By Amit Shanbaug, ET Bureau | 27 May, 2013, 08.00AM IST |Economic Times|
Last week, Kochi-based Anjana Badoor discovered that the option to prepay a loan does not rest with the borrower after all. “I had taken a loan of Rs 50,000 last year from a public-sector bank against jewellery roughly worth Rs 75,000. Though the loan tenure was two years, I was asked to prepay the entire outstanding amount immediately,” says the 53-year-old.
Given that she was servicing her EMIs on time and in full, Badoor can’t understand what prompted her bank to force her to prepay the loan. The reason is plummeting gold prices, which fell from Rs 32,500 per 10 gm in September 2012 to below Rs 27,000 in May 2013, a 17% drop. And yes, banks and NBFCs are within their rights to demand part prepayment or complete repayment of a loan.
Says Harsh Roongta, chief executive officer of Apnapaisa.com: “The terms and conditions for loans against gold are similar to other products, such as shares or other types of collateral. So if there is a drop in the value of the collateral, financial institutions can insist on accelerated payments to safeguard their money.”
Till mid-2012, banks and NBFCs were allowed a loan-to-value (LTV) ratio of 80-95%. In other words, you could walk home with a loan that was 95% of the value of the collateral you put up. As is evident, a high LTV ratio will be seen as higher risk. “Now that the price of gold has come down, the worth of jewellery pledged by gold loan borrowers is less than that at the time of giving the loan,” explains Rajiv Raj, co-founder and director at CreditVidya.com.
He also adds, “Banks, therefore, run the risk of some borrowers defaulting on their loans.” The default rates in leading gold loan companies are reportedly in the range of 7-9% of the total loans. As a preventive measure against collateral threat, they are likely to resort to prepayment notices.
The RBI move to cap the LTV limit for NBFCs to 60% in March 2012 is a safeguard mechanism, but it does nothing to protect loans that were disbursed earlier. These are the borrowers who need to be wary at the current juncture. According to Raj, if the LTV goes beyond the prescribed limit, lenders prefer to change the terms of the original deal. This isn’t really a bolt from the blue since most lenders clearly mention in the terms and conditions that customers need to make good on the margin if the collateral value of the asset comes down.
The good news is that banks rarely resort to twisting the customers’ arms as a start. Badoor happens to be unlucky to have been stuck with a panicked branch manager, who preferred to limit the risk exposure by calling in the entire outstanding amount. Ram Sangapure, general manager, Central Bank of India, explains that though banks have the right to recover the entire loan amount at any point, most refrain from doing so. “The possibility of a borrower defaulting would be higher if the banks force them to repay the entire amount at once. So most banks avoid doing so,” he adds.
Moreover, banks are wary of selling the collateral as it may not always fetch the outstanding amount. Besides the fact that organising the sale of collateral involves costs, gold jewellery also runs the risk of depreciating by 15-20% on making charges, if auctioned.
According to Sangapure, banks typically offer two options to a borrower in case there is a sharp drop in the value of the collateral. “The first one is part-payment of the outstanding principal amount, wherein the LTV ratio becomes appropriate again,” he says. Here, the customer may have to pay just the minimum outstanding principal to get the ratio right. Though prepayment penalties on gold loans are rare, experts confirm that the banks/NBFCs charging this fee waive it if they exercise their right to an early foreclosure.
Alternatively, banks may ask for a rise in the pledged collateral. “Most borrowers would prefer to take the second route if they are sure of repaying their dues and recovering their jewellery,” adds Sangapure.
If you are stranded
Badoor is thankful that she had taken a relatively small loan and managed to repay it by borrowing from friends. However, this option may not be open to everybody. If you are slapped with a notice for an immediate prepayment or increased collateral, but are unable to opt for either, don’t panic.
Explain the situation to the bank and it is likely to work out a mutually agreeable solution. For instance, you could ask your branch manager to be allowed to pay the difference in the LTV ratio. If you are expecting some cash flow in the near future, leverage on this windfall. As long as you have a good credit record, your bank is likely to extend you grace period. Unfortunately, the chances of being able to negotiate on your EMI are slim. “The lenders will not agree to alternatives such as a higher interest rate for the same collateral since they need to report these instances to the regulator,” says Raj.
The one thing you need to be careful about is not defaulting on the loan. For, you will not only lose your pledged jewellery, but will also ruin your credit score, making it difficult to land any other loan in the future.