Terms of Interest

Anyone who has spent some time researching Catholic social teaching has probably come across fierce debates on the issue of interest. The Bible condemns the taking of interest on a loan as the sin of usury and states that it is a form of bondage. However, the discussion is not that simple. Is all interest usury? If so, what of the demands of justice that he who gives out his money in a loan have some sort of compensation for the risk he assumes? If not all interest is usury, at what point does it become usurious? Are there any circumstances that mitigate culpability? Is there nuance in how interest is assessed? Do the Bible and the popes who follow in the biblical tradition have the same thing in mind when they condemn "interest" as the modern practices associated with the taking of interest? Has the Church's teaching on this point remained constant, or has it developed over history? There are many things to consider.

Two General Approaches

Personally, it has always been a disappointment that Catholics concerned about this topic have generally failed to move beyond certain theoretical debates to addressing some of the concrete abuses relating to interest in our contemporary economy.

Suppose there are two Catholics who take different sides on the question. The first says that all interest is usurious and sinful intrinsically. The second admits that interest can be usurious, but it is not so intrinsically, and opines that a lender is due some modest compensation for assuming the risk of putting his money out in a loan, sometimes depending on the type of loan, sometimes not. The argument that unfolds across a thousand Catholic websites and forums often centers on one of these two positions.

Rather than focus on the difference in these positions, let us admit their similarity: both positions agree that interest can become usurious and sinful. The former asserts it becomes so merely by its existence, the latter that it does under certain circumstances. The former believes interest becomes sinful merely by being exacted, the latter when it is of a certain type of goes beyond a mere "modest compensation" and becomes disproportionate.

Given this agreement, there seems to be room for these two positions to come together to uniformly address a particular facet of the problem. We refer to the problem, not necessarily of interest itself, but rather to how interest is assessed in the modern credit economy - the term of interest.

Too often the discussion of interest focuses on whether interest is intrinsically unjust or not. Not enough is devoted to examining the particular ways interest is exacted and calculated. It may seem counter-intuitive to dwell on the particulars when there is often not a consensus on the general question. But upon closer examination, we see the particulars are fairly important. For the man who believes interest only becomes usurious when it is disproportionate or beyond a modest compensation, the questions of how it is calculated and exacted make all the difference. They have a very strong bearing on resolving the general question.

Annual Percentage Rate

In almost every modern loan arrangement, interest is calculated on something called the Annual Percentage Rate, better known as the APR. Calculating interest on an APR means that the entire balance of interest on the loan is due every single year, and is paid every year until the loan is paid off. So, suppose a ten year loan of $50,000 is taken out with an APR of 8%. At 8%, the interest on the $50,000 loan is $4,000. But this amount is not payable over the life of the loan, but rather must be paid entirely in the first year. Then the entire 8% must be paid all over again in the second year based on the new balance, and so on until the loan is paid off. On a ten year loan with a fixed APR of 8%, the borrower will have paid $22,796.55 in interest on that $50,000 loan over its ten year life., because that 8% is due on the principal every single year.

This the reality many young people and first time borrowers do not understand APR terms. While the loan is advertised as being 8%, the actual interest levied on that $50,000 loan will be $22,796.55, which is 46% of the principal. In a certain sense, an 8% interest rate which is calculated and recalculated every single year becomes 46% after ten years. And this is at a rate of only 8%; we can see how with loans of 10%, 15%, or 20%, a borrower will often pay more in interest than principal over the entire life of the loan. This is why longtime homeowners often complain that they have paid double the cost of their home in interest.

Even if there were a moral argument to be made that a lender is due some compensation for the risk he incurs in loaning out his money, there is no necessary reason why the entirety of this compensation must be levied year after year. Furthermore, we must ask, even if "some" compensation is fitting, is it fitting that this compensation be equal or sometimes greater than the principal? Is $300,000 in interest over the lifetime of a $200,000 loan a just or reasonable compensation?

Some may ask, "What other alternatives are there?" As many as you can imagine. Suppose we want the rate to be calculated every two years or five years instead of every one. Support it is not calculated on any yearly rate, but is a fixed amount based on the principal - suppose 10% interest on a $100,000 loan is $10,000, and that $10,000 payable once; in other words, the interest due is not recalculated every single year based on the amount of outstanding principal. There are various other scenarios at which interest could be calculated other an APR. It is not the point of this essay to explore the various benefits and consequences of other scenarios, but merely to note that there is no necessary reason interest has to be calculated as an APR.

In short, even if we grant that interest itself might not always be intrinsically immoral, it would be very hard to justify calculating it as an Annual Percentage Rate, which is what makes it so oppressive. This position could be agreed to by both those who think all interest is evil, as well as those who take a more moderate approach. It is something we all could agree on.