Gold Loan vs Personal Loan: Which Is the Best Option for You?

Financial emergencies can arise anytime without notice, and taking a loan may become necessary to overcome them if you do not have planned for them in advance. Whether it is for covering a medical emergency or paying for a child's tuition fees, loans can be a saviour in such challenging situations. While there are various types of loans available, personal loans and gold loans are among the most popular ones. However, at times, it can be difficult to decide which type of loan to choose. This article compares gold loans and personal loans in detail to help you choose the suitable loan for your needs.

What is a Gold Loan?

A gold loan is a type of secured loan that is offered by banks and Non-Banking Financial Companies (NBFCs) up to a certain percentage of the value of the gold you pledge. The basic requirement is that you should hold 18 carats and above quality gold in any form, such as jewellery, coins, etc. A borrower also needs to submit additional documents, such as identification and address proof, income documents, etc. Since the loan is backed by a security, lenders do not do the credit check, although some lenders prefer to run a soft credit check. As the loan is backed by gold, there is no risk of default to the lender. Therefore, many banks and NBFCs are comfortable offering a gold loan at a reasonable rate of interest. Moreover, there are no restrictions on the usage of the loan amount as long as the purpose is legitimate. So, the borrower can utilise it for his/her personal as well as business requirements.

What is a Personal Loan?

A personal loan is an unsecured loan that is sanctioned based on your credit history and ability to repay the loan from your personal income. It is a multipurpose loan that can be taken for various reasons, such as buying the latest smartphone, covering medical expenses, a family member's wedding, paying off other loans, etc. However, since it is unsecured, the interest rate is usually higher than secured loans like home or car loans. You need to understand your financial situation well before applying for a personal loan.

Which is the better option, a gold loan or a personal loan? Let's compare and analyse these two loan options to determine which one would be the best fit for you:

1. Loan Amount:

For a gold loan, the amount of the loan is based on the total value of the pledged gold. Banks and NBFCs determine the loan amount by considering the current market price of the gold, its weight, and purity.

On the other hand, for personal loans, the loan amount is based on the borrower's credit history and monthly income. Typically, personal loans range from Rs 50,000 to 20 lakhs or even more. If the borrower's credit score is not good, it may be challenging to get approval for a personal loan.

2. Processing Time:

Because gold loans are secured, the documentation required is minimal. Additionally, since the lender takes possession of the gold asset until the loan is repaid, the disbursement process is quick and straightforward.

In contrast, personal loans are unsecured and therefore, require more documentation. Verification of these documents may take time, making the processing time for personal loans longer. However, many lenders have started providing instant personal loans to their pre-approved customers that can be sanctioned within a few minutes to your bank account.

3. Loan Duration:

Gold loans typically have a shorter tenure of 6 to 12 months, while personal loans can be taken for a longer period of 12 to 60 months. So if you need to manage a short-term financial emergency, a gold loan could be an excellent choice.

4. Interest Rates:

A gold loan is a type of secured loan that requires you to pledge your gold as collateral, while a personal loan is unsecured and does not require any collateral. Due to the added risk for the lender, personal loans typically have slightly higher interest rates compared to gold loans.

Top lenders generally offer gold loan interest rates ranging from 10% to 16%. Meanwhile, interest rates for personal loans can range from 12% to 24% or even more.

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5. Additional Charges:

Another significant aspect to consider when choosing between a gold loan and a personal loan is the additional charges that come with them, such as processing fees, late payment charges, pre-payment charges, foreclosure charges, etc.

In the case of personal loans, the processing fee can be 2% or more of the loan amount, and pre-payment charges can be as high as 5% or more, depending upon the terms and conditions of the loan. Due to the increased competition, many lenders have started offering personal loans for a flat processing fee, irrespective of the loan amount. On the other hand, the processing fee for a gold loan is typically around 1% of the loan amount. Pre-payment charges for a gold loan are also around 1% if you want to prepay or foreclose the loan.

6. Loan Repayment:

Repayment of personal loans is made through Equated Monthly Instalments (EMIs), which include both principal and interest components. In contrast, lenders offering gold loans usually offer a more diverse range of repayment options.

Lenders have varying options for gold loan repayment. Choosing a flexible repayment option from lenders can be beneficial when experiencing financial difficulties and anticipating funds in the near future. For instance, certain banks and NBFCs allow payment of only interest throughout the loan duration, with the principal amount due at the end of the loan term. On the other hand, some lenders allow payment of both interest and principal via EMIs. It is best to be aware of the repayment plan in advance and select the method that suits you the best.

7. Eligibility:

Personal loans have strict eligibility criteria as they are unsecured loans. The lender will consider factors like monthly income, age, work experience, type of employment, and credit score before approving the loan.

In contrast, gold loans have minimal eligibility requirements. You only need to be 18 years or above and the legal owner of the gold that you want to pledge for the loan amount.

8. Credit Score:

If a borrower has a poor credit score, they may not meet the eligibility requirements for a personal loan, and even if they are approved, the interest rate may be considerably higher than those offered to applicants with good credit scores. In such circumstances, opting for a gold loan can prove to be a suitable alternative to a personal loan.

Gold Loan vs Personal Loan: Which is better?

One major drawback of taking out a gold loan is that the lender has the authority to sell your valuable ornaments in case you are unable to repay the loan. As a result, defaulting on the loan may put your assets at risk of being seized. Hence, it can be an ideal option for those who require a small amount of credit for a short period of time or are facing an emergency. Business people who are experiencing financial difficulties can benefit from a gold loan, as they can pledge the same gold multiple times to obtain a loan as needed and benefit from flexible repayment terms and a lower interest rate. However, it is crucial to only take out a gold loan if you are financially responsible and confident in your ability to repay the loan. Failure to pay EMIs on time or defaulting on the loan will have a negative impact on your credit score, and the lender has the right to sell your gold ornaments to recover the outstanding amount, which could result in the loss of your precious family's gold.

But, if your loan requirement is high, you need a loan for a longer duration, or you are unsure of your repayment capacity and do not want to risk the gold, it is advisable to opt for a personal loan. Since it is an unsecured loan, there is no risk of losing your precious asset. Moreover, depending on your credit profile, you can get a large amount loan for a longer duration. However, take note that a personal loan is one of the costliest loans available, and frequently opting for them can put you in a debt trap.

Therefore, it is important to conduct thorough research, carefully review product features and terms and conditions, and ensure that you fully understand the implications before applying for a gold or personal loan.

KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.