How rising gold prices affect your gold loan

gold loan

Gold prices touched the record highs. The MCX Gold prices has been trading at Rs 62,197 per 10 gram on Monday, December 11, 2023. While high gold prices may be a problem for those purchasing gold, they benefit those seeking gold loans.

One can take a loan of up to 75 percent of the value of the yellow metal. Hence, when price rises, one can get more bang for the buck. One can even take out a fresh (top-up) loan for the gold already tended to banks, co-operative banks, non-banking finance companies (NBFCs), fintech firms, and lately, even gold refiners.

Following the Reserve Bank of India's (RBI) recent crackdown on unsecured lending, gold loans (which are against collateral, hence secured) have witnessed a substantial increase, from Rs 46,791 crore in September 2020, to Rs 97,660 crore in September 2023.

Also read: Be savvy about making charges when buying physical gold.

Approximately 5,300 (about 14 percent) of the 27,000 tonnes of gold owned by Indians globally is pledged, either through organised or unorganised channels.

Banks say that of late, the stigma associated with gold loans has been wiped off. “People from every segment come to us for gold loans. It is not that only the bottom of the pyramid seeks such loans. The asset is being utilised due to better financial awareness,” said Shripad Jadhav,  President and Head – Tractor & Farm Equipment, Crop Loans, Gold loans, Kotak Mahindra Bank.

How do you benefit?

As gold prices rise, one can unlock the higher value of the gold while seeking loans. “Lenders may be inclined to provide larger loan-to-value (LTV) ratios when prices are rising, since the collateral is  growing in value,” says Sachin Kothari, Director, Augmont Gold.

But you don’t get the entire value of your gold as a loan. If, for instance, the price of 22 K gold is Rs 5,873 per gram, lenders may offer only Rs 4,100-4,200 per gram, or  a maximum of 75 percent of the value of your gold, as  this gives the lender a margin of safety when prices crash.

How much loan do you get?

It is a myth that banks offer a higher percentage compared to NBFCs and fintech players. One could take a loan of up to 90 percent of the value of the gold only  between August 2020 to March 31, 2021, because of Covid.

So, if you pledge 50 grams of 22K gold, which is trading at Rs 5,873, you could get a maximum loan of up to Rs 2.08 lakh, as some banks and financiers offer a lower rate of Rs 4,100-4,200 per gram. However, if you were to purchase the same 50 grams of 22 K gold jewellery, you would pay Rs 2.93 lakh, plus making charges.

“Every Indian has gold, whether it is a rural microfinance investor or a wealthy person. If one has about 20 grammes of gold, then considering 75 percent of the  value,  one can get a loan of at least Rs 80,000 within two hours, and without having to furnish any past loan repayment record,” says Jadhav.

How do you repay?

A gold loan can be repaid in different ways. One has the option to pay it monthly, quarterly, semi-annually, or annually. Alternatively, you can opt for a bullet repayment, where you pay the principal and interest as a lump sum once the loan term ends.

“It is the only non-agricultural loan with a non-monthly repayment cycle. You can opt for a bullet, quarterly, or monthly payment schedule,” explained Jadhav.

Recently, the RBI increased the limit for gold loans under the bullet repayment scheme for urban co-operative banks to Rs 4 lakh, from Rs 2 lakh.

Interest rate differential

However, a lower rate of 0.80-0.95 percent is applicable if you pay back on a monthly basis. Also, the higher the loan tenure, the higher the interest rate. For instance, Muthoot Fincorp offers a rate of 1.25-1.5 percent per month for a loan tenure of 6 months, even though the interest charged is 0.83 percent for a one month tenure.

If you have been repaying the loan on a monthly or quarterly basis, then when gold prices shoot up, you have an opportunity to reduce the interest rate.

Take the case of Krushna Rao, who has a gold loan. Since gold prices rose, he sought a lower interest rate from his NBFC, Manappuram Finance, and it was reduced from 0.85 to 0.79 percent per month. The NBFC declined to comment when asked about the details.

A gold refiner throws some light on this. “Lenders may provide lower interest rates to attract borrowers during periods of high gold prices, since they feel more secure about the collateral's value,” suggests Kothari.

Types of jewellery

However, not just gold prices and the tenure, but the type of gold you offer also affects the interest rate. Banks and NBFCs currently lend only against 18 - 24 K gold. Many do not accept gold coins and bars, or even diamonds.

“Traditional gold jewellery is being offered for gold loans. If the jewellery is yellow gold of higher Karat, we banks face a lower risk of the valuation going wrong. Do understand that we cannot melt (the gold) and check its purity. Hence, if we perceive risk in, say, a bangle with a thin layer of gold, then we will have a different interest rate compared to a pure gold bangle,” says Jadhav.

He adds that different pieces of jewellery can have different interest rates depending on the purity of the gold, whether it’s studded with diamonds, etc.

Caution

But whether or not you can unlock the full potential of your gold also depends on your profile with the bank.

Also read: Which loan should you repay first? here's how to prioritise them

“You can ask for more money after the loan has been disbursed, but it is the bank’s prerogative whether to give that  or not based on multiple factors,” Jadhav says.

However, be careful while opting for a top-up gold loan purely because prices have risen. You would have to cough up more gold in case the tide turns and prices fall.

Adhil Shetty, CEO, BankBazaar.com, says: “The margin for the gold loan is calculated in such a way that a small correction in gold prices does not have an impact. But if the correction is large, and the revised LTV ratio changes substantially, then you may need to provide additional security to the lender.”

Opt for a shorter loan duration

During phases when gold prices are rising, it is best to opt for a shorter loan tenure. Gold loans can be taken for a period of seven days to a year.

Even though loan extensions aren’t granted, the financing company or bank may  consider your loan as a fresh disbursement when an extension is sought.