Borrow More for the Same Amount of Gold

The Reserve Bank of India has increased the Loan-to-Value (LTV) for gold loans offered by banks from 75% to 90%. This is to increase the availability of credit to households and small businesses during these difficult COVID times. Many Indian households hold gold. And gold makes for an excellent collateral. From a lender’s perspective, it is quite liquid which makes loan recovery easier in case of default. Thus, the banks/NBFCs can disburse loans without worrying too much about your repayment potential. They know they have a solid security to bank upon.

What Does the Increase in LTV Mean?

If the value of gold in your jewellery is Rs 100, the banks could offer you a loan of up to Rs 75 earlier. Rs 75 was the cap set up by RBI. Now, with the increase in LTV cap, the bank can lend up to Rs 90 for the same value of gold. RBI’s intent is to unlock more credit for the same amount of gold, providing some relief to households and small businesses. Note the value of gold does not include making charges or the value of studded stones/diamonds in the jewellery. The banks lend against just the gold in the jewellery.

What are the conditions?

The higher LTV applies only to gold loans sanctioned by the banks. Non-bank lenders (such as Muthoot Finance and Manappuram Finance) shall still comply with older LTV of 75%. By the way, these NBFCs have approached RBI to increase LTV for their gold loans too. There is no relief from RBI yet.

This 90% LTV is applicable only for fresh gold loans sanctioned up to March 31, 2021. Fresh gold loans sanctioned after March 31, 2021 shall revert to LTV of 75%. So, this is a temporary change.

The Banks May Not Pass This Higher Loan-to-Value Benefit to Borrowers

Even though the Reserve Bank has increased the LTV cap, it remains to be seen whether the banks are willing to offer a higher LTV to their customers. A higher LTV increases the risk for the lender. When the LTV is lower, the lenders have a greater cushion in case of a default. Even if the borrower defaults, the lender can be sure that the loan amount along with the unpaid interest can be recovered through sale of gold offered as security. When the LTV is higher, the comfort automatically goes down.

In the current context, when the gold prices have shot up sharply, the banks will think twice. What if they use a higher LTV and the gold prices go down? In such a case, the banks may not have enough security to recover the loan in case of default. By the way, the banks work with lower LTV for higher risk loans.

In case of bullet repayment gold loans, where the entire interest is paid one-shot at the time of loan maturity, the LTV is usually lower than the regular gold loans (where the interest is paid regularly). For instance, in case of SBI, the LTV for regular gold loans is 75% while it is 65% for the bullet repayment loans.

Therefore, even though the RBI has increased the cap on LTV, the banks may not increase the LTV on their gold loan.

Why Would You Borrow From a Gold Loan NBFCs Then?

The banks can now offer higher LTV and a lower interest rate. The interest rates for gold loans from banks are usually at a lower than interest rates from gold loans from non-bank lenders. For instance, you will get a gold loan from SBI at ~8% p.a. while Muthoot and Manappuram will charge you ~15-20% p.a. Therefore, for the same amount of gold, a bank can lend you more and at a lower rate of interest compared to an NBFC.

The gold loans are usually short-term loans. Thus, the absolute impact of higher interest rate is not high. For instance, on a 6-month bullet repayment loan of Rs 50,000, the difference between an 8% p.a. and a 20% p.a. loan is only Rs 3,000. The difference will grow with loan amount and loan tenure.

Secondly, gold loan NBFCs may offer a much lower turnaround time and you have a greater certainty of getting a loan. Given your requirements, you may value the speed of disbursement more. Or the swiftness may be worth the extra interest cost paid.

How Does This Affect You?

If you plan to borrow against gold, this is good news. You can borrow more for the same amount of gold if the bank chooses to increase the LTV for gold loans. At the same time, do not borrow more just because you can. Eventually, the money needs to be paid back with interest. If your cash flow problem is not temporary and seems prolonged, you are better off selling the gold, unless you have an emotional attachment with the jewellery.

Additional Reading: RBI Circular dated August 6, 2020 notifying the LTV increase

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