Recently one of my office colleagues took up the offer of free financial planning that we offer our own staff members. After the data gathering exercise was over, we realised that she had taken a loan from a neighbourhood cooperative bank to fund the down payment requirement on the house that she had recently bought. For this purpose, she had pledged her gold. What was surprising was that she was paying an effective interest rate of 41 per cent per annum on this fully secured loan.

To add insult to the injury, that co-operative bank had also taken a lien on her life insurance policy, which had a surrender value that was about 25 per cent of the loan value. Ankita had sought our assistance while taking the home loan but had not mentioned about her issue with raising the down payment. When we asked her why she decided to take the gold loan from that particular lender, her answer was illuminating.

Firstly she knew somebody in the bank who promised her a loan fairly quick. Secondly, since the repayment was in EMIs, she did not understand the fact that the actual interest rate was as high as 41 per cent per annum. Thirdly, she did not mind providing the additional security of her life insurance policy since it was “anyway lying around in her cupboard.”

Now most financial planners recommend taking gold loans as they are economically priced, available irrespective of your credit history and can be prepaid as and when you have additional funds without attracting any pre-payment fee.

My colleague’s case outlined above made me rethink this proposition. Yes, gold loans can be economical and convenient. But in the hands of formal sector loan sharks, even these loans can be exorbitantly priced. So how do you ensure that when you need a gold loan you get an appropriately priced offer?

Firstly do not take any offer from any bank or non-banking finance company that only states the EMIs but does not confirm the interest rate in writing. Secondly remember, the lower the loan amount that you take against the same jewellery, lower will be your interest rate, which in the same lender can vary from 12 to 24 per cent.

Here is an example that will illustrate this point. Suppose you have jewellery with a sale value of Rs 1 lakh and are looking for a loan of around Rs 50,000. So essentially you are looking at a loan of 50 per cent of the value of your jewellery. This should come fairly cheap at around 12 per cent per annum, whether you take it from an NBFC or private banks or a PSU bank. Now the lenders would perhaps be willing to lend you as much as Rs 80,000 against the same jewellery but it would come at a stiff cost of around 18 per cent or 24 per cent. So if you need a higher loan amount, it might be cheaper to provide additional jewellery as security rather than pay a higher rate by taking a higher amount of loan against the same jewellery.

There are various lenders in the market who offers good gold loan offers on interest rates for gold loans. Some of the gold loans details are given below:

Gold Loan Rates as on 15.10.2011
Muthoot Finance: 12.00 - 24.00%
Manappuram Finance: 12.00 - 26.00%
HDFC: 12.75 - 16%
Central Bank of India: 12.75%
Canara Bank 14%
Remember just like all that glitters is not gold similarly not all gold loans are necessarily cheap.

Harsh Roongta is the CEO of Apnapaisa.com. You can send in your queries to movingmoney@deccanmail.com