Loans

Businesses are financed either by equity or debt, usually by both. Equity, of course, is the capital paid into the business by its owner and other investors who buy shares. This money can be recovered only by selling the shares or by selling the company, and investors are at risk for the total of their investment. Debt is based on contractual arrangements under which both repayment of the principal and payment of interest are specified, although certain forms of debt bear no interest: an example is trade credit under which a buyer may have up to 90 days to satisfy a bill. All forms of credit, in effect, represent loans from one party to another. Thus leasing of rental space or of equipment may be viewed as loans of real estate or of equipment, with rents and lease payments representing interest. All such transactions are recorded on a company's books as liabilities. A company's debt-equity ratio (liabilities divided by equity) represents the degree to which it is said to be "leveraged." The ratio is one of the measures lenders use to make judgments on whether to lend or not or, alternatively, on how much to lend. The old-fashioned, traditional view is that debt should be avoided; progressive thought holds that a good balance between debt and equity gives a company optimum flexibility for growth; speculative views favor maximum leverage in order to achieve the highest possible return for stockholders.

CHARACTERISTICS OF LOAN TRANSACTIONS

Lending and borrowing transactions are characterized by time factors, costs, and risk considerations; all three are closely related.

Time Factors. Term loans are classified by the length of time for which money is lent. Loans come in short-term, intermediate-, and long-term forms. Revolving credit and perpetual debt, however, have no fixed retirement dates. Revolving credit, better known as a "line of credit," provides a sum of money which the borrower draws down and then pays back, borrowing again when funds are needed again. Interest is paid only when funds are being used. Brokerage houses that extend margin credit for customers on certain securities work the same way. The holder of a perpetual loan, usually issued through a registered offering, only pays interest on the money and decides in his or her own time when to retire the principal.

Repayment Schedules match the type of loan obtained and also affect the costs of the borrowing. Payment terms available either call for combined payments of principal and interest at regular intervals or require interest payments only with the principal repaid as a single sum at the end of the contract. In the first case interest is charged only on the remaining balance of principal so that the interest portion declines over time. Under some types of leases, the lessor gradually acquires the real estate or the equipment being leased. In these cases the lease payment remains the same but the lessor's costs decline because he or she is able to claim a portion of the property as depreciation against taxes.

Cost. The cost of a loan is the interest charged. Interest may be fixed for the term of the loan or may be variable. If the rates are variable, they may be adjusted daily, annually, or at intervals of years (3, 5, and 10). Such rates (called floating rates) are tied to some index such as the prime federal lending rate. As a general rule interest costs are based on the current cost of money and the relative risk of the loan, so that collateralized debt costs less than unsecured debt.

Security. Assets pledged as security against the loss of the loan are known as collateral. Credit backed by collateral is secured. In many cases, the asset purchased by the loan often serves as the only collateral, but in other cases the borrower puts other assets, including cash, aside as collateral. Real estate or land collateralize mortgages. Unsecured debt relies on the earning power of the borrower.

COMMON TYPES OF LOANS

Consumers and small businesses obtain loans with varying maturities in order to fund purchases of real estate, transportation and production equipment, raw materials, parts, and other needs. The source of such funding may be friends and relatives, banks, credit unions, finance companies, insurance companies, leasing companies, and trade credit. State and federal governments sponsor a number of loan programs to support small businesses.

Short-Term Loans

A special commitment loan is a single-purpose loan with a maturity of less than one year. Its purpose is to cover cash shortages resulting from a onetime increase in current assets, such as a special inventory purchase, an unexpected increase in accounts payable, or a need for interim financing. Trade credit is also a kind of short-term loan extended to the business by a vendor who allows the purchaser up to three months to settle a bill. In the past it was common practice for vendors to discount trade bills by one or two percentage points as an incentive for quick payment.

A seasonal line of credit of less than one year may be used to finance inventory purchases or production. The successful sale of inventory repays the line of credit. A permanent working capital loan provides a business with financing from one to five years during times when cash flow from earnings does not coincide with the timing or volume of expenditures. Such loans are common in seasonal businesses where, for instance, goods are manufactured in summer for winter sale or vice versa. In all such cases, creditors expect future earnings to be sufficient to retire the loan.

Intermediate-Term Loans

Term loans finance the purchase of furniture, fixtures, vehicles, and plant and office equipment. Maturity generally runs more than one year but less than five. Consumer loans for autos, boats, and home repairs and remodeling are analogous intermediate loans.

Long-Term Loans

Mortgage loans are used to purchase real estate and are secured by the asset itself. Mortgages generally run between ten and forty years. A bond is a contract held in trust with the obligation of repayment. An indenture is a legal document specifying the terms of a bond issue, including the principal, maturity date, interest rates, any qualifications and duties of the trustees, and the rights and obligations of the issuers and holders. Corporations and government entities issue bonds in a form attractive to both public and private investors. A debenture bond is unsecured, while a mortgage bond holds specific property in lien. A bond may contain safety measures to provide for repayment.

MIXED MOTIVES

In virtually all lending/borrowing situations the motives of the parties involved are in some conflict, at least on the margins. The business borrower's primary motive is to obtain the necessary financing to run the business at the least possible cost. His or her ideal source of funding is paid-in capital, but such equity is put at risk, and the owner feels this risk particularly if it is his or her own money. At the same time, if the money comes from investors, they will own shares of the company, and the more is owned by outsiders the less control the owner has. Even the most persuasive owner, able to get equity funding from others easily, will be constrained at some point—lest he or she lose control of the business. In this balancing act debt becomes an attractive alternative source of money. The owner's motive will be to get as much unsecured financing of this type as necessary at the lowest possible rates of interest and to obtain secured loans only if there is no other way. The owner will try to avoid debt because servicing it costs money—and it has to happen from cash flow. The less debt the business has to carry, the more rapidly his or her own equity will grow.

Independent investors in the business (if any) have yet another set of motives: they want to pay as little as possible for each share and see the value of that share grow. Investors like to "leverage" their investment by seeing it matched by borrowing. Since the borrowed money is used on their behalf, the more borrowing they can leverage the better. But, here too, constraints set it. Under current law the creditors of a business are first in line when the business fails. If the company is highly leveraged, investors are likely to lose their entire investment. Thus leverage is good—but it must be kept in line.

The lender, finally, is moved by a desire to earn money by lending it safely. Sources of large amounts of cash (banks, credit unions, insurance companies) are typically restrained by law and prudence from speculative investment of the money they hold in trust for others. They are conservative by their very structure and aim at predictable earnings by the safest possible means. Lenders ideally want secured loans at high interest rates, the latter kept low by competitive forces. They prefer to lend to the financially strongest possible borrowers; if competitive pressures force them to lend to weaker customers, they hedge the risks by charging more. From the lender's point of view, a financially strong borrower is one who has invested much and therefore has a great stake in the business's success; the business will also have a long, successful, and steady history of operations, and will offer ample collateral.

A small start-up with a brief history of mild success is thus in a relatively weak bargaining position and must make a very strong case before a favorable action by a potential lender is assured.

QUALIFYING FOR A LOAN

The three main factors that will help the small business qualify for a loan—aside from a successful track record—are good cash flow, a favorable debt-equity ratio, and carefully prepared documentation.

Net Cash Flow to Debt

The lender first looks at a loan-applicant's cash flow because it is the source of loan repayment. Cash flow is often different from the profitability or assets of a business because sales booked appear on the books immediately but may show up as cash only later (when payment is received) and purchases made are immediately shown as costs but may only require cash later (when payments are actually made). The lender will initially calculate the amount of cash available to service the current portions of any new debt. If this amount is minimally 1.25 times the debt service required, the business is at least in the ballpark to receive a loan. A company with a net cash flow of $5,000 a month and a future debt with a $1,750 monthly payment, has a ratio of cash to debt of 2.86—plenty, in other words. To be sure, the lender will look for a history of such cash flows: a two-month history will not be enough. The higher this ratio and the longer the history, the more inclined the lender will be to lend. If the cash flow is lower, the battle is almost certainly lost—for now.

Debt-Equity Ratio

This ratio is calculated by taking a company's liabilities and dividing them by the company's equity. A ratio of 1 means that for every dollar in equity the company has 1 dollar of debt. A company with no debt at all will have a debt-equity ratio of 0. Using data provided by MSN Money, in 2006 the combined debt-equity ratios of all companies part of the S&P 500 Stock Index was 1.04, suggesting that debt was just a hair greater than equity in these leading companies. But this ratio varies industry to industry. In capital-intensive industries the ratio will be significantly higher; in others much lower. In 2006 Microsoft's ratio was 4 cents to each dollar of investment; General Motors, struggling to stay solvent, had a ratio of nearly $20 in debt for each $1 of equity; General Electric's ratio was $1.94 to $1.

The ratio will tell the lender the commitment investors have made in the company, and the higher this commitment is in relation to borrowing, the more confidence the lender will have in being repaid.

Documentation

In addition to favorable financial ratios, the lender will be looking at the company's performance over time. The borrower should anticipate providing the lender a loan proposal justifying the loan. Parts of that proposal will be a business plan, financial statements, and details on other debts and liabilities. Sometimes unfavorable ratios can be overcome by a consistent history of profitable performance and high growth—and even innovative plans with high potential for success will carry weight. But the wise business owner will not bet on that.

The New Automation

In the modern lending environment, computers and the Internet have amplified (and sometimes even usurped) the role of lending officers at financial institutions. One such development is loan origination software (LOS) offered by a number of companies over the Internet to banks, credit unions, and other financing agencies. These packages automate judgment on loan applications by calculating ratios, using averages for industrial categories, weighting experience factors, and even obtaining credit ratings automatically. One such package is LiquidCredit Bank2Business offered by Fair Isaac Corporation, a leading company in the field—but there are a number of others. These packages "score" loan applications and thus give loan officers confirmation for their own judgment—or give them pause. Downsizing in the banking sector, as reported by Mike Byfield in Alberta Report has caused an increase in caseloads and thus reliance on such services. So much for the bad news. The good news is that capital markets in the mid-2000s were flush with money. Conditions continuously change and cycle, to be sure, but the well-prepared business owner with good justification can still prevail and get his or her loan. That, of course, is just the beginning of getting on with the program.

BIBLIOGRAPHY

Anderson, Tom. "Choosing a Corporate Bank for Business Loan, Partnership." Memphis Business Journal. 3 November 2000.

Booth, James R. and Lena Chua Booth. "Loan Collateral Decisions and Corporate Borrowing Costs." Journal of Money, Credit & Banking. February 2006.

Byfield, Mike. "Small Business Borrowing Gets Trickier." Alberta Report. 3 January 2000.

Green, Charles. The SBA Loan Book. Adams Media Corporation, July 2005.

Jepsom, Kevin. "Solution To Scoring Biz Loans." Credit Union Journal. 27 February 2006.

"LiquidCredit Bank2Business." Fair Isaac Corporation. Available from http://www.fairisaac.com/fairisaac/. Retrieved on 7 April 2006.

"Make Preparations Before Approaching Bank for Your Loan." Memphis Business Journal. 3 November 2000.

MSN Money. Available from http://moneycentral.msn.com/home.asp. Retrieved on 6 April 2006.

Zhai, David. "Comment: Lenders, Beware Pitfalls In Loan Scoring Systems." American Banker. 30 May 2000.

                              Hillstrom, Northern Lights

                                updated by Magee, ECDI

LOAN

LOAN (Heb. הַלְוָאָה, halva'ah), a transaction in which a thing, usually money, is given by one person, called the malveh ("lender"), to another, called the loveh ("borrower"), for the latter's use and enjoyment, and in order that such thing or its equivalent be returned by the borrower at some later date. In halakhic literature the term halva'ah is often used to describe an obligation or debt (ḥov) in general – i.e., not necessarily one originating from a transaction of loan – and many of the halakhot applying to debt in the wide sense of this term apply to loan, and vice versa (see Gulak, Yesodei, 2 (1922), 5f.; see also *Obligation, Law of). In this article loan is treated in the restricted sense of the term defined above

Oral Loan (Milveh be-al Peh) and Loan in Writing (Milveh bi-Shetar)

A loan established orally is distinguished from one established in writing in two main respects: (1) in the former case the borrower's plea that he has repaid the loan is believed, whereas in the latter case such a plea by the borrower is not believed when the bond of indebtedness is in the lender's possession; (2) in the case of a loan in writing, the creditor has the right to levy on the debtor's nekhasim meshu'badim ("alienated and encumbered" assets, see *Lien; Obligation, Law of), a right not available to him in the case of an oral loan. The term milveh be-al peh is apparently a post-talmudic creation, although the distinction between the two forms of loan was recognized as early as tannaitic times (Gulak, loc. cit.; Herzog, Instit, 1 (1936), 352).

Mitzvah of Lending

The precept of lending to the poor of Israel is based on Exodus 22:24: "If thou lend money to any of my people that is poor by thee" (see Mekh., Mishpatim, s. 19), and is included in the enumeration of the mitzvot (Sefer ha-Mitzvot, Asayin no. 197; Semag, Asayin no. 93; Sefer ha-Ḥinnukh no. 66). Some scholars derived this precept from other biblical passages (She'iltot no. 114; Semak no. 248). The lender, if he apprehends that he may not be repaid, may make his loan conditional on the receipt of a *pledge from the borrower (Tos. to bm 82b; Ahavat Ḥesed, 1:13). The merit of fulfilling this precept was lavishly extolled by the scholars – even beyond the act of *charity (Shab. 63a). The duty was held to cover also a loan to a rich man in his hour of need (Sh. Ar., Ḥm 97:1, Sma thereto, n. 1), but some scholars restricted its application to the case of a poor man only (Evenha-Ezer, Malveh ve-Loveh 1:1). In certain circumstances a person is prohibited from lending money to another. This is so if there are no witnesses to a loan (bm 75b), lest the borrower be tempted to deny his indebtedness or the lender forget that he gave the loan; it nevertheless became customary for a loan, even an oral one, to be given in the absence of witnesses, and the aḥaronim sought to explain the custom and reconcile it with the talmudic halakhah (Pilpula Ḥarifta to bm 75b; Resp. Ben Yehudah, 1:153). Similarly prohibited is a loan given to a poor man for the repayment of another debt, since – but for such loan – the creditor might come to his relief on account of his poverty (Tos. to Ḥag. 5a).

Nature of the Repayment Obligation

The nature of the borrower's obligation to repay the loan was a matter of dispute among the amoraim. R. Papa took the view that the duty of repayment was no more than a mitzvah – just as it was a mitzvah for the lender to give a loan – whereas R. Huna b. Joshua held that repayment was a legal duty (Ket. 86a; bb 174a; Nov. Ritba, Kid. 13b; Resp. Mabit, vol. 1, no. 51; Semag, Asayin 93). It seems that, alongside the legal duty, R. Huna recognized also the existence of a religious duty to repay the debt (Resp. Ribash 484; M. Elon (see bibl.), 20f. and n. 44, 45; for an opinion that the duty was a mitzvah only, see Nov. Ramban bb 173b). Some scholars held this mitzvah to be of Pentateuchal origin (Ritba, loc. cit.; Mabit, loc. cit., Resp. Pithei Teshuvah, Ḥm 97, n. 4), while others interpreted R. Papa's statement as relating only to an oral loan (Rashbam bb 174a). A borrower who fails to repay the loan is described as rasha ("wicked"; Ps. 37:21; Semag, Asayin no. 93; see also *Contract; Obligation, Law of).

Halva'ah and She'elah

She'elah (loan for use and return) relates to "utensils" (kelim), and halva'ah (loan for consumption) to money or "produce" (perot). Utensils are things which are not counted by weight and measure, nor exchangeable one for the other; things which are counted and exchanged in this way are "produce" (Gulak, Yesodei, vol. 1, p. 95; vol. 2, pp. 20, 171). The sho'el (borrower for use and return) must return the subject matter of the loan in specie, whereas the loveh need not do so. Unless otherwise stipulated, a loan is for consumption, and the borrower will only be liable for payment of the equivalent in produce or other property (see also *Shomerim).

Establishment of Loan

A loan transaction is concluded upon handing over of the money (or "produce") to the borrower. In post-talmudic times the opinion was advanced that a contract of loan might be established upon performance of a formal kinyan alone (see *Acquisition), without handing over of the money, and that thereupon the borrower would become obliged to repay the money (Tur, Ḥm 39:19 and Beit Yosef ad loc.); however, this opinion was not accepted by scholars (Beit Yosef loc. cit.; Ḥm 89:17). Once the money of the loan has been given to the borrower, the lender will no longer have any right to retract and demand its return, even if it is still intact in specie (Baḥ, Ḥm 39:19; Siftei Kohen, Ḥm 39, n. 49). Where the lender has undertaken to give a loan and the borrower has already written a deed on the former's instruction, some scholars hold that, as long as the money has not yet passed to the borrower, the lender remains free to retract from the loan (Resp. Rashba, vol. 1, no. 1054; Sh. Ar., Ḥm 39:17), while others preclude him from so doing (Sefer ha-Terumot 48:1; Maggid Mishneh, Malveh, 23:5). In the case of an oral loan, the lender may withdraw at any time before handing over of the money (Netivotha-Mishpat, Mishpat ha-Urim, 39, n. 17).

Repayment Date

when specified

If a specified date was stipulated between the parties, the lender may not reclaim the loan prior to that date (Mak. 3b; Yad, Malveh, 13:5). Some scholars maintain that the lender – even in circumstances where he has reason to fear the borrower's imminent departure abroad, or is aware that the latter may be squandering his assets and therefore become unable to repay the debt on the due date – is not entitled to anticipate the day of repayment (Teshuvat ha-Ge'onim no. 45; Sefer ha-Terumot 16:3; Tur, Ḥm 73); other scholars invest the court with discretion in the matter and the power to order distraint of the property in the borrower's possession (Resp. Rif. no. 113; Resp. Rashba, vol. 1, no. 1111). It was held that the court might do this only if the borrower is squandering his assets, otherwise – even though his financial position may be steadily deteriorating for other reasons – the court will not have the power to intervene prior to the due date of repayment (Yam shel Shelomo bk 1:20; Siftei KohenḤm 73, no. 34, see also below; *Execution (Civil)).

when unspecified

A loan for an unspecified period is given for 30 days (Yad, Malveh 13:5), and may not be reclaimed within this period. If it is customary in a locality to retain a loan of unspecified duration for a longer or a shorter period, that custom is followed (Sh. Ar., Ḥm 73:1, Sma and Siftei Kohen ad loc.). Some scholars expressed the opinion that in this matter even the gentile custom is followed (Sma, loc. cit.) – but others disputed this (Siftei Kohen, loc. cit., n. 1 and 39).

further differences

(1) In the case of a loan for a specified period, the borrower's plea that he has made repayment within the term of the loan is not believed, since "a person is not likely to make payment before the due date" (bb 5a), whereas in the case of a loan for an unspecified period the borrower's plea that he has paid within the 30 days as required is believed (Tos. to bb 5a). This distinction has been justified by the scholars on many grounds. Some hold that in the case of a specified repayment date, the borrower, for no particular reason, knows that he will have no money available until the due date, but not so in the case of an unspecified repayment date (Resp. Rosh, 76:3); others hold that when no date is specified, the borrower will feel ashamed if he should have money before the end of the 30 days and fail to make repayment – hence it is presumed that he will repay the loan, even within the said period, if he has the money (Shitah Mekubbeẓet, bb 5a); yet another view is that, in the case of an unspecified repayment date, the borrower is liable for repayment of the loan before expiry of the 30 days – save that he cannot be obliged by the court to make payment before then – hence he is likely to repay earlier if he has the money (Devar Avraham, vol. 1, no. 32). A minority opinion holds that, in the case of a loan for an unspecified period, the borrower is not likely to anticipate payment, and his plea to this effect is not to be believed (Nov. Ramban bb 40a).

(2) Apparently even those who adhere to the opinion that the property of a borrower – even when it is being squandered by him – cannot be distrained until due date of payment of the loan agree with all other scholars that, as regards a loan for an unspecified period, the court may distrain the property in the debtor's possession even before expiry of the 30 days (Kenesetha-Gedolah, Ḥm 73; Beit Yosef 20b).

anticipation of payment by the borrower

Since determination of the repayment date is for the borrower's benefit (Ran to Ket. 81a, s.v.vegarsinan), it is permissible for him to repay the loan before the due date, regardless of the lender's wishes (Ran, loc. cit.). He may not, however, anticipate payment without the lender's consent when there is a substantial apprehension of an imminent and official change in currency values (Sefer ha-Terumot 30:2; see also below).

Acceptance of Payment

Payment made to the lender against the latter's will is a valid payment; if the latter refuses to accept the money and the borrower throws it to him, he will be discharged (Sefer ha-Terumot 50:1; Tos. to Git. 75a). However, when the lender is prepared to accept payment, the borrower must make the payment into his hands and may not throw it to him (Git. 78b; Yad, Malveh 16:1). Payment to the lender's wife is held by some scholars to discharge the borrower, provided that she is accustomed to transacting her husband's business (see Husband and *Wife; Resp. Maharam of Rothenburg, ed. Prague, no. 225; Rema, Ḥm120:2), but other scholars dispute that this is a valid discharge (Yam shel Shelomohbk 9:39).

Place of Payment

The lender may claim repayment at any place, even in the wilderness (bk 118a; Sh. Ar., Ḥm 74:1). Upon due date the borrower may oblige the lender to accept payment at any settled place (yishuv), even if this is not the place where the loan was transacted, nor the place of residence of the lender or borrower (Sefer ha-Terumot, 30:1; Sh. Ar., loc. cit.). If the loan was transacted in the wilderness, the borrower may oblige the lender to accept payment there (RemaḤm 74:1).

Method and Means of Payment

A debt not yet due may be repaid little by little (bm 77b; Mordekhaibm no. 352; Ittur, vol. 1, pt. 2, s.v.iska); according to some scholars payment in this manner, although initially forbidden, is valid in retrospect (Bedek ha-BayitḤm 74; Siftei KohenḤm 74, n. 17). After due date the lender may, in the opinion of all scholars, refuse to accept payment in the said manner (Mordekhai, loc. cit.). The borrower must repay in money, and, if he has none, in land. The lender may refuse to accept the land and offer to wait until the borrower has money – even if this is after the due date (Resp. Rosh, 80:9; Sh. Ar., Ḥm 74:6, 101:4). If the borrower has no money, the lender may not instruct him to sell his assets in order to receive money for them, but must either take the assets as payment or wait until the borrower has money (Tos. to bk 9a). If payment in money entails a loss for the borrower, he may repay the loan in land (Tos. Ket. 92a and Ran ad loc.). If the borrower has money, land, and chattels, and wishes to pay in money, while the lender asks for land or chattels, some scholars hold the law to favor the lender and others the borrower (Sefer ha-Terumot 4:2; see also *Execution (Civil)).

Fluctuation in Currency Values

In case of official withdrawal and replacement of the existing currency, the position is as follows: If the new currency is of the same kind, the borrower pays in the currency in circulation at the time of payment (bk 97). If, however, the withdrawn currency is circulating in another country on the same terms as it formerly did in the country of its withdrawal, the lender – if he has the means of reaching such a country and there is no particular difficulty in transferring the old currency – will be obliged to accept the withdrawn currency in payment (bk 97; Sh. Ar., Ḥm 74:7). If as a result of a change in the value of the currency there is a reduction in the price index of the commodities ("produce"), the borrower pays in accordance with the new currency value and deducts for himself the excess (bk 97b, 98a); if the reduction in prices result from factors unconnected with a currency revaluation, the borrower pays in the stipulated currency, without any deduction (Sh. Ar., yd 165). The view that the rules stated with reference to a currency revaluation must also be extended, by analogy, to the case of a currency devaluation (Aferet Zahar no. 165) was accepted as halakhah (Piskei ha-Rosh, bk 9:12; Ḥikrei Lev, Mahadura Bafra, Ḥm 9) in preference to a contrary opinion (Piskei ha-Rosh, loc. cit.; Resp. Rashba, vol. 3, no. 34).

In many Jewish communities *takkanot were enacted which were aimed at reaching a compromise in disputes between parties relating to the manner of debt-payment in case of a change in currency values, and a decisive majority of the posekim inclined toward adjudging and compromising between the parties in terms of these takkanot (see Kahana, bibl.; *Takkanot ha-Kahal).

Plea of Repayment (Parati; "I have repaid")

An oral loan is repayable without witnesses; a loan in writing, before witnesses. In a claim for repayment of an oral loan, the borrower's plea that he has already made repayment is believed (Sh. Ar., Ḥm 70:1); such a plea is regarded as a general denial of the claim, and on taking a solemn *oath (shevu'at hesset) – the borrower is exempted (Sh. Ar., Ḥm 70:1). Where there is a bond of indebtedness, the borrower's plea that he has made repayment is not believed, and the lender – on swearing an oath that he has not been repaid – proceeds to recover the debt (ibid.). (As regards the borrower's plea of payment prior to the due date, see above.) As a means of protecting the lender against such a possible plea of repayment, it became customary to stipulate, at the time of the loan, that credence be given to the lender upon his denial of a repayment plea by the borrower – such stipulation availing to dismiss the latter plea (Sh. Ar., Ḥm 71:1). For the similar protection of the lender, the practice was adopted of stipulating at the time of the loan that it be repayable only before witnesses – the borrower's plea of repayment being thus deprived of credibility unless attested by witnesses (ibid., 70:3). In the latter case it still remained possible for the borrower to plead that he had repaid the debt before witnesses A and B, who had since gone abroad, and – upon making a solemn oath – become exempted; to forestall this possibility the practice was adopted of stipulating, "You shall not repay me except before witnesses so and so, or before the court" – thus precluding the borrower from pleading that he made repayment before some other witnesses (ibid., 70:4).

Multiple Loans

If a lender has given the same borrower two separate loans and the latter seeks to repay on account of one of them, the lender may appropriate the payment toward whichever loan he pleases, without any right on the borrower's part to protest or maintain that he intended otherwise (Tur., Ḥm 83:2 and Beit Yosef ad loc.; Sefer ha-Terumot 20:2). This rule only applies when both loans have already fallen due for payment (Sefer ha-Terumot, loc. cit.); if one loan has fallen due but not the other, the payment is deemed to have been made on account of the former (Resp. Radbaz, 1252 (181)); if neither has fallen due, the law is apparently the same as for two loans already due (Radbaz, loc. cit.; Keẓot ha-Ḥoshen 83, n. 1).

Conversion into Loan of Other Contractual Obligation

At times the practice was adopted, for various reasons, of converting an obligation originating from a transaction other than loan into an obligation of loan. This practice is referred to as zekifat ḥov be-milveh and was adopted – for instance in the case of a purchaser indebted to the seller for the purchase price – because of the restricted number of pleas possible against a claim for a loan-debt as compared to a claim for a debt originating from the sale of goods (bm 77b; Ḥm 190:10). Zekifat ḥov takes place in one of the following ways: (1) by the writing of a special bond of indebtedness for an already existing debt; (2) by the stipulation of a date for the repayment of an existing debt; and (3) by the gradual accumulation of a debt, for instance by purchase on credit from a shop. In this way the original obligation is largely – or even entirely – extinguished and converted into a new obligation. From the time of such zekifah the debt is an obligation of loan only, the new obligation retaining none of the legal characteristics of the old (Gulak, Yesodei, vol. 2, pp. 116–8).

Minor as Party to a Loan

By pentateuchal law, a minor has no legal capacity to lend. As long as the subject matter of such a loan is still intact (in specie), it must be returned by the borrower; hence in case of loss resulting from *ones (force majeure) the borrower is exempt from liability, as the property is deemed to be in its owner's possession for purposes of loss arising from ones. The rabbis enacted that a loan given by a minor should be valid, the borrower being liable also for loss resulting from ones (Gulak, Yesodei, vol. 1, p. 40). A minor who has borrowed is exempt from returning the loan, even after reaching his majority. According to some scholars, a minor who has borrowed for his own maintenance can be recovered from even during his minority (Gulak, loc. cit.; see also Legal Capacity).

Measures to Prevent "Bolting the Door" to Borrowers

Hillel the Elder instituted a *Prosbul designed to overcome reluctance to lend to a borrower at the approach of the shemittah (sabbatical) year (Shev. 10:3; Rashi Git. 37a; see also *Takkanot). Although according to pentateuchal law the need for derishah and ḥakirah (examination of witnesses) extends also to civil law (dinei mamonot) matters, the scholars enacted for the obviation of this procedure in the latter cases, so as not to bolt the door before borrowers (Sanh. 3a; see also *Practice and Procedure; *Witness). Despite an opinion upholding the need, by the pentateuchal law, for three expert judges in matters of hoda'ot ("acknowledgments") and loans, the scholars enacted for the competence of a court of three laymen, lest the door be bolted before borrowers, for fear that no expert judges may be found to enforce the law (ibid.; see also *Bet Din). The scholars enacted that in certain circumstances the judges, if they erred, were not to be exempted from liability, in order not to discourage people from lending to others (ibid.). According to pentateuchal law, the creditor recovers the debt out of the zibburit ("worst land") of the debtor, but the scholars enacted that he might do so from the beinonit ("medium land"), for the reason mentioned above (Git. 50a; see also *Execution (Civil)). According to those who held that the doctrine of shi'bud nekhasim was non-pentateuchal, the scholars enacted for a lender on a bond to recover from the debtor's nekhasim meshu'badim ("encumbered and alienated property"; see *Lien; bb 175b).

[Shmuel Shilo]

The Community as a Debtor

The Responsa literature relates to the mode of conduct in cases where the community had taken a loan for its various affairs, and it has to settle the debt. Rabbi Shlomo b. Aderet (Rashba) was asked about a case in which community members were taxed in order to return the loan – whether taxation should be made according to the financial status of the community member at the time of taking the loan or according to the time of its discharge. Rashba ruled that legally this loan should be regarded as a loan taken by partners, and the burden of repayment is in the same proportion as when the loan was taken; therefore community members should be taxed according to their status at the time when the loan was taken. Nevertheless the community has the authority to enact that participation of each member should be made according to the time of repayment, because a loan taken by the community could be regarded differently from an ordinary loan – "they are unlike debtors who take the loan directly for themselves, but like debtors for the community chest." Nevertheless, Rashba negates the possibility of obliging recent citizens of the community, who were not members of the community when the loan had been taken, because it is like a retroactive obligation which is not equitable (Resp. Rashba, 1, no.777; 3, no.412; see *Takkanot ha-Kahal). For the present discussion, see also *Legal Person.

[Menachem Elon (2^nd ed.)]

bibliography:

Gulak, Yesodei, 1 (1922), 145f.; 2 (1922), 33–35, 42f., 83–88, 105–9, 113–8, 170–2; 3 (1922), 102–6; 4 (1922), 85–90; idem, Oẓar, 205f., 208; J. Rappaport, in: Zeitschrift fuer vergleichende Rechtswissenschaft, 47 (1932/33), 256–378; Herzog, Instit, 1 (1936), 121–4, 219f., 359f.; 2 (1939), 57f., 186f., 215f.; J.S. Kahana, in: Sinai, 25 (1949), 129–48; ET, 1 (1951³), 263–6; 4 (1952), 110–4; 5 (1953), 92–132; 9 (1959), 215–40; M. Silberg, Kakh Darko shel Talmud (1961), 71–75; M. Elon, Ḥerut ha-Perat… (1964); idem, Mafte'aḥ, 48–57. add. bibliography: M. Elon, Ha-Mishpat ha-Ivri (1988), 1:104f., 120, 189f., 252, 264, 346, 418f., 476, 482f., 487f., 489, 498, 528, 531f., 533, 535, 569, 597, 600, 626, 636, 653f, 733, 775f, 813; 2:866, 983; 3:1443; idem, Jewish Law (1994), 1:117f, 135, 212f, 295, 309, 416; 2:510f, 580, 587f, 593f, 596, 607, 643, 646f, 649, 651, 699, 738, 743, 774, 788, 808f, 904, 953f, 996; 3:1058, 1187; 4:1716; M. Elon and B. Lifshitz, Mafte'aḥ ha-She'elot ve-ha-Teshuvot shel Ḥakhmei Sefarad u-Ẓefon Afrikaḥ (legal digest) (1986), 89–103; B. Lifshitz and E. Shochetman, Mafte'aḥ ha-She'elot ve-ha-Teshuvot shel Ḥakhmei Ashkenaz, Ẓarefat ve-Italyah (legal digest) (1997), 61–67; I. Warhaftig, Hitḥayyevut (2001).

Loans

BIBLIOGRAPHY

A loan is a type of debt. In general, a loan refers to anything given on the condition of its return or the repayment of its equivalent. All material things can be lent, but the most common type of loan is the monetary loan. Like all debt instruments, a loan implies the redistribution of financial assets over time between the lender and the borrower.

In a monetary loan, the borrower initially receives an amount of money from the lender, which he pays back, usually in regular installments. This service is generally provided at a cost, referred to as interest on the debt. The provision of loans is one of the principal tasks of financial institutions. A loan also may be acknowledged by a bond, a promissory note, or a mere oral promise to repay.

The concept of loans dates back to the very old ages of the agricultural era, when people had started living in organized societies. However, it developed and became widespread with the use of money. Because of biblical injunctions against usury, the early Christian church forbade the taking of interest. In feudal European society, loans were little needed by the great mass of relatively self-sufficient and noncommercial farmers and serfs, but kings, nobles, and members of the church community borrowed heavily for personal expenditures. The role of the moneylender was undertaken back then by merchants and other townsmen, especially the Jews, while various devices were found for circumventing the prohibition of usury.

The development of money lending among the Jews as their almost exclusive occupation began in the twelfth century, and it was probably the consequence of the persecutions during the First Crusade; Jews at this time could not own land or vineyards, so money lending was one of the few occupations open to the Jews as a means of livelihood. In addition, the Catholic Church’s prohibition against money lending for Christians provided Jews with a unique opportunity to step into this void in establishing themselves as bankers. The laws regarding pawn-broking also became increasingly more detailed. During the Middle Ages, local rulers prohibited Jews from occupying most professions, so they were pushed into marginal occupations that were considered socially inferior, such as money lending.

Historically, attacks on usury have often been connected with anti-Semitism. Moreover, Judaism has been a more lenient religion with respect to lending than other religions. The Torah and later sections of the Hebrew Bible criticize the taking of interest, but interpretations of the biblical prohibition vary. One common interpretation is that Jews are forbidden to charge interest upon loans made to other Jews but allowed to charge interest on transactions with non-Jews. However, the Hebrew Bible itself gives numerous examples where this prohibition was evaded. Moreover, legislation concerning the Jews recognized the rabbinical law. According to the latter, for instance, a Jew who had advanced money on a stolen article was entitled to recover the amount he had loaned for it, including interest, if he could swear that he did not know it had been stolen.

By contrast, many religions prohibit the charge of interest. The most prominent example is that of Islam. Sharia, the Islamic law, does not allow the collection and payment of interest (riba ). However, as Maxime Robinson demonstrates in his book Islam and Capitalism (1974), even the Islamic prohibition of usury and other kinds of transactions was no barrier to the continuation and elaboration of pre-Islamic capitalistic practices. The Koranic revelation, therefore, did not bring into being an exemplary moral economic system that was fundamentally different from any other existing economic system. Thus, Islamic prohibitions on usury were circumvented with the establishment of Islamic banks. Islamic banks have the same purpose as conventional banks but are believed to obey the rules of Sharia. Islamic banking is based on the sharing of profit and loss and the prohibition of interest. According to a common practice used to lend money for a purchase, a bank might buy the item itself from the seller and resell it to the buyer at a profit while allowing the buyer to pay for it in installments. To protect themselves against default, Islamic banks retain ownership of the item until the loan is paid.

The United States has an old tradition of lending. Americans have long relied on credit, which, for day-to- day matters, typically took the form of charge accounts with local retailers. In the early years of the United States, when it was primarily an agrarian society, income for many people rested upon when the crops were harvested and sold. Credit and charge accounts, rather than the more structured repayment of an installment purchase, were more individual in nature, relying heavily on the personal relationship between the consumer and the retailer. Credit cards and other more modern and impersonal means of credit and charge-account purchasing became a fixture in the consumer-retailer relationship in the 1950s. However, even today the traditional, more personal and informal types of charge accounts do exist. Without extending some sort of credit to customers, many businesses in the past simply would not have been able to operate. Today’s modern means, the credit card, has greatly reduced the degree to which individual retailers personally extend credit to consumers. However, credit itself remains as essential to the retail economy as it has ever been.

The history of formal lending in the United States is also deeply related to the rise of homeownership in the lower socioeconomic classes. Formal lending, in terms of institutional lending, has long been the means by which many have been able to buy their own home. Before institutionalized lending that was accessible to those who were not wealthy, people relied on private loans or small, regional networks serving a particular ethnic or professional group. These types of lending situations, however, did not nurture and support homeownership in the same ways, or for as great a percentage of people, as does formal or institutional lending today.

The early types of formal mortgages were extended by insurance companies. The terms of these mortgages, however, were often quite risky for the borrower, with the balance of power distinctly tipped toward the lender in ways that would be deemed unfair and even predatory by today’s standards. Savings and loan associations also evolved, although they remained separate from traditional banks, which could offer checking accounts and other services, until the 1970s, when banking regulations changed. Once those regulations changed, savings and loan associations became almost indistinguishable from the typical bank of today, but their loan practices became the universal standard among many of today’s financial institutions. The practices have been revised continuously through the years by regulations meant to ensure that minorities and women were able to have equal access to fair lending.

Today, banks and finance companies usually extend loans against collateral, such as stocks, personal effects, and mortgages on land and other property. Credit activity is considered to be strongly correlated with consumption, and it is expanding due to the gradually decreasing savings rates of typical households. Financial institutions are the ones responsible for extending loans, and they make a large share of their profits out of this activity. The low penetration of loans to an economy, as is the case in the developing countries of central and southeastern Europe, attracts many foreign direct investments in those countries.

Bank loans and credit are considered to be one way to increase the money supply. Policymakers, such as many central bankers, take into account credit growth developments in their decisions about interest-rate movements. Another aspect of the internationalization of loans is the ability of the participants of economic activity—governments, companies, and households—to borrow from abroad under better terms and conditions.

Apart from those who have access to financial markets, the establishment of organizations such as the International Monetary Fund and the World Bank allow the provision of loans to countries experiencing economic problems. This financial assistance enables countries to encounter economic difficulties, reconstruct, and restore conditions for economic growth. Moreover, Muhammad Yunus of Bangladesh, who was awarded the Nobel Peace Prize for providing, through his Grameen Bank, small loans known as micro-credit to poor people without any collateral showed that loans can be accessible and provide support even to those who have no financial security.

SEE ALSO Banking; Banking Industry; Discounted Present Value; Equity Markets; Financial Instability Hypothesis; Financial Markets; Hedging; Leverage; Liquidity Premium; Microfinance; National Debt; ROSCAs

BIBLIOGRAPHY

International Monetary Fund. 2006. IMF Lending. International Monetary Fund, September. http://www.imf.org/external/np/exr/facts/howlend.htm.

Robinson, Maxime. 1974. Islam and Capitalism. Trans. Brian Pearce. New York: Pantheon Books.

Secor, Sharon. 2004–2006a. A Brief History of Formal Lending in the United States. Direct Lending Solutions. http://www.directlendingsolutions.com/history_of_lending.htm.

Secor, Sharon. 2004–2006b. Credit History: Before There Was Plastic … The Earliest Charge Accounts. Direct Lending Solutions. http://www.directlendingsolutions.com/history_of_credit.htm.

Tran, Mark. 2006. Pioneering Economist Wins Nobel Prize. Guardian Unlimited, October 13. http://business.guardian.co.uk/story/0,,1921726,00.html.

Eleni Simintzi

Loan

What It Means

A loan refers to a sum of money borrowed by a corporation, an individual consumer, or another entity. Generally speaking people use loans to pay for goods or services that they are unable to pay for in full at the time of purchase. The cost of a loan to the consumer typically takes the form of interest (a percentage of the loan amount that must be repaid in addition to the original amount of the loan, which is known as the principal). Interest is usually calculated on an annual basis. The two types of interest rates are fixed and adjustable. A fixed rate is an annual percentage rate that never changes, while an adjustable rate fluctuates regularly. The amount of money owed by the borrower for the duration of the loan is often referred to as debt.

There are two principal parties to a loan. One is the individual or entity providing the loan, also known as the lender. Lenders are usually financial institutions, such as banks, credit card companies, or other commercial entities, that are authorized by law to loan money to businesses or consumers at established interest rates. The other party to the loan is the person or group that is receiving the loan, also known as the borrower. Many lending situations also involve a third party, known as a broker. The broker is an agent who acts as an intermediary in creating the loan and who receives a commission, or fee, for overseeing specific aspects of the lending process.

The two basic types of loans are secured and unsecured. With a secured loan the lender assumes certain rights of ownership over the item being purchased by the borrower. Typical examples of secured loans are home loans, also known as mortgages, and car loans. In the case of home loans the lending institution has the right to sell the borrower’s house or property in the event the borrower fails to repay the loan according to the requirements of the loan agreement. This right is known as a lien. To fail to repay the borrowed amount is to default on a loan. Unsecured loans include credit card loans, personal loans, or bonds (notes issued by the borrower to the lender pledging repayment of a loan).

Credit refers to the trust placed by a lender in the borrower’s ability to repay a certain amount of money in an agreed-upon manner. The more faith a lender has in the ability of the borrower to repay a loan, the greater the amount of money the lender will offer to that borrower. A borrower’s credit rating is determined by such factors as income, employment status, current level of debt, family responsibilities, total assets (items of value owned by the borrower, such as an automobile or a piece of property), and past credit history. These factors also play a key role in determining the interest rate of the loan. A borrower with an excellent credit rating will generally receive a favorable interest rate on a loan, because the risk of defaulting on the loan is relatively low. On the other hand high-risk borrowers, such as consumers who have bad credit histories or who hold low-paying jobs, will usually only receive a loan if they agree to repay the money at a substantially higher interest rate.

When Did It Begin

Some form of lending likely existed in the earliest civilizations. Historical sources indicate that loans served an important role in the commercial activities of the ancient Greeks and Romans, and numerous allusions to lending practices appear in the Bible. The Bible makes repeated references to the practice of usury, or the charging of interest on loans. Originally usury could refer to any form of interest, regardless of the percentage rate, although over time it came to mean interest charged at an excessive or unfair rate. Various passages in the Old Testament contain explicit rules concerning interest. For example, Exodus 25:25 expressly forbids charging interest on loans to the poor, and Deuteronomy 23:19–20 prohibits Jewish people from lending at interest to other Jews, while allowing them to charge interest to people of other faiths. Because usury and debt were regarded as immoral by early Christians, the lending of money at interest was officially prohibited by Pope Leo I in the fifth century ad .

Because of these bans on the charging of interest, most loans in medieval Europe involved collateral, which is a piece of property or another object of value given by the borrower to the lender as an assurance of intention to repay a loan. Such lenders, also known as pawnbrokers, retained the collateral for a set amount of time and then sold it back to the borrower, collecting an agreed-upon fee in the process. In the Middle Ages the most powerful money lenders in Europe were Jews, the Lombards of northern Italy, and the Cahorsins of southern France. Because these groups amassed a great deal of wealth through the collection of fees on loans, they were generally despised and frequently persecuted.

As economies expanded toward the end of the Middle Ages (c. 500–c. 1500), usury laws began to be viewed as a hindrance to commercial growth, and laws against charging interest relaxed considerably. By the early sixteenth century the modern practice of charging interest on loans had gained widespread acceptance throughout Europe.

More Detailed Information

All loans are governed by the terms stated in a contract established between the lender and the borrower. This contract, also known as a loan agreement, outlines the various terms relating to the loan and its repayment. These terms include the amount of the loan, the interest rate (a finance charge), the amount of time the borrower will have to repay the loan, and, in most cases, a payment schedule specifying the amount of money the borrower must pay each month until the loan is completely paid. In the United States the rules governing the issuance and administration of commercial loans fall under the Uniform Commission Code, a system of laws created in the 1950s to ensure that business transactions are conducted in a fair and standardized manner from state to state.

Most loans are categorized as installment loans, which are loans that require the borrower to make periodic payments, with interest, until the loan is repaid. Most installment loans require the borrower to make a minimum payment each month. Typical installment loans include automobile loans, home mortgages, and student loans. The duration of an installment loan varies widely and is generally determined by the amount of the monthly payment. In the case of most home mortgages, the duration of the loan repayment schedule can be 15, 25, or 30 years, depending on how much money the borrower is able or willing to repay each month. In the case of automobile loans, the duration is much shorter, and the monthly payments are considerably less. Installment loans are sometimes referred to as closed-end loans.

Other common types of loans include time loans, term loans, and demand loans. Time loans are short-term loans that the borrower is obligated to repay in full after an agreed-upon length of time. The duration of time loans is frequently measured in months. The repayment date of the loan is often referred to as the point at which the loan reaches its maturity. In most cases the interest on a time loan is paid at the time of the loan’s initiation, as a deduction from the total amount borrowed. Term loans are similar to time loans, in that they are repaid after the loan reaches its maturity, except that term loans have longer durations, generally between one and 15 years. Term loans also require the borrower to make regular interest payments, typically every month, quarter, half year, or year, before the principal is repaid in full. Like term loans, demand loans require the borrower to pay regular interest, in advance of repaying the full principal of the loan. Unlike term and time loans, however, demand loans have no set duration and therefore have no maturity date. In other words a demand loan is a loan for which a lender may demand repayment at any time.

In some cases a financial institution will offer credit to a consumer or a business, enabling them to borrow sums of money at their discretion. A credit card, or electronic payment card, is a plastic card that enables customers to purchase goods or receive cash by borrowing money from the financial institution from which they received the card. A credit card has a line of credit, or credit limit, given as a set dollar amount that the customer is entitled to borrow. Consumers repay credit cards, with interest, on a monthly basis. In some cases a bank will offer a consumer or business a line of credit without issuing a card; this is known simply as a line of credit. Lines of credit are also subject to interest rates. One typical example of a line of credit is the home equity line of credit, which allows a home owner to borrow funds against the value of his or her house. In some cases involving the purchase of goods and services, a seller might extend credit to a buyer without charging the buyer interest. For example, a store might allow a customer to acquire goods without paying for them right away; the store then issues a bill, typically at the end of the month, itemizing the amount owed, which the customer is obligated to pay within an agreed-upon amount of time.

Recent Trends

The 1990s witnessed a precipitous and dramatic increase in the number of loans being offered to borrowers with poor credit ratings. These loans typically offer relatively small lines of credit, usually have high interest rates, and often include additional fees, because of the higher likelihood of default on the part of the borrower. Because the interest rates on these loans were often significantly higher than the prime rate (the lowest or most favorable interest rate available), they became known as subprime loans. In the early twenty-first century subprime loans began to play a significant role in the home mortgage industry. Between 1996 and 2004 subprime mortgages accounted for only 9 percent of all mortgages in the United States; by 2006 this ratio had risen to 21 percent and accounted for $600 billion in home loans. The situation reached a breaking point in 2006, when a large number of subprime borrowers suddenly defaulted on loans, forcing several of the nation’s leading sublenders to declare bankruptcy. As a result of this trend most reputable financial institutions began imposing tighter restrictions on loans to subprime borrowers.

loan / lōn/ • n. a thing that is borrowed, esp. a sum of money that is expected to be paid back with interest: borrowers can take out a loan for $84,000. ∎  an act of lending something to someone: she offered to buy him dinner in return for the loan of the car. ∎ short for loanword.• v. [tr.] (often be loaned) borrow (a sum of money or item of property): the word processor was loaned to us by the theater| he knew Rob would not loan him money. PHRASES: on loan (of a thing) being borrowed: the painting is at present on loan to the gallery. ∎  (of a worker or sports player) released to another organization or team, typically for an agreed fixed period.DERIVATIVES: loan·a·ble adj.loan·ee / ˌlōˈnē/ n.loan·er n.