The interest rate on gold loans can range from 7.5% to 29% per annum depending on LTV ratio, loan tenure and repayment option
Borrowers can now unlock more value from their idle gold jewellery as Reserve Bank of India has raised the loan-to-value (LTV) ratio for loans against pledged gold to 90% from 75% till March 31,2021. Individuals and small entrepreneurs can now borrow more from banks by pledging gold to manage the liquidity challenges because of Covid-19. However, gold finance companies such as Muthoot Finance and Manappuram Finance cannot lend at the higher LTV.
With many people facing cash crunch in these extraordinary times and banks turning risk-averse to unsecured loans, demand for gold loans has risen. Banks find it safe to lend against gold —the collateral provides adequate risk cover against any future default—while customers get loans faster with less documentation and even at lower rates of interest.
As gold prices have soared 42% between January 1 to August 6, 2020 and have touched lifetime highs, borrowers can raise a higher loan amount against jewellery. With the increase in LTV ratio, now borrowers will be able to get an even higher amount against the gold jewellery. However, experts feel that the increase in LTV for loans against gold increases the risk of the lenders as any correction in the gold prices may lead to defaults.
How to get loan against gold
For the valuation process, the gold jewellery accepted as security or collateral will be valued at the average of the closing price of 22-carat gold for the preceding 30 days as quoted by the Indian Bullion and Jewellers Association. If the gold is of below-22-carat purity, the bank will convert the collateral into 22 carat and make an exact valuation. For documentation, banks need address and identity proofs.
Customers also need to prove ownership of gold being pledged. Some banks may even ask for a no-objection certificate from the lady of the house for giving the loan. The tenure of gold loan can be seven days to three years with a few lenders offering tenures of up to five years. As longer loan tenure means higher interest outgo, opting for a gold loan will be more cost-effective if one is confident of repaying the loan within one or two years.
Points to watch out for in gold loans
The interest rate on gold loans can range from 7.5% to 29% per annum depending on the LTV ratio, loan tenure and the repayment option opted for (See graphics). Interest rates will be higher for longer tenure and higher LTVs ratio. In contrast, the interest rate of personal loans ranges from 8.45% to 26% per annum. Like all types of loan, borrowers with a good credit profile will be charged a lower rate.
For processing fee, some lenders may charge 0.5-1.5% of the loan amount or a flat fee of as low as Rs 10. A borrower must compare the processing fee and look at the credibility of the financing company before finalising the loan.
There are various types of repayment options in gold loans apart from the regular EMI option. A borrower can just pay the interest component each month and pay the principal amount on maturity. He can also repay the interest amount upfront at the time of loan disbursal and pay the principal amount at the end of the loan tenure or do a bullet payment of both the principal and the interest at the end of the end of the loan tenure. So, one must look at all the repayment options carefully.
After the loan amount and the interest are repaid, the customer gets back the gold in exactly the same state and weight that she gave at the time of taking the loan. In case the borrower fails to repay the loan, the lender can liquidate the gold pledged to recover the money.