When personal loans outshine loans against gold

As non-banking finance companies (NBFCs) that offer loans against gold are vying for new business, many of them have projected the product to be a better alternative than a personal loan.

A personal loan can score over a loan against gold in some cases, if you compare the interest rate, tenure and charges for the two products.

Sachin Hansraj realised this when he wanted to take a loan for renovating his house.

He was seeking a loan of Rs 150,000.

When he went to a popular finance company that offers gold loans, the NBFC valued his gold at Rs 170,000.

This gold was valued at over Rs 200,000 at the market price.

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Cost

The finance company said Hansraj could get 70 per cent funding (around Rs 120,000) against the value of his assets at an interest rate of 12 per cent a year and if he opts for a loan of Rs 136,000, he would need to pay an interest of 18 per cent a year.

For the loan amount that he was seeking (90 per cent of the gold value), the interest rate would be 24 per cent a year.

Hansraj went for a personal loan from his bank at 18 per cent.

"In a loan against gold, financial institutions charge a risk premium as the loan-to-value (LTV) ratio increases," said VP Nandakumar, chairman, Manappuram Group.

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He further explains the product that is a short-tenure loan (of up to one year), does not entail equated monthly instalments (EMIs) as in other loans.

For a borrower seeking a long-term loan and repayment in EMIs it would make more sense to opt for a personal loan.

That's why the average size of the loan against gold is Rs 35,000 and the average tenure is three months.

A person with a good credit history can get a personal loan at 13.5-14 per cent from banks.

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Credit card companies, too, charge a similar rate if the person maintains a good track record.

This could be even cheaper if the borrower has an ongoing home loan and takes a top-up on the same.

This would be a loan against property and the rates can be as low as 12-12.5 per cent.

On the higher side, the interest rate on a personal loan can be as high as 30 per cent.

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NBFC versus banks

Taking a gold loan from an NBFC can be more expensive as compared to a bank due to the high interest rates charged by the former.

While the NBFCs charge a maximum interest of 24 per cent a year, most banks restrict the interest rates between 11.5-14 per cent.

"Most NBFCs charge a fixed interest rate, whereas banks charge interest on a reducing balance," said Tilisa Gupta Kaul, head-microfinance, agri and gold loans, Dhanlaxmi Bank.

On a one-year loan of Rs 50,000 loan, a person would pay Rs 6,000 in interest if the loan is fixed at 12 per cent.

In case of reducing balance for the same interest rate, the outgo would be around Rs 3,400.

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However, banks have caveats. For example, most banks deduct advance interest from the loan value sanctioned if the borrower does not have an account with them.

This could further lower the LTV ratio and you may not get the desired loan amount.

The popular gold loan NBFCs do not charge any advance interest rates.

The processing charges of banks, too, are high compared to the NBFCs that are in the gold loan business.

Manappuram Finance, for example, has no processing charges. Banks charge a minimum of 1 per cent of the loan amount as processing charges.

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Conditions

Lenders auction the gold if the borrower does not repay the loan within 6-12 months after the expiry of the tenure.

Say, a person took a six-month loan, the company would sell the gold after 1-1.5 years if the loan owner does not repay.

The lenders also give a lower value to the gold, as opposed to the market price, to de-risk them from price fluctuations.

In addition, the person buying gold in the auction usually purchases the metal below the market price.

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Depending on individual risk perception, lenders value the gold 20-40 per cent lower than the market price.

"The best part of a gold loan is that none of the institutions takes the credit history of the borrower into account before sanctioning the loan," said Kaul Even if the borrower is unable to repay the loan on time, the credit profile remains intact, as institutions do not report gold loans to credit information bureaus.

For a personal loan, financial institutions look at the relationship with the borrower, the repayment capability and the credit report for the borrower's track record and current financial position.