Explained: How fluctuations in gold prices impact gold loans?

There has been a monumental rise in the popularity of gold loans since the pandemic last year. The sudden economic slowdown amid an emerging health crisis forced Indian borrowers to risk their most cherished asset in exchange for immediate cash. The shrinking economy was accompanied by considerable unemployment across sectors. People with no savings, emergency funds or loan eligibility had to pledge their gold to avail credit to finance medical and other needs.

Now, gold is an inherent part of Indian households. The significance of gold isn’t limited by its monetary value. In fact, the yellow metal is linked to the family’s respect and honour. It comes in handy during emergencies like the ongoing pandemic. This is precisely why gold loans are a preferred choice of most people during an unplanned financial crisis.

Gold loan is the preferred choice

“A significant section of Indian households have sizable exposure to gold in the form of gold jewellery. Most lenders process and disburse gold loans within a few hours of applying for it, making them have one of the quickest disbursals among all credit options,” said Ajay Mishra – head of gold loans at Paisabazaar.com.

Moreover, as gold loans are adequately backed by liquid collateral, lenders are less stringent on credit score and eligibility criterion while approving loan applications.

“With lenders becoming more risk averse while approving fresh loans, gold loans allowed those with poorer credit profiles to monetise their gold holdings for meeting their financial exigencies or short-term liquidity mismatches,” Mishra added.

What is Loan to Value?

The Loan to Value (LTV) is basically the ratio of the loan amount vis-a-vis the pledged gold. Capped at 75% by the Reserve Bank of India (RBI), LTV is supposed to be a key factor while opting for gold loans. For example, if the gold being pledged is valued at Rs 50,000/-, only Rs 37,500/- would be given as loan.

“The LTV ratio of gold loan is the proportion of the market value of the gold loan offered as loan. Hence, higher the LTV ratio, higher would be the loan amount for the same value of gold jewellery offered as collateral. Remember that RBI has put a regulatory cap of 75% on the LTV ratio of gold loans. Lenders are free to decide the LTV ratio of gold loans for individual borrowers within a set regulatory cap,” Mishra explained. 

The LTV is calculated by evaluating the purity of the metal offered by the borrower. While the conventional way to measure gold purity involves the use of nitric acid on the stone, financial institutions prefer to use the modern loan evaluator for accurate results.

Gold price fluctuations

Due to constant volatility in the price of gold, lenders often ask for a pre-payment for the existing loan amount. This is when the rate of gold seems to be fluctuating marginally during an existing gold loan. While lenders tend to give a gold loan up to 75% of the total metal value, it can inch as high as 80-85% in case of falling prices.

“If a fall in the gold prices leads the LTV ratio of an existing gold loan to exceed RBI’s regulatory cap on gold loan LTV ratios, then the lender can ask the borrower to either deposit cash or pledge more gold as collateral to bring down the LTV ratio below the regulatory cap,” Mishra pointed.

Meanwhile, failing to do so can lead the lender to sell the gold jewellery or coin pledged by the borrower. If any default stretches beyond 90 days, lenders have the option of liquidating the gold for auctioning.

Hence,  Mishra added, “Borrowers should try to deposit the difference in the margin amount in the form of additional collateral or cash/cheque payments within the stipulated period as and when they receive any notice or call for doing so from their lenders.”