Gold loans rising: should you take one?

The total gold loan outstanding of banks shot up by 45.1% to Rs 70,871 crore during the 12-month period ended December 2021. Compared to March 2020, when it stood at Rs 33,303 crore, the gold loan outstanding has risen 112% over the last 21 months. The business witnessed a big jump when the Covid-19 pandemic hit the country in March 2020 and people started pledging their gold for meeting healthcare, agriculture, wedding and education expenses. PSU banks have now started focussing on this segment in view of the trend.

While this is RBI data and relates to business done by banks, industry experts say that if one includes loans extended by gold loan companies like Muthoot Finance and Manappuram Finance, the outstanding will be much higher.

How the loan works

The loan-to-value (LTV) ratio while pledging gold is 75%: The borrower will get only 75% of the value of the gold that he or she pledges against the loan. If the borrower fails to repay the loan, he or she will have suffered a loss, as they will not have got the full value of the gold. The best option is to sell the gold and get its full value during an emergency situation. The borrower can always buy back gold in stages from the market when their financial position improves. On top of this, the interest rate from gold loan non-banking financial corporations (NBFCs) in this era of low-rate regime works out to 12-18%.

According to India Ratings, unlike other secured loans — such as two-wheeler, commercial vehicle, or home loans — where the collateral stays with the borrower and only in an event of default is it repossessed, the collateral in a gold loan rests with the lender for the entire tenure of the loan. In case of default, the entire collateral will be auctioned by the lender and the money will be recovered. Since gold is a price-sensitive commodity, any default in gold loans typically beyond 90 days calls for an auction, as per internal policies of the originator. Hence, for up to 90 days, the lender makes efforts to recover the loan; beyond that, the efforts are towards an auction of the gold.

Should you take a loan?

In line with all interest rates in the economy, the interest rates on gold loans also are low. State Bank of India is offering loans at 7.3%. However, low rates should not be the only reason for individuals or small business owners to go for a gold loan. Experts say taking a loan in these times could be both a good and a bad idea depending upon who you are and what you are borrowing for.

Taking a loan for consumption needs or to fund a marriage may not be a good idea if your income is under stress. if you are unable to repay the gold loan, you run the risk of the financier selling the gold you pledged.

However, if the loan is for funding short-term working capital needs and to cover up for a stretched payment cycle, experts say that one can go for it.

“For a small businessman whose need is driven by a rise in the payment cycle and who is looking to cover a gap for a few months, it is not a bad idea,” said an expert.

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