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Interest-free loans

Tuesday, 20 December 2011 09:03am

©The Star (Used by permission)
by Articles of Law By Bhag Singh

Offers to credit card holders of interest-free advances or loans can be misleading.

THE word “free” is indeed a word many people like. There is freedom in the sense of liberty that humanity yearns for; free time to do what one likes is something most, if not all, people desire; and who would not seize the opportunity to get something for free?

Which brings me to credit cardholders who are lured into applying for loans or advances that are proclaimed to be interest-free. Rare indeed would be the person who would complain if he is offered an interest-free loan, whatever it is called.

A reader says a bank has offered him an advance on his credit card for three months on an interest-free basis. Knowing that banks always charge an interest and there are penalties when payment is even a day late, can this really be true, he asks.

It would be wonderful to get an interest-free loan from a bank for any period of time. But before one rejoices, one needs to find out more.

I personally doubt that in reality, customers will get a loan or advance on an interest-free basis. Thus, I wonder if the offer was verbally made or in writing. If in writing, is it the complete message or only a part of it?

The reader welcomes this if it is true as, based on his finances, he can repay the loan within the stipulated period. He will therefore actually enjoy a truly interest-free loan which would be a first-time experience in his life.

Whilst there is nothing to prevent any bank from giving an interest-free loan, I am more inclined to tell the reader that he is likely to be in for a disappointment. The real picture may only emerge when the customer actually applies for and decides to take the loan.

Upfront fee

In most, if not all cases, when the cardholder calls up to make use of this facility, he will, after due verification, be told at first that indeed in this case the advance or loan is interest-free for three months.

This would not only be tempting but extremely pleasant to the ear.

However, the customer service personnel will tell the customer that while no interest is charged, there is an upfront fee of 5% or some such amount to be charged where the loan period is, for example, three months. Strangely enough, the customer will be told that this is not interest-free!

The fact of the matter is that it will cost the customer 5% to borrow the money for three months. If the money is only repayable at the end of three months, the effective interest rate per annum would be 20%.

Besides this, it is not unusual for an “administration fee” to be paid upfront upon receipt of the next statement that may be just days away depending on when the facility was taken.

In other cases, the customer may not have the benefit of the loan for the full three-month period. This is because he may, for example, be required to pay back the amount in equal instalments over the three months.

The effect of this would be that at the end of the first month, he would have repaid a third of the amount whilst paying interest on the full amount.

At the end of the second month, and sometimes earlier, he would have paid another one-third, leaving one-third unpaid while having to pay full interest on the full amount. All this, of course, ends up in the effective interest rate being more than 20% per annum.

In all fairness, it is not incorrect to say that the upfront 5% fee is “not interest”. What is interest does not depend on what the lender chooses to call it.

Guidance may be obtained from the Moneylenders Act 1951. Section 2 sets out what interest means in this way:

“Interest” does not include any sum lawfully charged in accordance with this Act by a moneylender for or an account of stamp duties, fees payable by law and legal costs but, save as aforesaid, includes any amount by whatsoever name called in excess of the principal paid or payable to a moneylender in consideration of or otherwise in respect of a loan.”

Of course, a bank may not call itself a money lender. But the fact is that a bank, though making an advance based on credit cards, does conduct the business of lending money. Basically, these are unsecured loans. Therefore the definition of interest would be equally applicable.

Individuals who are encouraged to apply for advances and loans through their credit card should therefore be aware of how much interest they will actually be paying and the cost to them to borrow the money. The customer should also be fully aware of the terms and conditions which will apply to him.

In previous times, the terms used to be given in writing though many people chose not to read them. Today, the questions are asked and terms and conditions are conveyed to the cardholder through a recording.

This is not to say that the banks are doing anything wrong in adopting this approach. After all, the bank does not force anyone to take advances on his credit card. It is the customer’s choice but the customer should choose what he wants with full awareness of what he is in for.

At the end of it, it will be noted that what is purported to be free may not in all cases be free after all.

Though most people welcome what is free, the fact is that apart from the word “free” itself being freely used, there is little that is free when transactions between two or more people are involved.

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