Tuesday, May 28, 2013

Has the Gold Bug Bitten You?

The past one year has been really hard for gold investors. They have witnessed carnage in gold prices and have seen the value of their investments go down, day after day. In one of our older articles titled Why is Gold Price Falling? we had taken a detailed look at why the gold price is falling in the recent past. However, that is not the purpose of this article.

As collateral damage due to this fall in gold prices, individuals who had pledged their gold jewelry to make some quick cash to meet their funding demands have been caught unaware. The purpose of this article is to understand what problem these individuals are facing and how to handle the situation.

Before we begin: As you all may be aware, companies that grant loan against gold have been coming up in hundreds over the past year or so. Last year in June, I had written an article in this blog titled Tough Times Ahead for Gold Loan Companies where I had elaborated on these companies and the problems they face. It was just a matter of time before they ran into trouble and the inevitable has just happened in the past few weeks.

Who did this Gold Bug Bite?

The gold bug bit anyone and everyone who had recently pledged their gold jewelry at a bank or a gold loan company to get money.

Why is this Gold Bug Biting people?

The reason is simple – The Gold Loan Company Wants to Minimize its Losses.

Read this example from a banks perspective to understand the situation – before I actually explain what this bug bite is:

Let us say you run ABC Gold Loan Co, and I turn up at your branch to pledge 100 grams of Gold on 1st January 2013. Let us say, on that date, one gram of gold is being sold in the market at Rs. 3000/- and you are happy to give me a loan for 90% of the price value of the gold I am ready to pledge. Which means, you give me a loan of Rs. 2,70,000/- for the 100 grams of gold that I pledge with you. The difference of Rs. 30,000/- will be your cushion in case I default.

Sounds straightforward isn’t it?

Here comes the kicker…

Let us say, today 28th May 2013, the price of gold is only Rs. 2200/- per gram and I have just made interest payments in the past 6 months. So, the loan amount outstanding against my name is Rs. 2.7 lacs while the value of the 100 grams of gold I pledge with you is only Rs. 2.2 lacs.

Common sense would tell me that, it would be cheaper for me to let the loan default rather than pay 2.7 lacs for gold that is worth only 2.2 lacs. Isn’t it?

Gold Loan customers these days are doing this exact calculation outlined above and are willing to default on their loans instead of repaying their loan obligation.

What is this Gold Bug Bite?

Banks and Gold Loan companies are sending out letters to their loan customers to make either a part or full repayment of their loans to redeem their gold jewelry.

Can the Bank or Gold Loan Lender ask for this kind of repayment?

Yes, they can. If you read the loan terms & conditions carefully, there will be a clause which would say that the bank or the lender at his/her discretion can ask for part or full repayment of the loan at any time they want.

This, at their discretion means – they can ask for part or full repayment if they feel the value of the collateral held isn’t enough to meet the loan.

Go back to the above example, you as the owner of ABC gold loan co, will be sending me a letter stating that the value of the gold I have pledged isn’t enough to offset the loan outstanding. So, I should make a part or full repayment of my loan money. If I do not have surplus funds to meet your repayment needs, I may have to let the loan go into default…

What are my options – As the Loan Customer?

Option 1: The first option would be to minimize losses from my side and let the loan default because, I will actually be paying more money than what my gold is worth.

Limitations: None. You can do it anytime you want

Problem Due to Option 1: If I default on my loan, my credit history will go for a toss and no one will be willing to give me a loan in future. Banks and lenders these days are giving more and more importance to our credit history before actually giving us loans.

So, Option 1 is a REALLY BAD IDEA…

Option 2: Make a part or full repayment of the loan and redeem your gold if you have surplus cash available.

This is the best or easiest option because the bank or lender will be more than happy to close the loan or accept part repayments to keep their margins safe.

Limitations: You cannot do this if you do not have surplus cash

Problem Due to Option 2: None

Option 3: Pledge more Gold
If you do not have surplus funds to make a part or full repayment, you may consider pledging more gold as collateral to cover your loan. Most lenders will be happy to accept more collateral to cover the loan they have granted you.

Limitations: You cannot do this if you do not have surplus Gold

Problem Due to Option 3: None

From a borrowers perspective, these are our only options. Though we can let the loan default, we will end up making more damage to our credit history than the small profit we may make. So, try to liquidate your savings or borrow money from friends and family to do a part repayment as per Option 2.

Remember: The bank or lender cannot force you to do a full repayment immediately. They can only ask for part repayment or additional collateral to cover the loan amount. They may try to intimidate you into submission but the fact is, as a customer you have rights. It is a collateralized loan and the maximum liability from your side is – forfeiting the item you pledged as collateral if you default. They cannot bully or intimidate you any further. You can tell them that the best you can do is make a part repayment or pledge additional gold to cover their margin and that is all. If they push too much you will let the loan default and they can sell your gold to cover their losses.

Chances are that the bank or the lender will come down on their demand and let you do a part repayment or pledge more gold.

Best Wishes!!!

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