disasters of Personal Finance: Credit Cards and EMIs

Albert Einstein said, “Compound Interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.” Over the years, financial institutions have come up with new and exciting ways to lure the people interested in the latter into walking down the slippery slope of EMIs and credit cards.

Some might argue 0% EMI is favourable, but there are no free lunches! The RBI Circular in 2013 quotes, “In the 0% EMI schemes offered on credit card outstanding, the interest element is often camouflaged and passed on to the customer in the form of processing fee. Similarly, some banks were loading the expenses incurred in sourcing the loan in the applicable rate of interest on the product.

Since the very concept of 0% interest is non-existent and fair practice demands that the processing charge and rate of interest should be kept uniform, product or segment-wise, irrespective of the sourcing channel, such schemes only serve the purpose of alluring and exploiting the vulnerable customers.”

0% EMI is just a marketing gimmick. Either the discount of the product (when paid upfront) is forgone and paid as interest or the interest is stacked in the product price itself. Nevertheless, you are paying more than you should, for certain consumeristic temptations.

Using credit cards for groceries, fuel, clothes and a galore of things that await your arrival in those flashy shops and glutted malls – makes you spend way more than you earn. It often leads to overmounting debt or you pay it off from your savings (only if you have them) or worse, bankruptcy.

While champions of Consumer Finance and those who want the production cycles to keep running incessantly might argue that EMIs and Credit Cards are a revolution in the microfinancing industry, enabling people to get things that are too expensive or out of their financial reach (and there is some truth embedded in it, undeniably). However, what matters is the fact that they instigate people, especially the youth, to buy things they don’t need from the money they don’t have.

Let’s take an example, a recently graduated young man has begun to settle in his first job. He knows that he is going to get a periodic fixed income. The dream of owning the car he always wanted as a boy, now seems more real than ever. So, he buys the car on EMI and feels pleased with himself. But what he does not realise is that he has just bought a depreciating asset as well as a periodic negative cash flow that will go on for a long time. So, he has 2 liabilities: depreciation and debt, and worse, he is all pleased and satisfied with it. Though, this still does not mean that debt is inherently bad.

Let’s take another example of yet another, recently graduated young man who started his job. He too knows that he is going to get a fixed income for a specific period of time. Instead of going for the car, he decides to increase his long-term value by planning for an MBA. He knows that MBA fees are astronomical and he can’t pay for them. So, he decides to take it on debt, while investing a fixed portion of his current salary in some growing assets. Essentially, he is taking on liability for an appreciating asset that will increase his worth and value in the long run. The merit of the debt should far outweigh the debt itself.

The underlying principle to remember is that debt is not always bad. A wise decision is to take it on only when the underlying asset (that you are getting from the debt) grows at a rate faster than the debt.

EMIs and credit cards have made money look cheap, fungible and less valuable when it is actually not. They have created a perception of need. They like to make people believe that needs and wants are the same when they are not.

The gist is that one should never borrow to consume, and worse if you are doing it to be at par with your friends or neighbours, you are digging a hole for yourself to fall in.


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