How Is The Interest Rate Calculated For A Gold Loan?

While availing a gold loan from a lender, there are a few factors that affect interest rate. Here are the 4 key factors you should know before you avail gold loan!

27 Jun,2022 09:00 IST 580 views
How Is The Interest Rate Calculated For A Gold Loan?

People who are in need of short-term cash for certain extraordinary expenses items—and do not want to get into a situation where they have to ask friends and family for money—have the option of taking a loan via a quick hassle-free process.

The type of loan that one should choose would depend on various factors such as the use of the money, the duration or the tenor, and so on. One type of loan which has become a key way to borrowing is for a person to use passive, or unused, household gold jewellery to get money to meet short-term needs.

Borrowers essentially give their gold jewellery to a lender, who keeps it as a security and lends against it. Lenders factor in a discount on the value of the product to meet the regulatory norms. This means they are required to lend an amount which is less than the current value of the gold jewellery.

Gold loans are offered against the value of ‘gold’ in the jewellery after deducting the weight of any stones or other embellishments as they don’t have a standard value benchmark. So, even if one has a small diamond stud in the gold jewellery pledged, the lender does not take the value of that precious stone into account while processing the loan.

Calculating Interest Rate

Lenders, whether they are a bank or a non-bank finance company, offer a wide range of interest rates that they charge on a gold loan, depending upon several factors. Moreover, they also use different methods to calculate the interest rate itself. For instance, some lenders charge a simple interest rate while others charge compound interest.

Simple interest means borrowers pay interest only on the principal amount that they borrowed for a fixed period. Compound interest, on the other hand, means borrowers pay interest not only on the principal amount but also on the interest accrued on the principal amount. Essentially, this means they pay interest on interest.

Therefore, loans that charge compound interest are costlier than those that charge simple interest, unless the actual rate of interest is substantially lower. So, borrowers must be cautious in choosing a lender that offers a loan at simple interest.

Factors That Affect Interest Rate On Gold Loan

While the value of the gold jewellery is critical in determining the loan amount, there are several other aspects that can change the actual interest rate being charged for the same gold loan.

The actual rates vary according to the amount and tenor of the loan as well as the purity of the yellow metal that is being given as a security. Some other factors that are taken into account at the back end to customise the loan cover aspects such as the borrower’s credit score, benchmarking and income of the borrower.

• Loan Amount:

The maximum loan amount one can avail is dependent on the weight of the gold jewellery and the prevailing price of the yellow metal. But how much one should avail should be a key consideration as a higher loan amount also means a higher rate of interest.
So, just because you can borrow a larger sum, you shouldn’t avail a bigger loan as that also pushes up the cost of servicing or the rate of interest on the same loan.

• Income:

While a gold loan is availed against a security, lenders still bake in the monthly income of the borrower to ascertain their repayment capacity and tune their rate of interest accordingly. If a borrower has a reasonably high monthly cash flow as salary or other source of income, one can benefit from a lower interest rate for the same gold loan.

• Credit Score:

One’s credit score doesn’t decide whether one gets a gold loan as the lender’s primary concern is the value of the security. However, the credit score still plays a part in the process as it affects the rate of interest offered by the lender. Usually, those with a credit score of 700 and above are seen as prized customers with a higher propensity to repay.

• Benchmarking:

Another aspect that affects the interest rate is external benchmarking. If a lender follows external benchmarking with the Reserve Bank of India’s repo rate-linked rate (RRLR), every time the central bank tightens its monetary policy, the interest rate being charged for a gold loan moves up.

Conclusion

A number of factors determine the rate of interest being charged on a gold loan. These include the quantum of loan, the purity of the gold being pledged as a security, the credit score, monthly income of the borrower and external benchmarking.

The same weight of gold jewellery being pledged as a security can attract very different rates by the same lender based on these aspects linked to the borrower. In addition, borrowers should also check the method of interest rate that the lender uses and go for a lender that offers a loan at simple interest.

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