Choosing the right loan for your needs:
Personal Loan vs. Gold Loan

In the previous parts of this series on choosing the right types of loans, we have seen the kinds of loans available and what kind of loans are available to each category of borrower and the type of situations in which these loans can be used. However, if it comes down to choosing between the various types of loans available, many borrowers are unable to get a clear understanding of which type of loan would work better for them overall with respect to the amount that can be borrowed vs. the interest paid etc.

With this article, we’ll begin a new series that compares the variety of loans available against one another in order to give you a better understanding of the type of loans you should be going in for in a given situation. In this part, we take a comparative look at personal loans and gold loans.

The personal loan is essentially an unsecured loan, i.e. there is no asset backing the loan, except the credit-worthiness of the individual based on his or her credit history, scores and the projected cash flows being generated through salary or business income. Therefore, this is one of the riskiest forms of consumer lending and attracts a relatively high-interest rate due to the nature of the loan. Personal loans typically span 1 to 5 years in tenure, i.e. the duration of the loan, and the installments are calculated on a monthly reducing balance principle, i.e. every installment is a composite repayment of the interest on the loan as well as a part of the principal amount being borrowed. Due to the relatively risky nature of the loan, these carry a relatively higher weightage in calculating the credit score, and a default or late payment on these reflects poor fiscal discipline. Personal loans are therefore more easily available for those with a steady monthly cash flow, mainly employees of companies and government undertakings, as these are seen as safe borrowers, who will repay on time. Personal loans also take relatively longer time to disburse as the credit history and other factors are verified before loan approval can be given. Repayment is usually attached to the salary or regular bank income account of the borrower. The quantum of the loan is therefore restricted by the repayment ability of the borrower. Usually, early repayment of these loans attracts a foreclosure charge of up to 2%, though some borrowers may reduce or waive this.

A gold loan or Loan against Gold (LAG)is radically different from a personal loan. Unlike a personal loan, a gold loan is essentially a secured loan, given against the custody of the asset, i.e. gold ornaments. Presently, under RBI guidelines, gold loans can only be offered against gold jewelry, and not against coins or bars. Gold loans also cannot be offered against gold ETFs or Gold mutual funds, which are essentially the dematerialized form of buying gold, as per RBI guidelines. However, many aspects of gold loans make them attractive to borrowers. Since these are secured loans, i.e. loans against a physical asset with a value that can be defined, the level of risk is much lower and therefore interest rates are lower for gold loans as compared to a personal loan or other forms of unsecured loans. Lenders take possession of the asset i.e. the gold jewelry, evaluate it and determine a value to the asset based on purity, quantity, etc. Loans are given to the extent of 60-90% of the value of the asset, depending on the gold loan norms of the bank or lender. Since the borrower takes over physical possession of the asset until the loan is repaid, loan disbursal is speedy and can be done within the same working day as the application. Most gold loans have a minimum lock-in period of 6 months, though the borrower can choose to repay the loan earlier. The second unique aspect of the gold loan is the fact that the monthly installment can comprise of only interest payment if the borrower chooses to repay the principal amount borrowed at the end of the tenure. This reduces the monthly outgo of the borrower during the tenure of the loan. However, should the value of the underlying asset, i.e. gold, reduce drastically during the tenure, the borrower may be called upon to pay up some amount to make good the difference between the permitted loan amount and the current loan taken by the borrower.

The table below lists the comparative features of the two categories of loans: