Borrowing against gold might be emerging as a preferred financing option, but this could land you in trouble

You may ignore the sparkle of the yellow metal itself, but it is really difficult to overlook the glitter of gold loans these days. In fact, spurred by soaring prices, rise in consumerism and, more importantly, changing social norms, gold loans have not only seen an unprecedented rise in recent times, but are also all set to shine more brightly in future. Sample this: The organised gold loan market in India, pegged at 25,000 crore in FY 2009, grew at a compounded annual growth rate (CAGR) of around 38% between FY 2002 and FY 2009 and is expected to grow at an annual rate of 35-40% over the next three years to reach a portfolio size of 50,000-53,000 crore by FY11. This study by ICRA Management Consulting Services alone is enough to set the alarm bells ringing for those in the pawn broking business. The reasons for this kind of growth in gold loans, however, are not far to seek.

Firstly, it is convenience. "The sheer convenience of a loan proposition against such a liquid asset suits both the lender and the borrower. In some cases, it may be the last resort for the client, but it is a convenient one. Lenders find it a timeless, good business model, while clients, who need money quickly, find this the best way to raise funds," says Jayant Manglik, president of Religare Commodities.

Secondly, it is low interest rates. In fact, borrowing against gold is fast emerging as the most preferred financing option as the interest rate charged by institutions are less compared to other retail loans such as personal loans. For instance, the rate of interest on these loans is between 10% and 24% per annum. In comparison, personal loans charge 16-26% per annum, depending on your credit profile.

Therefore, "it is better to take a loan against gold than a personal loan as the rates will be lower-since this type of loan is secured. Another good reason to take a loan against gold is that most banks/NBFCs allow you to pay only the interest on the loan monthly and the principal payment at the end of the term and not as an EMI; which works better from an interest perspective," says Lovaii Navlakhi, managing director & chief financial planner, International Money Matters.

Besides, you can decide the approximate loan amount based upon your gold value, i.e. no income proof is required unlike in a personal loan where the loan amount is decided based on your income proofs provided. The processing of the loan is also much faster because of easy documentation. Banks such as ICICI Bank and HDFC Bank may ask for your ID and other personal details which can take up to an hour while non-banking finance companies such as Muthoot Finance or Manappuram Finance claim to process the loan in a few minutes. Also, instead of keeping gold idle in a locker at home or in a bank's locker, "it is a good idea to borrow against it at lower rates in comparison to other retail loans. Moreover, lenders also prefer this route of financing as the default rate is negligible. In general, the loans may be provided for 70-85% of the value of gold," says Amar Ranu, senior manager, Motilal Oswal Securities.

Added to these is the fact that pledging gold is no longer considered a taboo and disgraceful in Indian society. This explains why gold loans are now widely recognised as acceptable means of raising funds for meeting urgent requirements by all segments of society. Some people also go for it because they find it more private than going to a neighbourhood moneylender. Also, with gold prices soaring, even banks have begun to push customers toward gold loans. The transactions have become more popular as small personal lending dries up because of rising defaults on risky loans. This is, however, not to suggest that you should throw all caution to the wind while opting for a gold loan, as the chances of losing your family heirlooms are higher in case of a dispute or default. That is because gold loans are secured loans. So if you fail to repay the loan within the stipulated loan period, a higher interest will be charged and the gold may even be auctioned off.

"Typically jewellery is an item of personal use and its emotional value is sometime far higher than its market value. If for any reason you are unable to pay pack the loan, the lender can sell your jewellery in the market to recover its dues after which you can never get your jewellery back," says Harsh Roongta, CEO, Apnapaisa.com, a price & features comparison engine for loans, insurance and investments. This goes without saying, therefore, "if you need money quickly and don't have any other assets to pledge, this is a useful avenue. But if you don't have the confidence of returning the principal and interest in time, then you should avoid taking a loan against gold," advises Manglik.

Also, gold loans are good in a rising market. However, if gold prices correct drastically during the loan tenure, banks may ask for the payment of the difference. Thus, even availing a gold loan is not without risks, which explains why you need to mull the pros and cons of pledging the yellow metal carefully and also look for some other options available before going for a gold loan. It also makes sense to consider in what circumstances you should go for it and when to avoid it. In normal circumstances, for instance, if your credit history is bad or completely beyond repairable in near future, you can think of availing a loan against gold, that too at a discounted rate in comparison to personal loans. Customers with low or understated income can also avail a loan against gold.

However, "if you take a loan against gold for personal expenses such as a 3D TV, car or foreign trips, then it is quite possible that you may default on the loan. Also, a gold loan is not recommended for people with low financial IQ because there is a higher risk of default and your assets may be auctioned off," suggests Ranu. Normally, one does not plan to pledge one's jewellery to take a loan. "Obviously, if you possess the jewellery for a specific purpose-to gift to your daughter, for example-you are unlikely to sell it. Economically, however, if the expected appreciation in value is greater than the cost of the loan, it is better to take a loan. But the period for which you propose to borrow should be short term or temporary, and you should have a high probability of being able to repay the loan on time," advises Navlakhi.

It is, however, a strict no-no to borrow against gold if you wish to use these funds for instant gratification or speculative investments. In that case it is advisable to just look for some other options!

DOS AND DON'TS

Go for a gold loan only if you are looking for emergency funds and don't have any other option

Customers with bad credit history, low or understated income can also go for it

Avoid a gold loan in case you are unable to repay the loan or are likely to default on repayment

Avoid it if gold prices are likely to correct drastically during the loan tenure

Don't use the funds for instant gratification or speculative investments.

Source: The Economic Times