A gold loan is a secured loan in which the borrower keeps his gold, ranging from 18K to 24K, with a bank or financial institution as collateral and has capital against it. In comparative terms, a gold loan can be understood as a concept similar to a “mortgage loan” in which the owner keeps his house or property as a mortgage with the bank and takes out a loan to meet his capital requirement.
How do gold loans work?
A gold loan is one of the profitable loans from banks as banks no longer have to worry about non-performing assets (NPAs). In fact, the jewelry taken as security remains with the bank even if the borrower does not respect the payment of his monthly installments (EMI) on his loan.
How a gold loan works is as follows:
- Quality check: When a customer approaches a financial institution for a gold loan, the first step the institution takes is to verify the purity of the gold jewelry considered as collateral as well as determining the value of the jewelry.
- Know your customer (KYC): Know your customer standards and the checks given by the Reserve Bank of India (RBI) are carried out by the bank, where the bank learns the details of its customer such as identity, credit history, need to apply for loan and other crucial details. in granting the loan.
- Gold loan approval: Once the quality and value of the jewelry is determined and the KYC procedure is completed, the terms of the loan are agreed upon by both the financial institution and the consumer. After approval, the loan is approved and the amount is then credited to the borrower’s account. This entire process can be completed in a few hours.
Features of a gold loan in 2024
Interest rates on gold loans vary depending on the purity of the gold. The higher the purity of the gold, the greater the amount that can be used. Interest rates vary from 8% per year to 18% per year in the public sector, while in the private sector these rates can reach 24% per year.
Haircut and loan-to-value (LTV) ratio
According to RBI guidelines, banks can extend a maximum of 90% of the value of gold as loan, which implies a minimum of 10% haircut. Generally, the actual loan-to-value ratio ranges from 55-65%, which means a margin of around 35-45% for banks, making it the safest loan for banks.
Loan to value ratio or LTV ration refers to the amount a customer will get in relation to the value of gold. For example, if the value of a piece of jewelry is INR 10,000 and the LTV is 65%, the maximum loan amount the customer can get would be INR 6,500.
A gold loan is generally a short to medium term loan, the duration of which varies from six months to 24 months. It is therefore not a long-term loan instrument.
Loan available even for people with low credit score
Since the jewelry will be deposited with the bank as security for the loan, the bank is confident that it can provide a loan to the person even with a low credit score.
The weight of the stones and their value are not counted
Even though precious stones are of great value, they are not taken into account while calculating a gold loan. Only the value of gold is taken into account for the calculation, which is why a digital gold product is often preferred over a regular product for pledging purposes.
Who should opt for a gold loan?
Those who have short-term funding needs
Gold loan works as a common working capital loan in businesses that meets short-term fund requirements. In such scenarios, a gold loan is preferred over a personal loan with unfavorable interest rates, on a comparative basis.
Those with a low credit score
As the jewelry serves as collateral against the loan, the bank is comfortable in granting a gold loan even to a person with a low credit score.
Those who have gold but take out a personal loan
People who are considering a short-term personal loan and have unused gold in lockers should consider taking a gold loan instead of a personal loan to save on interest charges.
Those who opt for gold loan from unorganized sector
Users are considering opting for gold loan from unorganized players, fearing rejection from organized financial institutions who may not give them loan due to their credit history. These users end up paying high interest rates ranging from 25% to 50% per year.
Opting for a gold loan from banks and other organized players is a better option since credit history is not a factor that affects the loan as a gold loan is completely secured. This would save interest charges as banks are required to charge interest as per RBI norms, which are market compliant and not exorbitant.
How to apply for a loan with digital gold in 2024?
With the introduction of digital gold products, people now have access to a more lucrative option to reduce the overall interest burden on gold loans.
You might consider liquidating your physical pure gold (available in the form of ‘vedhnis’, biscuits, coins and bars) and converting the cash into digital money. sovereign gold bonds (SGB). This would help you in two ways: firstly by securing the necessary funds and secondly by earning an interest income of 2.5% per annum on the face value, even during the term of the loan, thereby reducing the overall cost of credit. For example, SBI’s interest rate for loans against SGBs is 9.25%, but since the underlying is an SGB, the effective cost would be 6.75% per annum.
Tax Benefits of Gold Loans:
Tax benefits associated with using gold loan for specific reasons include:
- Buying a house or improving it: Tax benefits may be availed under sections 24(b) and 80C of the Income Tax Act, which allow for exemption of the eligible portion of interest charges and repayment of principal respectively, thereby reducing the overall cost of credit.
- Cost of trading interests: Interest charges on a gold loan taken for business purposes can be claimed while filing income tax returns as business expenses, effectively saving on your tax liability.
Gold loans, in general, serve as a source of support when you are in dire need of capital. You not only need to understand these products in order to meet future necessities but also understand the new upcoming variants that are safer and effectively reduce the overall interest burden on the loan.