Our current mortgage system provides an excellent example of why usury used to be illegal. Many people today believe that usury is just another word for interest, but that is not strictly correct. George O'Brien gives a more thorough explanation of usury in "An Essay on Medieval Economic Teaching," but one aspect of usury is the attempt to conduct a transaction without any risk, or where the risk is only one-sided. One of the fundamental differences between Capitalism and Distributism is the attitude toward usury.
In the current system, based on solidly capitalist principles, you come to me for a loan to purchase a house. I loan you the money (which the banking rules allow even if I don’t really have the money to loan) and the transaction is done. You get legal title to the property, but I have a lien against it. You pay your monthly mortgage bill which, during the first half of the thirty year arrangement, is almost all interest. The interest is money I am charging you for the time it is taking you to repay the money I loaned you. Not only that, but the terms of the agreement establish that, the balance of the principle due is not necessarily the amount needed to pay off your loan. You may have to pay me “early payment” penalties so to offset my "loss" of interest payments. If you fail to pay according to the terms defined in the contract, I can kick you out of your house and you would get nothing in return. I get to keep all of the interest payments, all of money you’ve paid against the principal, and I get the property. This can occur at any point of the term of our contract.
The only way you can avoid this is to pay on schedule, or, if you are not able to do this, sell the house and pay me from the money of the sale. However, you still owe me the balance of the original loan. If you sell for less than you owe, you would still be in debt to me. You are the only one who runs any risk if the value of the property declines. I have entered the agreement with absolutely no risk. Even if you default, the fact that the current system permits me to loan you money I don’t actually have means that I gain title to real property for nothing. Therefore, it doesn’t really matter if the value of the property has decreased; any value greater than zero is pure profit for me along with all of the payments you have made. A better description of this arrangement is that I am purchasing the house at one price and immediately selling it back to you at a much higher price, because I am charging you for the time it takes to repay. I am taking no risk, but you are.
Distributism would make the arrangement quite different.
You come to me for a loan to purchase a house. There are various ways to accomplish this that would be compatible with Distributism. Because of the amount involved, I think the most reasonable way to accomplish this is to go into a contractual partnership regarding the property, but I will use the term “loan” throughout because of its familiarity. The terms I have devised for this partnership are as follows.
1: You and I are joint owners of the property with all of the rights that pertain to ownership.
2: At any time that you are able to pay the balance of the loan, you can do so, bringing our contract to an end and transferring exclusive title to the property to you. If the planned term of our arrangement was fifteen years, you would be required to pay one fifteenth of the loan per year. There would be no requirement for monthly minimum payments beyond the payment for exclusive use. Throughout the year, you are free to pay whatever you can afford against the principle, provided that you pay at least one fifteenth of the loan per year. If the purchase price was $200,000 and you paid $5,000, my loan to you was $195,000, making your yearly payment obligation $13,000. If you were to pay in equal monthly payments, it would be about $1,083 per month. If you pay more than the fifteenth in a year, the amount is applied toward what would be due in future years.
3: Because my ownership of the property gives me rights to use it, but the purpose of the contract is your eventual exclusive ownership of the property, the contract has a provision whereby you pay me for exclusive use of the property on a monthly basis. This includes all rights, like mineral rights, to the land. This arrangement prevents me from interfering with your use of the property, but compensates me for not being able to make use of property in which I have a share of ownership. The amount you would need to pay for this exclusive use would be determined by the purchase price of the property and the percentage of ownership. You would pay me my percentage of one half of one percent of the original purchase price in order to gain exclusive rights to the property for a month. If the purchase price was $200,000 and you paid $5,000 on the initial purchase, you would own 2.5% and I own 97.5% of the property. One half of one percent of the purchase price is $1,000, so you would pay me $975 for exclusive use of the property for the first month. As my percentage of ownership decreases, so does the amount you have to pay for exclusive use.
4: There are no interest charges except as follows. In the event that you have not paid the required fifteenth by the end of a given year, you will pay a monthly interest of 0.5% of the remaining balance of that fifteenth until you have done so. This is not usury because the basic terms of the loan are interest free. I have initially made you the loan at no interest. In doing do, I have forgone the opportunity to use that money for other potentially profitable purposes according to the payment schedule. The agreement is that I will get back one fifteenth of the loan ($13,000) per year. If you fail to pay me that amount, I am unjustly deprived of the use of that money and can charge you interest to counter that loss until it is recovered.
Let’s say that at the end of a given year, you have not paid the full $13,000 due for that year. You will owe 0.5% per month (6% per year) interest on the balance of that $13,000 until it is paid. If the entire $13,000 were past due, the monthly interest charge would be $65. The interest payment will be calculated each month based on the amount past due until you have finished paying it. As with today's interest loans, payments will be applied to the interest due first. However, the interest due is treated as completely separate from the balance due for the loan. The load itself is interest free, so there can be no compounding of the interest with the principal.
5: Your spouse is automatically a participant of this contract, and the two of you can pass it on to one of your children. The same terms would apply and your child could, in turn, pass it on to one of his children.
6: If you stop making payments for a period of time to be determined by the contract, I have the following options:
6a: I can forgive part or all of the money due for either the repayment of the loan or the payments for exclusive use. If I only forgive a portion of the loan due, the remaining terms of the contract remain the same. Forgiving a portion of the loan means transferring you that portion of ownership without payment. Forgiving the balance of the loan grants you full ownership of the property without any further payment.
6b: I can choose to grant you more time, provided that there is no additional charge beyond the terms laid out above for doing so. This would effectively be the same as forgiving you for any interest due for not paying the fifteenth of the loan by the end of the year.
6c: I can buy back your percentage of the property. This means paying you your current percentage of ownership against the original purchase price. If your current percentage of ownership it 50%, then I have to pay you $100,000 in order to buy you out.
6d: We can sell the property. The money from the sale of the property is divided according to our percentage of ownership.
As you can see, there is no option where you walk away empty handed; or worse, still in debt. The only risk, if the property sells for less than the original purchase price, is that our return from the sale will be less than we have invested, but we share this loss in proportion to our percentage of ownership.
Is this really a better arrangement for you? Compare our example, a $200,000 loan with $5,000 down payment for a term of 15 years against the results of any standard mortgage calculator. Since the loan I describe has no interest, compare the exclusive use payments against the interest payments of the standard loan.
Under the Distributist agreement I have outlined, you would need to pay $1,083 per month to pay back the $195,000 I invested over 15 years. The first month after the purchase, you would pay me $1,083 principal plus $969.58 for exclusive use. The following month, you pay $1,083 plus $964.17 for exclusive use. At the end of five years (sixty months), your payment is $1,083 plus $650.00 for exclusive use.
In my proposed Distributist arrangement, assuming that all payments were made on time, you will have paid $200,000 for the property and $88,237.50 for exclusive use. Your total payment for the full term is less than 150% of the original loan. Of course, if you paid the loan off early, your overall cost would be even less. How does that compare to the standard mortgage?
Let’s take a look at what happens if, after five years, you lose your job and cannot continue the contract. Your percentage of ownership is 35%, which is $70,000. If I chose to end our agreement and sell the property, the amount received from the sale is divided according to our percentage of ownership. If it sold for $200,000, you would get $70,000. If I can only sell the property for $100,000. You would get $35,000. The amount of loss (or gain) from the sale is proportionate to our percentage of ownership. The terms of the contract involves a proportionate risk of loss for both of us, but we both walk away with cash in hand.
There is a fundamental fairness in this setup that is certainly appealing, and a refreshing change from our current system. There are factors to be considered however:
ReplyDeleteWhat if the borrower wants to enter the contract over a longer period of time and the contractual partner is willing. Is there any prohibition of that and does it alter the terms in any way?
Shouldn't the contractual partner have legitimate claim to some form of payment for their time and inconvenience if the borrower does not act in good faith (i.e. a non-refundable security deposit, say 1% of the loan for arguments sake).? After all their goal was not ownership, and if they are saddled with the responsibility and time consumption of having to sell a property. As per the basic premise here however, it should not entitle them to everything.
The length of the contract could certainly be adjusted. The point of my example was to illustrate that, under the terms I described, you could make the same purchase, for less money per month, and end up fully owning your property sooner, than under our current usurious system.
ReplyDeleteThe fundamental principal of distributism is to establish a just system of economic exchange. Therefore, if one of the partners acts in bad faith, a claim could certainly be made against such an unjust act.
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ReplyDeleteRegarding potential critics of this proposal and the exclusive use payment, couldn't this be theoretically viewed as a lesser form of usury or a cheap way to get around the ban? I'm trying to rationalize it in a way that doesn't sound like the typical rationalizations for interest.
ReplyDeleteSzent István király,
ReplyDeleteThe exclusive use payment is more akin to rent than to interest. However, my idea is that, because the buyer is actually a partner in a joint ownership, the agreement specifies that it is not considered as rent for legal purposes.
The reason I maintain the claim that it is not interest is that the amount charged is not based on the amount of money "owed" but on the percentage of ownership applied to the original purchase price. If you compare this charge with the actual cases where interest may be legitimately charged against past due payments, I think you should be able to make the argument successfully.
Some may consider the difference to be too subtle to be of any real difference, but it is a significant difference as applied to the overall financial arrangement when compared to how usurious interest is typically applied. Here is another article on usury that might help.
One of the problems with eliminating interest is it ignores the time value of money. If I were to loan $100,000 with the expectation of getting paid back over 30 years I would actually have less money 30 years from now. Then look at the alternatives the lender has, they could invest that money and at an 8% interest rate compounded annually. Leaving it there for 30 years would give them a million dollars.
ReplyDeleteThe solutions that you come up with are just rephrasing and in reality the same thing is happening. I think the real solution is educating people on the reality of debt and how to use it, when to use it, and the advantages of not being in debt. Not making lending money so unattractive that you can't buy the house, because no one would sign up for those terms.
I completely disagree with the theory of the "time value" of money. Money is a medium of exchange. The only reason you claim that you would have less money 30 years from now is that you accept that inflation is a natural aspect of the economy and of money itself. We do not. Inflation is an injustice, and our money, in the present economy, only decreases in value over time because it is created through the creation of debt - meaning that new debt increases the so-called money supply, thereby inflating the currency (even if it only exists electronically) and simultaneously reducing its value.
ReplyDeleteThe solution I presented in this article is not at all "rephrasing" interest bearing debt. It is not interest on a debt of money. It is an exchange of money for use of a property owned based on the percentage of ownership. It is not based on the remaining debt. The real solution is to educate people on the inherent injustice of interest on money loaned so that other options, which would be more attractive because it is a more just solution to the problem of when debt is needed for specific things.
Other than that, I agree that people need to be educated on the advantages of not being in debt and to take much more care about what things are, and are not, worth being in debt to have.
"You pay your monthly mortgage bill which, during the first half of the thirty year arrangement, is almost all interest."
ReplyDeleteThough you write this in condemnation of the current system, I think that this can be justified. It is simply a mathematical artifact of whether you favor:
1. Constant payments on equity with decreasing rent (as you do in your scheme)
2. Constant total payments (which the current system does)
Scheme 1 has the problem of being roughly twice as expensive in the beginning as it is at the end. What if someone can't afford this?
Scheme 2 has the problem that you point out--you are not buying equity very fast, but simply paying rent.
However, I totally agree that “early payment” penalties and deficiency judgments are always intrinsically evil, as they are usury.
Garrett,
DeleteSince the buyer is also an owner whose name is on the title of the property, he is not paying rent, as you characterized it. I understand that it has much the same feel, but it fundamentally different. A renter pays rent for the use of property owned entirely by someone else. In the arrangement I suggest, he is a joint owner of the property. If you cannot get past that, then I really don't know what else to say.
The interest on money loaned in the current system is not simply a mathematical artifact of calculating a consistent payment amount over the course of the loan. It is an ongoing charge applied to the use of money that has been loaned - the classic example used to explain what usury is.
https://practicaldistributism.blogspot.com/2014/01/the-errors-of-economists-usury.html
You say that early payment penalties are usury, but the interest in such loans is at best a penalty for borrowing in the first place, or a penalty for paying on the agreed schedule.
David,
DeleteI mean the word "rent" as shorthand for "payment for exclusive use." We are on the exact same page, it's just the semantics of whether "property" refers to the whole house or a specific party's equity in the house.
I agree that usury is the ongoing charge for use of money that has completely transferred ownership. This occurs regularly in credit cards debt, student loans, and payday loans.
But as you distinctly point out, the home lender does not loan money to the borrower to spend on anything (consumer goods) or non-property (education)--really, the "lender" doesn't loan the "borrower" money at all. The bank co-buys a house with the man, and the man progressively buys the bank out.
Aquinas makes this exact same distinction in his discussion of usury in the Summa: https://www.newadvent.org/summa/3078.htm
"He who lends money transfers the ownership of the money to the borrower. Hence the borrower holds the money at his own risk and is bound to pay it all back: wherefore the lender must not exact more. [GGM: don't exact usury]. On the other hand he that entrusts his money to a merchant or craftsman so as to form a kind of society [GGM: a jointly owned business], does not transfer the ownership of his money to them, for it remains his, so that at his risk the merchant speculates with it, or the craftsman uses it for his craft, and consequently he may lawfully demand as something belonging to him, part of the profits derived from his money."
You only have to pay more than the principal in the mortgage so long as the bank co-owns the house. If you buy out the bank at any point, and they demand more, they are demanding a price for use of the house which they no longer own. Aquinas again:
"On like manner he commits an injustice who lends wine or wheat, and asks for double payment, viz. one, the return of the thing in equal measure, the other, the price of the use, which is called usury."
Garrett,
ReplyDeleteYour quote actually proves my point. While it is technically true that the bank doesn't pay the borrower who then pays the current owner, the bank pays the owner on the borrower's behalf. At that point the person who got paid is no longer part of the equation. This is what makes the current mortgage arrangements completely different than what you quoted from Aquinas.
First of all, in Aquinas' example, the lender gives the money to a merchant who speculates with it or a craftsman who uses it to make something. That isn't happening at all here. The bank is affecting a transfer of ownership of property from the person who receives the money to the person on whose behalf the bank is making the payment. This is a completely different situation.
Second, the basis of the justification for claiming more than was loaned is entirely based on the first point. This is exactly the situation I described in my article on usury - the loan is a temporary investment where you get a share of profits until the loan is paid off. There are no profits involved in the mortgage arrangement from which the lender can claim a portion.
Third, Aquinas is clear that the profit that goes to the lender is specifically a portion of the profits ("he may lawfully demand as something belonging to him, part of the profits derived from his money.") not a charge on the money loaned and owed.
This is why the interest charged in the common mortgage is completely different from the justifiable forms of interest described by Aquinas.
In point three, I meant to say "the profit that goes to the lender is specifically a portion of the profits made possible by the loan"
DeleteI know that I am a novice Thomist, so I expect to be corrected in philosophy.
DeleteBut I like to think myself an experienced mathematician, so I did not expect to have so much trouble verifying your claim in the comments:
"under the terms I described, you could make the same purchase, for less money per month, and end up fully owning your property sooner, than under our current usurious system."
Can you please prove this numerically? Every mortgage calculator I find says that the monthly payment would be $1646, which is less than your scheme for the first 75 months, and in either case you end up fully owning your property in 15 years.
Ah, yes. The math. If you are using online mortgage calculators, then they are using the current interest rates, which have been kept artificially low for many years. I wrote the article 12 years ago when that was not the case. I don't remember precisely what they were back then, but I seem to recall numbers in the 12% to 15% range if you had very good credit. Lower rates were only available for ARMs, which typically raised the rates above that after the first few years. I believe this is most likely the cause of that difference. I did the math at the time and even had it double-checked by real-estate agents.
DeleteThis comment has been removed by a blog administrator.
ReplyDeleteGarrett,
DeleteI want to apologize for this. Because your comments have been perfectly fine, I published this last one before reading it. I then read it and saw that you asked for it to not be published. It was only visible for about a minute, but I should have read it first. I will reply to you directly as requested.
No harm done, David. My fault for not putting the request at the top.
DeleteHere are my calculations: https://docs.google.com/spreadsheets/d/1Csa9qMCCpUq28UDaZRWjS14c9SLMHiBeDZyD5sX394s/edit?usp=sharing
ReplyDeleteAnd here is my attempt at furthering the project which you started, redeeming mortgages for distributism:
https://docs.google.com/document/d/1U8os2xKLFRH-Gk6xxIHR5H9iRNVQDrKkBzAbvzxtGYk/edit?usp=sharing