What is usury? The term comes from the Latin usuria, and the original definition was simple the charging of interest, which by many religious traditions was considered immoral. Fortunately religions evolve, and most allow for a reasonable interest rate to be charged for the use of money. If not, imagine how few people would own their homes. How long would it take you to save the cash to pay for the average $180,000 house in The United States? For that matter, how would you be able to start some businesses if there were no lending allowed? (Not impossible, but all other systems are less efficient to say the least.)
The word eventually came to mean either the charging of interest beyond the legal interest rate allowed, or just the charging of unreasonably high rates of interest. What is unreasonable is something determined by each of us as well as established in general by the feelings of people in a given culture. What is reasonable or unreasonable changes with times and circumstances, of course.
Usury – A New Moral Definition
The basic concept is a moral one, regardless of where the particular limits of reasonableness come from. The idea is that it is wrong to charge too much interest because it unfairly takes advantage of the borrower. Now, to the extent that a lender does unfairly take advantage of a borrower, I have to agree that it is wrong. On the other hand, this is certainly not determined by interest rate alone. With that in mind, here is my own working definition of usury:
To loan of money for interest when the lender knows or can reasonably be expected to know that the loan will do more harm than good.
That allows a lot of “wiggle room” for those who wish to rationalize away many destructive loans. Close your eyes and ears, for example, and you don’t have to know that a given loan will fund a gambling addiction. There is no avoiding this, though. Those who wish to make money while helping others to harm themselves will do so under any system, and usury laws generally make the matter worse because laws by their nature cannot consider context or make case-by-case judgments. Let’s look at a couple examples.
I once loaned a friend $200 and charged him a total of $25 for the five weeks it took him to repay. That’s an annual interest rate of 130%, far above the rate allowed by law, I imagine (I didn’t check). Another time I loaned a different friend $300 and collected $350 from him a year later, which amounts to almost 17% annually. The first was an honest loan in my mind, while the second was usurious (we’re all subject to making poor judments).
In the case of the first loan my friend was ready to get back to work after a time of unemployment, but he needed a special piece of equipment or he couldn’t take the job that was offered. Nobody else would loan him the $200 he needed, nor do banks or traditional lenders even make such small loans, especially to unemployed people. I loaned the money, he got a good job, and repaid the loan quickly (it was agreed that he would pay $5 interest weekly). It is difficult to imagine any way in which my loan hurt him, and it seems clear that it was exactly what he needed at that moment in life.
On the other hand, when I made the other loan for $300, I knew that friend was not only in financial trouble because he was irresponsible with his money, but it was also clear that he hadn’t yet changed his ways. I can honestly say that if I gave it ten second’s thought it was clear my loan would only compound the problem. In fact, it was quickly wasted like the rest of any money that went through his hands, some of it on gambling. No surprise.
I was just looking at the $60 in interest I expected to make in a month (it wasn’t supposed to be a year). The way I see it now, whether it was the 240% annual return I expected or even if I had made the loan at a 4% rate, it would have been usurious in either case. Why? Because I was profiting off of a loan that I clearly could see was more harmful than helpful.
As these two real cases suggest, it isn’t the interest rate that makes a loan usurious. Usury should be seen in context and strictly by the moral definition as it applies to each case. In other words, whether or not there are laws about this, each of us should consider our own actions both in lending money directly or even in supporting lenders who practice what we consider to be usury.
Determining Usury in Practice
I really only care about usury as an individual moral issue. I think the law is too blunt an instrument to be used in this area. It would have prevented my friend from getting that job, for example (at least if I obeyed the law), while perhaps allowing for the other friend to be more self-destructive. But whether there are laws or not, we still may have personal judgments to make about loans and lending, so how do we do it? My own thinking on the subject follows.
It seems to me that we cannot always know about the particulars of how a person will use money. A borrower may lie, but that’s not the only reason. As a practical matter a person or business that lends money regularly won’t have the resources to ask all the right questions and verify the answers. So, for example, it isn’t necessarily wrong for a pawn shop to make high rates of interest without knowing the purposes the money lent is put to. On the other hand, I would consider it usury if the owner of the shop knew the money was going to a gambling or drug habit. To me the moral choice in that situation is to refuse to make the loan.
In fact, a pawn shop presents a good example of a service that can easily do good orcause harm. This was the only other likely alternative for my friend who needed the $200 to get a good job. These businesses loan to people who have few if any other options, and sometimes those loans make a real difference in a person’s quality of life. Furthermore, the financial harm they can do is very limited, since they can’t really put the borrower into more debt. The “debt” they incur is covered by the collateral they leave, and losing ones favorite stereo, gold ring or gun does not have the potential negative consequences of taking on more real (unsecured) debt.
On the other hand, as much as I always liked the general business concept of a pawn shop, I also would feel a bit uneasy about ever owning one. It seems – from my experience with friends who use these places – that most of the loans made just fuel bad habits and make problems worse. And were there a way to easily screen for loans that actually helped the borrower, I suspect that the business would be far less profitable. Although there is nothing wrong with the concept, in practice it seems that pawn shops fall into a gray area in terms of usury. (A clear case of usury would be opening a pawn shop next to a casino to profit from people’s gambling addiction.)
A clear example of usury in my mind is credit card companies that target borrowers who are irresponsible with their money, as evidenced by their credit reports. In fact, I know of a friend who just had his rate increased to 48% annually. It was due to a changed due date – a tactic some companies may be purposefully using to trick people into paying late so rates can be raised. Encouraging people to go into debt for consumer items when they have already shown themselves unable to handle money responsibly, and then tricking them in order to raise rates – that’s usury.
Again I have to point out that high interest rates alone are not the issue. For example, in the world of real estate investing there are people and businesses called “hard money lenders” who some would call usurious, but when you take a closer look you see the real good that is done. An investor cannot get a fast loan from a bank to both buy and fix up a house, so he goes to a hard money lender. Let’s look at a quick example.
The house costs $62,000, and the investor will also need about $18,000 for repairs, closing costs and the expenses of selling. He expects to sell the home for $110,000 when finished. He has only a few thousand dollars of his own money to invest. He would want to check with Summit Point Roofing to see what project would give him the biggest return on investment with what money he has to work with. The hard money lender looks at the numbers and lends 70% of the ARV (after repair value) of $110,000, or $77,000. These are risky loans, so he charges accordingly, taking adding a $5,000 fee to the loan amount and charging 18% annual interest.
The home is repaired and remodeled – notice that there is real value added – and sold to a nice family for $107,000 about two months after purchase. The investor makes a net profit of $19,500 after paying all costs, including a total of about $7,500 to the lender. Now, the lender, who risked $77,000 to make $7,500 in two months, got an effective annual return of 58%. Is that usury? Not by my definition. Notice that the lender, the investor and the new home owners all benefit.
Of course there are gray areas in determining when a loan is for good an when it does harm. Is it harmful to loan money to a couple to go on vacation when they already have a fair amount of debt? Tough call – maybe they need the vacation to reenergize themselves and their business. The law certainly can’t make such fine distinctions, but you and I can make decisions that take into account everything we know about the case. With or without legislation, usury is a moral law in my mind, and the moral definition is the one that matters most.