'Borrowers make the mistake of equating their EMI payment capacity with the asset's liquidation value, rather than their own personal cash flow.'
'The loan becomes difficult to manage when the price dips and often leads to a debt trap.'
Bank loans against gold surged 125 per cent as of November-end from a year earlier, according to Reserve Bank of India data.
The RBI has flagged concerns over rising volatility in gold prices and advised lenders to exercise caution in the gold loan segment.
Borrowers must be careful about how much they borrow and how they structure their loans.
Loan eligibility rising
Gold loans are sanctioned as a percentage of the pledged gold's value. As gold prices rise, the same quantity qualifies for a higher loan amount.
"Average ticket sizes have risen by 20 to 25 per cent over the past year," says Adhil Shetty, CEO, BankBazaar.
Regulatory limits apply to the amount that can be lent.
"Lenders can only lend up to 75 per cent loan-to-value (LTV), according to RBI norms," says Harsh Vira, chief financial planner and founder, FinPro Wealth.
High borrowing raises risks
Higher gold prices do not automatically raise the risk of margin calls.
"They increase the collateral value of the pledged gold, improving loan security," says Prasanna Pathak, managing partner, The Wealth Company.
The risk arises when gold prices correct sharply.
"This can happen due to changes in global interest rates, currency movements, or geopolitical issues," says Colin Shah, managing director, Kama Jewelry.
Risk also increases when borrowers take loans close to the maximum permissible limit.
"Gold loans taken at LTV above 65 to 70 per cent are vulnerable during periods of price volatility," says Shetty.
Demand for additional cash, collateral
Gold loans are revalued periodically using current market prices.
"If falling gold prices push the LTV ratio above the permitted limit, lenders issue margin calls or ask for partial repayment," says Vira.
"Such requests typically arise when gold prices fall by 15 to 20 per cent or more from the valuation date," says Shetty.
For instance, a borrower who pledges gold worth Rs 10 lakh and takes a loan of Rs 7.5 lakh at 75 per cent LTV will see the ratio jump to nearly 94 per cent if gold prices fall 20 per cent and collateral value drops to Rs 8 lakh.
To restore the ratio, the borrower would need to repay Rs 1.5 lakh or pledge additional gold of similar value.
Triggers for auction
Non-compliance by borrowers also contributes to pledged gold being auctioned.
"Lenders move to auction only after borrowers ignore margin calls and miss repayment periods beyond the permitted grace period," says Shetty.
Gold loans are often structured as bullet repayments.
"Lenders initiate auction proceedings when borrowers default on these instalments," says Pathak.
Once an account turns overdue, lenders typically provide about 15 days' notice.
Maintain valuation buffer
Avoid taking the maximum loan amount permitted.
"Limit the amount borrowed to less than 80 per cent of the permitted amount to avoid triggering a margin call.
"This would allow a safety margin of at least 20 per cent," says Abhishek Kumar, Sebi-registered investment adviser and founder, SahajMoney.com.
Avoid risky repayment option
Bullet repayments carry higher risk as interest compounds, while collateral value may fall if the price corrects.
"EMI-based payment options gradually reduce the principal balance every month, which automatically lowers the LTV ratio and protects the borrower from price volatility," says Kumar.
However, the choice of repayment option must also align with cash flows.
"Non-EMI-based repayment options like bullet repayment suit borrowers who have income and cash flow uncertainty that can lead to repayment constraints through EMIs.
"However, the interest cost for EMI-based payments is usually much lower," says Santosh Agarwal, CEO, Paisabazaar.
Finally, rising gold prices have created a wealth effect among owners, who have used it to borrow.
"Borrowers make the mistake of equating their EMI payment capacity with the asset's liquidation value, rather than their own personal cash flow.
"The loan becomes difficult to manage when the price dips and often leads to a debt trap," says Kumar.
Precautions borrowers must exercise
- Understand interest and penalties
- Know the conditions under which pledged gold can be auctioned
- Borrow only from regulated lenders
- Have a clear repayment plan; don't rely on gold prices rising
- Keep loan tenure short, ideally 6–12 months, to avoid getting caught in long-term price cycles
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Feature Presentation: Ashish Narsale/Rediff
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