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insight

Instalment Payment Plans involving Pre-payment for Goods or Services

Have you ever pre-paid for goods or services by means of an instalment payment plan (IPP) using a credit card?  If you have, you are not alone, as many consumers also use IPPs for paying their fees for the use of yoga centres, beauty salons and the like, and for buying things like electronic gadgets.  What is more important is whether you understood the terms and conditions of the IPP before you entered into the arrangement.  If you did not, you are not alone again.  Many consumers did not seem to understand the nature of IPPs and their obligations, and lost money because the merchants went out of business before the consumers received all the goods and services they had contracted for.  Therefore, the next time you want to make a pre-payment for goods or services through an IPP, do take note of the following before plunging in:

  1. What is an IPP arrangement? What obligations does it entail?
    • An IPP through a credit card essentially involves a consumer paying for the purchase of goods or service provided by a merchant, using the consumer’s credit card by making monthly instalment payments through his or her credit card account to the credit card issuing bank.
    • In most cases, an IPP is effectively a loan agreement between a bank and its customer (the cardholder) under which the bank advances a loan to the customer to pay the merchant in full for the purchase of goods or service, while the customer undertakes to repay the bank the loan in monthly instalments through his or her credit card account.  If the merchant goes out of business, not only will the customer be unable to enjoy the goods or services contracted for, the customer generally has the obligation to service the remaining monthly instalments to the card-issuing bank in accordance with the IPP agreement.
  2. Is there any risk involved?
    • The risk of the merchant going out of business always arises no matter whether the pre-payment is made in cash, or through credit card involving a lump-sum payment upfront or IPPs. Whenever consumers pre-pay for goods or services, they are inevitably exposed to the credit risk of the merchant. Should a merchant go out of business before delivery of the goods or services, consumers may face the possibility of not being able to get a refund of their pre-payments or having to continue to pay the remaining instalments by credit card. Consumers are often enticed by the discounts offered on, for example, long-dated service plans. While this might be tempting, consumers should be aware of the pre-payment risk involved and should think carefully before entering into IPPs.
  3. What is credit card “chargeback”? Are IPPs subject to chargeback protection?
    • Generally speaking, consumers using credit cards to make lump-sum payments upfront are eligible to apply for a refund of their payments, or a “chargeback”, in accordance with the credit card association’s rules, for services that they are not able to enjoy because the merchant has gone out of business. Having said that, it is also worth pointing out that not all credit card issuers offer chargeback protection for IPPs and even if they do, chargeback applications are subject to certain rules and criteria set by the respective card associations. Chargeback applications not meeting these requirements would be rejected. One should also note that the processing of a chargeback application takes time because the bank needs to ascertain the customer’s claim about the services that they had contracted for but were still outstanding when the merchant closed down its business. A consumer can call up his or her credit card issuing bank to understand the details of any chargeback rules and criteria that may apply to his or her credit card transactions.
    • In August 2010, the HKMA issued a circular to all authorized institutions setting out the requirements they should follow when marketing IPPs involving pre-payment for goods or services through third parties, such as merchants.1 Under the new arrangement, the salient terms and conditions of IPP agreements that are not subject to chargeback protection should be specified clearly in a readily readable format.
  4. Are other payment options available? Is IPP through a credit card the best option?
    • Merchants generally offer different payment options to consumers, and IPP is usually one of the options only. When consumers pre-pay for goods or services, they should explore all payment options and choose the payment option that suits them most. A table setting out the major payment options for pre-payment of goods or services is shown below:


    Payment options Pre-payment risk Is it a loan agreement? Payment to merchant Monthly instalment repayment obligations
    (in case the merchant goes out of business before delivery of the goods or services contracted for)
    Chargeback mechanism
    Cash or EPS Yes No Merchant is paid in full upfront N/A No
    IPP through a credit card Yes Most likely it is a loan agreement but this depends on terms and conditions of IPP of different banks

    Most likely the merchant is paid in full upfront

     

    (Cardholder repays the bank by monthly instalments)

    Depends on the exact terms and conditions of the IPP agreement, which may vary from bank to bank

     

    (Most likely the IPP transaction is irrevocable, and cardholder is liable to repay the monthly instalments to the bank)

    Some but not all banks offer the chargeback mechanism for IPPs

     

    (Cardholder should check with the respective credit card issuing banks)

    Lump sum payment through a credit card Yes No

    Merchant is paid in full effectively more or less upfront

     

    (Cardholder pays the transaction amount to the bank on or before the due date of the credit card statement)

    N/A Generally yes, but chargeback applications are subject to relevant chargeback rules and procedures
  5. Note: The table above only sets out the major payment options, there could be other payment options for consumers, including paying the merchant direct by instalments through autopay arrangement.

  6. As a smart consumer, you should always ask the following questions before entering into a credit card IPP:

    > Is the IPP a loan agreement?

    > What are the repayment obligations, in particular if the goods or services contracted for are not delivered by the merchant?

    > Is the IPP subject to “chargeback” for goods or services that have not been delivered? Under what circumstances can credit card cardholders apply for chargeback, and what documents do credit card cardholders need to provide to the bank? Are there any other specific rules?

    > Is there any other payment option available?

    • The features of consumer credit products, such as IPPs, offered by banks may change over time. It is important that consumers should read and understand the details of an IPP agreement before entering into the arrangement for the purpose of making pre-payment for goods or services. It is always better to sit back and allow oneself more time to read and understand the IPP agreement. Consumers should not hesitate to call up the credit card issuing bank’s hotline and ask for answers if they do not fully understand the IPP arrangement or the obligations it entails. The catchword is “Caveat Emptor” or “Buyer Beware”.



Meena Datwani
Executive Director (Banking Conduct)
25 October 2011

 

1 The circular is designed to ensure clearer documentation.  The emphasis has been on greater transparency rather than prohibiting such arrangements altogether or requiring chargeback for all such transactions.

Last revision date: 25 October 2011
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