Why Consumer Finance Loans are a scam.

Note: This is a relatively comprehensive and complex exposè. It took us considerable time to understand and explain how the scam is happening. It has a bit of math as well. So please bear with us because the deal and the devil are in the details. You can skip to the conclusion if you want the gist.

I have a friend. He purchased an iPhone. He took a loan to get that device. The agreement is that he pays back that loan in the next 48 months (4 years). I have another friend. He & his wife purchased a lot of furniture by taking a loan. The condition is that they repay the money in the next 24 months (2 years).

It’s not just them. I have also taken out a loan to get a product. Like me & my friends, more than 91% of Indian Graduates & 78% of Individuals earning more than Rs. 30,000 prefer taking a consumer finance loan to purchase iPhones, MacBooks, Laptops, furniture, TVs, etc.

There is only one reason these many people prefer taking loans: it allows them to get the product now and pay for it later. This convenience begs the question: Is consumer finance a good thing, or is it too good to be true? So, we started researching.

We reviewed the policies of HDFC Bank, Bajaj Finserv, ICICI Bank, IDFC First Bank, Indusland Bank, Tata Capitals & Kotak Mahindra Bank to reach our present conclusions (Table 1 consists of all the essential details for your reference). We reviewed the recent measures the Reserve Bank of India (RBI) took to regulate these loans. We researched the current market situation when it comes to credit cards & other types of consumer loans. And we came to one conclusion.

Consumer Finance is a dishonest & abusive scheme created to cash in on the hopes of middle-class, hardworking employees. Consumers who purchase through this will likely end up paying more than 65% of the cost of the product in penalties and interest.

Through this exposè, we prove how consumers are drastically impacted by Banks & Finance Companies offering Consumer Finance.

What is Consumer Finance & what can be purchased?

Indian Banks developed a unique instrument that allows consumers to purchase any product of convenience. They created Consumer Durable Loans, also called Consumer Finance/ Consumption Finance Loans / Consumer Finance Loans (CFL, from now on).

CFLs are a kind of funding banks and financial organisations provide to enable customers to acquire essential, enduring merchandise. These products are often everyday household items frequently required to improve the individual’s standard of life. 

That said, which products are eligible for CFL is at the Banks’ discretion. For instance, HDFC Bank and Indusland Bank provide CFLs for various goods, including furniture, electronics, lifecare & wellness, education and tour packages. IDFC Bank offers CFL on electronics, home appliances, and Automotive parts like Tyres, CNG fitments, etc.

Usually, the following products are eligible for CFL:

• Digital Products: Television, audio devices, smart watches & phones, laptops and tablets
• Lifestyle: home decor like beds, dining tables, automotive parts and other necessary furniture
• Domestic Machines: Water purifiers, air conditioners, Microwaves, and Refrigerators
• Others: Wellness equipment.

How much can one borrow?

(Please refer to Table 1 below)

Different Banks provide different loan amounts to attract consumers from various backgrounds. HDFC allows the consumer to borrow between Rs. 10,000 to Rs. 5 Lakh & Rs. 10,000 to Rs. 15 Lakhs (for lifestyle products). Bajaj Finance keeps the maximum limit to Rs. 15 Lakh (with the minimum being Rs. 10,0000. IDFC gives loan amounts up to Rs. 5 Lakh. Tata Capital provides amounts ranging between Rs. 10,000 & Rs. 5 Lakhs. Kotak Mahindra provides loans from Rs. 5,000 to Rs. 15 Lakhs.

How much one can borrow depends on the bank’s discretion. There are no all-encompassing criteria, and there is no precise, straightforward information the banks provide on their online portals regarding the standards to determine the upper limit for each borrower. What is known is that factors that allow the bank to evaluate the borrower’s economic stability and repayment capability (like a credit profile, bank history, monthly income, etc.) are considered.

This relaxed strategy permits banks to personalise their offerings for loans based on the individual economic positions of each borrower, guaranteeing not only minimal risk faced by the bank but also the ability of the borrower to pay back.

What are the Interest Rates charged?

(Please refer to Table – 1 above)

CFLs have varied interest rates, subject to the financial institution that issued them, the lenders, the goods being financed and the borrower’s credit history.

HDFC Banks’ put-forward interest rates range from 9.98% to 39.57% of the loan amount taken. Bajaj Finserv charges interest rates between 11% & 35%. ICICI Bank charges interest rates ranging from a minimum of 9.97% to a maximum of 28.33%. Meanwhile,  IDFC First Bank provides charges that range from 10.25% to 27%. On the other hand, Indusland Bank provides a limited range of rates, which span from 22.15% to 22.25%. Lastly, Kotak Mahindra Bank charges a fixed interest rate of 18%.

A consumer has a choice in preferring which Bank for the sake of taking the loan & that choice ultimately boils down to how much interest rate they would like to pay & what all Banks are providing the CFL for that product at that particular merchant.

How does a CFL work?

The procedure commences when the customer chooses their preferred item from a physical, such as gadgets, home decor items or online store. The Consumer can pay for the product through these mechanisms: Cash, net banking, UPI, debit card, credit card, & CFL.

When the consumer chooses CFL over a credit card & debit card, the finance representative of the respective Bank or finance institution checks the total amount that can be borrowed as CFL and informs the consumer.

The consumer can pay a nominal amount if they so wish to. After the nominal amount is deducted, the remaining amount is considered CFL.

Essentially, the merchant who is selling the product receives the total value of the product (nominal amount from the consumer, if paid + the amount under CFL from the Bank). It then becomes the bank’s duty to collect the amount given as CFL from the consumer.

When taking a CFL, i.e. at the merchant’s location, the loan agreement details are communicated to the consumer. The Loan details consist of the interest rate upon the CFL, the Equated Monthly Installment (EMI) of the entire loan, and the repayment schedule, which includes the total no. of months and every month’s repayment date.

Usually, the repayment date is the 3rd day of every month / 5th day of every month.

The loan agreement also consists of provisions for cheque deposits. When taking the Loan, the consumer essentially signs cheques for every month of repayment (if the loan is for 12 months, 12 cheques are drawn in on the bank’s Name at the time the CFL is being taken). This is done so the loan provider can electronically deposit these cheques on the day of repayment with the consumer’s Bank and ask the consumer’s Bank to transfer the funds.

Once the loan application is complete, & the consumer signs, the money is transferred to the merchant, and the consumer possesses the product. Thereon, every month, the Bank/finance institution deposits the Cheque in the concerned bank of the Consumer seeking funds to be transferred from the Consumer’s bank account.

What are the hidden costs involved?

(Please refer to Table – 1 above)

Besides Interest, four different types of costs are involved in CFLs: processing fee, late payment fee, Cheque Bounce penalty and Pre-closure rates.

The banks charge a processing fee / Loan processing fee at the time of purchase. Different banks have different processing fees. HDFC charges a processing fee of Rs. 749 + 18% GST (per loan taken). Bajaj Finserv charges 3.93% of the loan as the processing fee. Indusland charges 1% of the loan amount as the processing fee. Tata Capital charges between Rs. 89 to Rs. 10,030. Kotak Mahindra Bank charges processing free from Rs. 99 onwards.

The Late payment penalty fee is the fee that is to be paid when the consumer fails to pay the instalment on the agreed-upon time. HDFC charges Rs. 550 + 18% GST as a penalty. Bajaj Finserv charges between Rs. 8 – Rs. 12 per day per instalment from the due date until receipt of the full amount. ICICI charges 5%  per annum, and IDFC charges 2% per month of the overdue instalment / Rs. 300, whichever is higher. Tata Capitals charges 3% of the amount overdue per month. Kotak Mahindra Bank charges 8% + GST as a late payment fee.

A Cheque Bounce Penalty fee is a fee that needs to be paid by the consumer taking the CFL if in case the cheque deposited by the Loan provider on the date of repayment bounces because of lack of funds or for any other reason. For each cheque bounce incident, Banks charge this cheque bounce penalty. HDFC charges Rs. 550 + 18% GST. Bajaj Finserv Charges Rs. 700 – 1200. ICICI Bank charges Rs. 500. IDFC Bank charges Rs. 700 + 18% GST. Tata Capitals charges Rs. 450 + 18% GST & Kotak Mahindra Bank charges Rs. 750 + 18% GST.

Pre-closure rates are rates charged by Banks for closing the loan early. HDFC charges 3% of the balance outstanding principal, Bajaj Finserv charges 4.72% on the outstanding loan amount. Both IDFC & ICICI charge 5% of the outstanding amount. Kotak Mahindra Bank charges 4% on the pending loan amount.

If a product is purchased through CFL, is it costlier & by how much?

Let’s settle this debate once and for all. Purchasing a product through a CFL IS more costlier than buying the product by using other means.

How? We explain this using an example.

Let’s assume that Mr Tarang wants to purchase an iPhone 15. The retail price of an iPhone 15 base model (as of the day of the exposè) is. Rs. 79,900/-* Let’s also assume that Mr Tarang is eligible for a CFL of Rs. 1,00,000/-  through HDFC. Suppose Mr Tarang purchases the mobile through the CFL (without paying any nominal amount) and not by paying cash, net banking, UPI, debit card, or credit card.

The following table presents everything that needs to be known about the total costs of the products, interests paid, and penalty paid for a loan to be repaid in 12 months, 24 months, 36 months & 48 months.

All values are in INR & all are rounded off to the nearest numbers.

We know that math is a complication for some of you, so we created this table and explained the table using the simplest of terms for your convenience.

Before describing & discussing the table, it is pertinent to note four industry practices at this stage.

Firstly, no. of months of repayment and interest rates have an inverse relationship. If a loan is taken for a shorter period, the interest rate is higher & vice-versa.

Secondly, banks / financial institutions do not distribute the interest re-payment equally amongst all the 12 months. They employ a varying scheme of interest repayment, i.e. they charge more interest in the initial months of the repayment tenure and less in the final few months. Because of this, the interest paid in a specific month may vary drastically. In the initial months of repayment tenure, the interest paid could be extremely high, and in the last months, the interest paid could be just nominal. Whatever the interest rate charged in the month, the overall interest is spread inequally and recovered by the end of tenure.

Thirdly, in any month, if a consumer does not receive their salary on time and is unable to pay the instalment on the date of repayment (which is on the 5th day of the month for HDFC), a cheque bounce penalty of Rs. 531 is immediately levied by HDFC. This is because, on the repayment date, the Loan provider deposits the cheque in the consumer’s Bank, which bounces due to lack of funds.

Fourthly, in any month, if a consumer does not receive their salary on time and is unable to pay the instalment on the date of repayment (which is on the 5th day of the month for HDFC), a late payment fee is also immediately levied, and the consumer is required to pay that late payment fee along with the cheque bounce penalty & the amount that is due for that month.

Back to the example.

If Mr. Tarang agrees to repay the loan in 12 months: he has to pay Rs. 15,980  as interest (calculated at 20% per annum). This means, per month, he has to pay Rs. 1332 (approx as interest) on top of the principal amount i.e. Rs. 6659 (approx.) {79,900/12}.  Per month, he has to pay Rs. 7990 as interest & principal.  He also has to pay Rs. 884 as a Loan processing fee in the first month. So the total cost of the product is Rs. 96764 (approx.), which is calculated by adding the total interest paid, principal borrowed and loan processing fee.

If Mr. Tarang agrees to repay the loan in 24 months: he has to pay Rs. 28,764  as interest (calculated at 18% per annum). This means, per month, he has to pay Rs. 1199 (approx as interest) on top of the principal amount i.e. Rs. 3330 (approx.) {79,900/24}.  Per month, he has to pay Rs. 4528 as interest & principal.   He also has to pay Rs. 884 as a Loan processing fee in the first month. So the total cost of the product is Rs. 109548 (approx.), which is calculated by adding the total interest paid, principal borrowed and loan processing fee.

If Mr. Tarang agrees to repay the loan in 36 months: he has to pay Rs. 38352  as interest (calculated at 16% per annum). This means, per month, he has to pay Rs. 1066 (approx as interest) on top of the principal amount i.e. Rs. 2220 (approx.) {79,900/36}.  Per month, he has to pay Rs. 3285 as interest & principal.   He also has to pay Rs. 884 as a Loan processing fee in the first month. So the total cost of the product is Rs. 119136 (approx.), which is calculated by adding the total interest paid, principal borrowed and loan processing fee.

If Mr. Tarang agrees to repay the loan in 48 months: he has to pay Rs. 44744 as interest (calculated at 14% per annum). This means, per month, he has to pay Rs. 933 (approx as interest) on top of the principal amount, i.e. Rs. 1665 (approx.) {79,900/48}.  Per month, he has to pay Rs. 2596 as interest & principal.   He also has to pay Rs. 884 as a Loan processing fee in the first month. So the total cost of the product is Rs. 125528 (approx.), calculated by adding the total interest paid, principal borrowed and loan processing fee.

If he does not receive the money on time for repayment in any of the instalment months, then a cheque bounce penalty (Rs. 531) & late payment fee (Rs. 649) are immediately levied. Suppose he did not receive the salary on time for 5 months; then the total amount he must pay in penalties is Rs. 5900 (cheque bounce fee + late payment fee multiplied by the no. of months of default). This increases the product costs from Rs. 96764 to Rs. 102664, from Rs. 109548 to Rs. 115448, from Rs. 119136 to Rs. 125036, & from Rs. 125528 to Rs. 131428.

To sum up: For a product that costs Rs. 79,900, Mr. Tarang would have to end up paying either Rs. 102664 / Rs. 115448 / Rs. 125036 / Rs. 131428. This means that for a product of Rs. 79,900, Mr. Tarang is paying an additional Rs. 22,764 / Rs. 35,548 / Rs. 45,136 / Rs. 51,528.

Keep in mind that these costs are calculated on the presumption that default happens for 5 months in the entire tenure. If the default happens for more than 5 months, the additional amount paid by Mr. Tarang will be even more.

Why is it a scam?

We know what you may be thinking – this is the cost of the product if the funds are NOT available on the repayment date. If funds are properly available, all that needs to be paid is the interest & the loan processing fee.

True. If funds are available on the repayment day, CFL is an extraordinary way to purchase a product because one doesn’t need to pay a late payment penalty/cheque bounce fee. However, such an idea ignores two major problems.

The repayment date problem:

The law (Payment of Wages Act, 1936 & Code on Wages 2019 that governs wages under Rs. 24,000 & above, respectively) obligates the employer to pay the salary before the 7th day of the succeeding month.

Not the 5th. Not the 3rd. But the 7th day of the succeeding month.

The reality, however, is different from the law. And the reality is this:

Several private & public companies are refusing to pay their employees several due months of salary. Several private & public companies are paying salaries in the second and & third weeks of the month. Several ineffective governments in India pay salaries in the last week of the month. Several companies pay on irregular dates.

Against this backdrop, we put forth a few questions:

In the 91% of Indian Graduates & 78% of Individuals earning more than Rs. 30,000 that prefer consumer finance to purchase products, how many people will receive their salaries right on time every month without fail? How many people will have, without fail, their salaries on or before the 3rd day of every month / 5th day of every month? How many people will receive their salaries every month, without any delays, in the 12 months / 24 months / 36 months / 48 months of the loan period? How many consumers will not pay the cheque bounce penalty & late payment charges, at least a few times, during the entire duration of the loan?

If you are a bank / finance company in the business and want to earn money, isn’t it smart to bet on consumers failing to pay at least a few times during the course of the loan? Isn’t it smart to have a high penalty fee for late payment?

This brings up the second problem.

The Penalty problem.

Gold Loans, Car Loans, Mortgage Loans, Education Loans, and other consumer loans provided by banks & finance companies also have Late payment fees & Cheque Bounce Penalties. Not only that, the late payment fee & cheque bounce fee that the Banks & Finance Companies charge for these loans is precisely the fee that is charged for CFL.

The only difference between CFL and other consumer loans is the EMI amount. Other Consumer loans almost always have a minimum EMI of Rs. 25000 or more, whereas a CFL is almost always likely to be considerably less than that threshold. And because of this particular distinction, the penalty charged becomes a massive problem.

In CFL, the cheque bounce penalty and late payment charges amount to an additional Rs. 1298/-. If the monthly EMI is low (Rs. 2000 / Rs. 3000, etc.), Rs. 1298 is almost half the EMI amount that Banks & Finance companies receive in addition to the EMI. If the loan is taken for a longer period, considering how receiving salary on time every time throughout the extended period is an issue, Rs. 1298 is a considerable profit that can be easily made.

It’s like this: if the loan is for a more extended period and it is with a low EMI, the Banks & Finance Companies are more likely to earn a lot in cheque bounce penalty & late payment charges & if the loan is for a shorter period, and it is with a low EMI, then they’ll earn a lot by charging high interest. Either way,

How are Banks able to do this? Is it because, after the purchase, consumers are less likely to keep track of how much they are being charged throughout the loan period? Is it because the EMI amount is relatively low compared to tens of thousands charged for car loans/gold loans/others, and consumers are less likely to think twice when paying slightly more? Is it because consumers cannot understand this complex transaction? Or is it because of all these issues? We may never know. But the answer to the question: Is CFL a scam? – is simple.

Yes. It is a scam. It’s a dishonest scheme created to cash in on the hopes of middle-class, hardworking employees.

Is it a scam because people are paying a lot of money?

No. It’s a scam because the late repayment fee is just as much as, if not more, in gold loans, car loans, education loans, mortgage loans, etc, even when the loan amount is significantly and substantially less in CFL.

It’s a scam because Banks & Finance Companies are acting oligopolistically to abuse the consumers by betting on them to miss out on their payments.

It’s a scam because more than 91% of Indian graduates, 78% of employees who are earning Rs. 30,000 & millions of other struggling families in India are being incentivised to take these loans and start a cycle of debt that haunts them for the rest of their lives.

After all, the rich need to get richer & the poor need to get poorer. Right?

The defence:

There exists a justification for businesses. The CFLs are unsecured loans. Banks / Finance Companies are handing out these loans without taking any security from the consumer, and they are just relying on the promise made by the consumer that they will pay back the amount they have taken without fail.

This defence is 100% justified. CFLs ARE unsecured. The Banks/Finance Companies do not know whether they will recover the entire amount they provide to the consumer. However, this argument disregards three significant practices: The varying interest rates charged by the providers, the way the limit on how much can be borrowed is determined, & the ability to increase interest rates arbitrarily.

Banks & Finance companies determine how much one can borrow, how much interest can be collected & how much interest can be collected in the initial months (varying interest). They control who they give the money to, how much they want to collect from the person as interest & how much money they recoup in the initial stages of the loan payment. They can give loans to different people, charge different interests, and, most importantly, recoup most loans provided in the early stages of the repayment tenure.

This is important because it shows that they have placed themselves in such a way that they may NOT lose money and gain everything they are required to in the initial months.

Let’s not forget that there exists a clause in the loan agreement signed by the consumer at the time of taking the loan, which clearly states that Banks & Finance companies can, at any time during the tenure of the loan, increase the interest rates at their discretion without any prior intimation.

All of this only means one thing: Yes, CFLs are unsecured loans, and Banks & Finance Companies are justified to be wary of them. But seeing how they are the ones that are determining the limit upon the borrowing, the amount of interest that can be collected in the initial stages of repayment tenure & how they can increase the interest rates arbitrarily, this defence of unsecured loans does not have any merit.

Banks & Finance Companies are in a safe position. Any risk that they say they have is unlikely to be there. It’s like we said before:

Conclusion

CFLs symbolise a concerning trend targeting middle-class consumers by exploiting their dreams and desires. These loans, designed to help purchase long-lasting items, frequently come with interest rates and undisclosed fees that can push the total repayment amount up by more than 65% above the initial product cost.

The process starts with consumers choosing their desired goods and opting for CFLs, unsecured loans provided by banks without collateral, relying solely on the consumer’s commitment to repay. For example, when a customer buys an item for Rs. 50,000 using a consumer finance loan with an 18% interest rate over 24 months, the final amount could go up to around Rs. 69,000 after considering interest charges and processing fees. The cost will only increase beyond Rs. 75,000 after factoring in the hidden fees (cheque bounce penalty, & late-payment fee). This results in 50% increase from the original price.

While institutions offer loan amounts and terms, the absence of guidelines for borrowing limits exposes consumers to predatory lending practices. Moreover, the recent regulations from the Reserve Bank of India requiring banks to maintain capital reserves against defaults have resulted into increased interest rates, adding further strain on borrowers. 

As highlighted above, a significant portion of the population, including 91% of graduates and 78% of individuals earning over Rs. 30,000, get caught in this debt cycle without understanding the lasting consequences created by these loans.

In the end, being a financial resource, CFLs can often trap consumers in a vicious cycle of debt, casting doubt on their value and potentially exploiting those looking to improve their standard of living. Therefore, CFLs, as they stand now, are a scam that puts bank profits above the well-being of consumers.