0% financing (zero percent), alternatively known as discounted finance, is a widely used marketing tactic for attracting buyers of consumer goods, automobiles, real estate, or credit cards in different parts of the world.
Maps 0% finance
Definition
For the buyer, the scheme is offered as a steal, without any levied interest for a specific period, subject to special terms or conditions.
Mathematics behind 0% finance
The financial mathematics behind the 0% finance scheme is somewhat complex, as the calculation differs with respect to the type of product and the country. These deals are offered by finance companies or banks in conjunction with a manufacturer or dealer network. The schemes offer "zero percent" finance, where a customer pays for the financing cost in an indirect manner. The indirect cost will include paying a processing fee, a significant amount as advance EMIs (equated monthly installments), as well as a minimum cash down payment. Often, the biggest cost may involve forfeiting a cash discount which might otherwise be available on a cash purchase.
Suppose a customer opted for 0% finance to buy an electronic device worth $1000, offered on a term of 6 months EMIs, with a $50 application processing fee and one month EMI in advance. This sale actually results in a 12.48% effective interest rate for the customer.
Several central banks have reacted strongly to zero per cent or discounted interest rate schemes and want them stopped, as they feel consumers are misguided by such schemes into believing that bank funding comes for free. As such, schemes serve the purpose of attracting and exploiting vulnerable customers.
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