Meera and Ravi both walk into your office on the same Monday. Each needs 60,000. Meera wants it for her daughter's school fees. Ravi needs stock for his tailoring shop before the festival season. The only real difference between them is that Ravi brings his wife's gold bangles to pledge, and Meera has nothing to pledge.
That one difference is the whole story of secured and unsecured loans. Ravi's loan is secured by gold. Meera's is unsecured. Here is what changes for you as the lender, and for them as borrowers.
What secured and unsecured mean
A secured loan is backed by something the borrower pledges, called collateral. Gold, a vehicle, property and shares are common. If the loan is repaid, the collateral goes back. If it is not, the lender may be able to sell it to recover what is owed, within the agreement and the rules that apply where you lend.
An unsecured loan has no collateral. You are lending against the borrower's income, history and word. A personal loan is the usual example.
Meera and Ravi, side by side
| Ravi (gold loan, secured) | Meera (personal loan, unsecured) | |
|---|---|---|
| Amount lent | 60,000 | 60,000 |
| What backs it | Gold bangles, valued at 100,000 | Nothing, only her income and record |
| If they stop paying | You can recover from the gold | You must chase the borrower |
| Risk to you | Lower, as long as the gold holds its value | Higher |
| Rate you can offer | Usually lower | Usually higher to cover the extra risk |
| Checks needed | Identity, valuation of the gold, signed agreement | Identity, income proof, repayment history |
| What the borrower risks | Losing the bangles | Collections follow-up and a damaged record |
Why the gold makes it safer for you
- You have a second way to be repaid. If Ravi's shop has a bad season, the bangles still stand behind the loan.
- Ravi has something he does not want to lose, so he tends to put your instalment first.
- Because your loss in a bad case is smaller, you can usually lend more, or charge less, than you could to Meera.
- A clear record of the gold (weight, purity, photographs and a signed note) settles most disputes before they start.
Secured does not mean risk-free. Gold can fall in price, a valuation can be wrong, and a pledge is only as good as the paperwork behind it. That is where LTV comes in.
LTV: how much cushion do you have?
LTV stands for loan-to-value. It is the loan divided by the value of what backs it, shown as a percentage. Ravi borrows 60,000 against gold worth 100,000, so his LTV is 60%. That means the gold could lose a good part of its value and still cover the loan.
| Loan against the gold | LTV | What it means |
|---|---|---|
| 40,000 | 40% | A large cushion. The gold could lose more than half its value. |
| 60,000 | 60% | A comfortable cushion, Ravi's case. |
| 80,000 | 80% | A thin cushion. A modest fall in price leaves you exposed. |
Many lenders set a maximum LTV and keep it lower for assets whose prices swing more. Where your limit sits is your call, and in some places the rules set limits for certain lenders, so check what applies to you. LTV also moves after the loan starts: as Ravi repays, the balance falls and his LTV improves, and if the gold price falls, it worsens even if he has paid on time.
What is a margin call?
A margin call is the lender's request to restore the cushion when the value of the collateral falls and LTV rises past an agreed limit. The name comes from lending against shares, but the idea applies to anything whose price moves, gold included.
Ravi's gold loses value
Ravi's agreement says LTV must stay at or below 75%. Gold prices fall and his bangles are now valued at 75,000. Against his loan of 60,000 that is an LTV of 80%, over the limit. You contact him and he has three choices within the agreed time: add more gold, pay down part of the loan so LTV is back under 75%, or repay the loan in full. If he does none of these, the agreement may allow you to sell some or all of the gold.
For this to be fair to Ravi, the trigger level, the notice period and what happens next must be written in the agreement before the money is lent. He should never learn the rule for the first time on the day you invoke it.
Do secured loans improve a credit score?
Not by themselves, and this is worth telling borrowers honestly. A credit score such as CIBIL in India rests on a borrower's reported repayment history, how much credit they use, how long they have had credit and the mix of credit they hold. Paying every instalment on time is what lifts a score. A gold loan repaid late can hurt Ravi's score just as much as a late personal loan would hurt Meera's.
A secured loan can help indirectly. A lower rate makes the instalment easier to afford, so Ravi is more likely to pay on time, and a healthy mix of secured and unsecured credit can count in a borrower's favour.
One more point for small lenders. A loan only affects a score if it is reported to a credit bureau, which is generally done by lenders who are members of the bureau. If you do not report, Ravi's on-time payments still earn your trust, but they will not show in his score. Check what applies to you before promising a borrower anything about their score.
Keeping gold loans in order
- Record each item with its weight, purity, estimated value, who valued it and when.
- Note the LTV on the day you lend and the limit you will accept.
- Attach photographs and the signed agreement to the loan.
- Review the value of the gold on a regular schedule, and write down any margin call and the borrower's response.
- Keep secured and unsecured loans apart in your reports so you can see how much of your book has something behind it.
Keep your loan book in order
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