Spend, Save and Invest Smartly
One has surely faced a situation where funds are needed in an emergency and there is a shortfall of cash. It is in such a situation that one remembers the family gold ornaments. This is not a situation anyone would want to be in but desperate needs call for desperate measures. There have been cases when many successful businessmen especially in the construction business have had to mortgage the family gold in order to tide over an emergency .In rural households gold jewellery is available sometimes in plenty but there is a paucity of cash. The gold loan is a popular route for raising cash particularly for medical and other emergencies. Availing a gold loan is no longer taboo and is gaining popularity in middle income families.
A gold loan is basically a loan obtained from a bank or a non banking finance Company. One has to pledge gold jewellery or gold coins in case of banks. In the case of a non banking finance Company only gold jewellery can be pledged. The gold needs to have a purity of 18-24 carats. Loans are sanctioned after the proper scrutiny of the documents and the quality of the gold. The loan amounts are dispersed in the form of cash, demand drafts or an account transfer.
These loans are also called emergency loans as they can be procured in a hurry and are very convenient. They are popularly marketed as 5 minute loans. These loans are more popular than personal loans as they are secured in nature. Non banking finance Companies follow a liberal procedure when it comes to sanctioning these loans as they are secured against gold jewellery. One can literally walk in with gold jewellery and walk out with a gold loan from a non banking finance Company in a matter of hours. On repayment of the borrowed amounts the gold jewellery is returned.
Certain banks offer a special feature known as an automatic sweep facility. One has to open a savings bank account at the branch of the bank. An ATM card and a cheque book are provided. The gold loan amount is transferred to this account as an overdraft amount and can be withdrawn from any bank and any branch using the ATM card. Purchases can also be made by swiping the card and using the loan amounts. The savings bank account comes down to zero and the overdraft amount then kicks in. Amounts can be withdrawn using the cheque book facility. The banks have a maximum tenure of repayment of 3 years and a maximum quantum of loan sanctioned can be INR 70-75 Lakhs. The loan to value ratio may be 75%.The processing fee depends on the bank and a transaction fee might also be charged. If a gold bangle which has been pledged is replaced by a gold bracelet then the transaction fee kicks in .If the entire loan amount sanctioned on pledging the gold ornaments has not been used then one can take back part of the jewelry use it and then re pledge it. The loan limit might come down due to this. Interest payments have to be made on a daily basis based on the amounts withdrawn.
Let us consider Mr Sumith had taken up a gold loan in December 2011 from a popular non banking finance Company. The price of gold per 10 grams was around INR 29000.Non banking finance Companies used to have a loan to value ratio of 80-90% in the year 2011.It has now been capped at 60%.The loan amount of INR 23200 was availed by Mr Sumith at a loan to value ratio of 80% on pledging gold jewellery of 10 grams. The interest rate charged was 26% per annum charged on the gold loan compounded quarterly. The tenure of the gold loan was 2 years.
P = Initial amount borrowed.
r = annual rate of interest.
t = number of years the amount is borrowed for (t=2).
A = amount of money accumulated after n years including interest.
n = number of times the interest is compounded per year (n=4)
A = 23200(1 + 0.26/4) ^8 = 38400.
Thus an amount of INR 38400 has to be repaid in a couple of years by Mr Sumith. Non banking finance Companies offer the option of only interest repayments with the principal coming up for repayment at the end of the tenure. In April 2013 gold prices crashed to INR 24000 per 10 grams. Mr Sumith had made interest payments of around INR 9000 from December 2011 to April 2013.The principal comes up for renewal at the end of the term under the bullet repayment structure. If Mr Sumith defaults on his gold loan at this point he can save on about INR 6000 worth of interest payments as well as INR 23200 worth of principal payments totaling around INR 28200.Mr Sumith will forego the gold jewellery but can purchase the gold at its current value of INR 24000 per 10 grams.
If Mr Sumith were to default on his gold loan repayments his credit score would be impacted and he would not be able to avail any loans in the future. This would particularly impact him in case he wanted to avail of a home loan at a future date. Credit Information Bureau of India Limited (CIBIL) maintains the past credit history of borrowers and Mr Sumith would be a defaulter impacting his credit score.
I would like to end this article stating that gold loans are a major source of emergency funding in rural areas where gold ornaments are present in large amounts in households but there may be a paucity of cash .Gold loans help to raise this cash as and when needed. This trend is now on the rise among the middle class families in India and the need and demand for gold loans can only rise.