the lender wants. There is this difference in the quality of a promise to pay and a steam engine. The quality of the engine may be and should be independent of the standing of the seller. The quality of a promise to pay depends on the integrity and ability of the promisor. The lender must be confident of the capacity and willingness of the borrower to pay. 82. The character of loan desired. What sort of a loan is made depends on the use to which the funds are to be put, whether they are for permanent or temporary use, the sort of security that can be offered, the time in which the loan is to be repaid, the method of repayment, what sort of a loan is cheaper, and the condition of the money market. Often when it is desired to sell longtime bonds, interest rates are high and money is tight. It may pay to market short-term notes. Later when the bonds are sold at a lower rate the notes are paid. 83. The real cost of a loan. -The nominal interest rate and the real cost of the loan are different. Sometimes bonuses, discounts, commissions, or expenses have to be paid. These may be trifling or large. The AngloFrench loan of 1915 was made from bankers of the United States at 4% discount. The Federal Reserve Bank of Minneapolis reported in 1915 that while the commodity rate to the farmer on a wheat note was 6%, he had to have a warehouse receipt as security, and in some cases the elevator charges were so high as to make the rate plus the charges amount to 17% to 21%,1 a prohibitive cost. The farmer's alternative was to store the wheat himself, in which case the lender had to be willing to accept a chattel mortgage, a land mortgage, or the farmer's general credit. 84. Profits from borrowing. -The opportunities for profit of the wise enterpriser exceed the funds which he 1 Annual Report of the Federal Reserve Board, 1915, p. 325. PROFITS FROM BORROWING 109 has in hand. A loan permits the use of goods at once without waiting, in order that they may be used to produce the means of paying for themselves and more. If money is worth 10% to a business man who can obtain credit at 6%, he can borrow at 6% for ninety days, make his trade, repay the loan and have a profit of 4%. If a purchase will yield 10% and a loan can be had at 6%, Gray can borrow, repay the loan from profits, and in twenty years have the property as his own. A contractor who has to put up a certified check as an evidence of good faith can borrow for this purpose at an exceedingly low rate, since the bank remains in possession of the funds. It does not pay to keep capital for use during only a part of the year. A year's income from a permanent investment will more than pay the interest, even at a higher rate, on a loan for three months. The chance of profit, or of buying what exactly suits, will not tarry while funds are being slowly accumulated. Carnegie Bros. & Co., Ltd. could buy the Homestead Steel Works on their credit. They gave their notes, worked the plant to its capacity, and repaid the loan from profits at the end of the first year. Irrigation, levee, and drainage works are built now and paid for gradually. Coal, metal, and timber bonds permit immediate operation, or enable the properties to be held against a time of scarcity, or enhancement, often 400% or 500%, in value. It is only by borrowing that many a concern gets control of enough raw material for future use to safeguard its present investment. A loan may furnish the impulse to save. The tenant farmer by a loan over a long period of years can save a farm which he would never be able to buy with cash. Many a family has thus procured a home. There should be a margin in the saving from rent above the annual outlay for interest, taxes, repairs, and depreciation. A business loan should not be made except for a pro ductive purpose. 85. Failures.-A loan may produce failure. When disaster wrecks a hope, or man has misjudged an opportunity, or his ability to reproduce his borrowings, he loses. Unless his resources are sufficient to absorb the loss, he cannot meet his obligations and becomes bankrupt. A loan properly adjusted as to maturity may prevent failure. Ready money to make improvements may be all that is needed to keep a business in the running, and any plant is useless without ample working capital. 86. Loans for permanent investment. -If funds are needed to buy property which remains a fixed asset of the business, and is not in the ordinary course of business to be resold at a profit, they are said to be for permanent investment. There are often needs for more land, building, or equipment, in order to expand a business, or develop a farm, and secure greater profits. How long will it take the business with these improvements to yield sufficient to pay the principal and interest? The date of maturity of a loan should be fixed at a time when funds will be at hand for payment. Will it require twenty years? Then sell twenty-year bonds. If the time will be five years, or six months, notes for that term may be given. According to the income of the borrower, loans for permanent investment may be made for a long or a short term. The removal of one's appendix is desired to be permanent; the need for a loan to pay for it is temporary. When a professional man purchases a home for $10,000 and pays $2,000 down, the maturity of his notes for the balance are made to correspond to his probable savings. If he can save $2,000 a year, he can pay the amount with interest in five years. If he can save only $1,000 a year, he will require about ten years. Suppose a loan of $10,000 to be repaid in ten years. The giving of serial notes of LOANS FOR PERMANENT INVESTMENT 111 $1,000 each and interest for from one up to ten years is one method. Another is to calculate the principal and interest so that equal annual payments for ten years may be made. These are known as amortization payments, a method largely used in farm loans. A less satisfactory method is to let the entire amount run for ten years, the ANNUAL PAYMENTS FOR A LOAN OF $1000 TO BE PAID OFF interest to be paid quarterly, semi-annually, or annually. The borrower must then set aside such amounts regularly that he may have enough funds at maturity to settle the debt. The duration of a loan should never exceed the productivity of the property for the purchase of which it was borrowed. It should be repaid during the life of the loan, or a fund accumulated for payment at maturity. There seems to be an exception to this expectation of repayment in the case of certain borrowing corporations and governmental bodies. A corporation needs funds and sells its bonds for $100,000,000. Does it ever expect to retire all its bonds? Probably not. Why did it not issue stock instead of bonds, since stock never gets its share of the property until the business is liquidated? For three 2 D. E. Truesdell, Amortization Methods for Farm Mortgage Loans, U. S. Department of Agriculture, Circular 60. reasons: (1) A bondholder is a creditor of the corporation. He must be paid his interest before the stockholder gets a dividend. He must be paid his principal before the stockholder can claim any part of the property upon its liquidation. This guarantee of principal and interest attracts many investors to whom a stock issue would not appeal. (2) On account of the safety of a well-secured bond (usually secured by a mortgage), the bondholder is satisfied with a low guaranteed rate of interest, and all additional profit accrues to the stockholder. (3) A sale of stock would add to the burden of those who wish to retain control of the business. They might have to buy a majority of it. The most of our railroads never expect to be free from bonded debt. Most of the bondholders want only the income and when their present bonds mature will gladly accept new bonds in payment. However, any bondholder who wants his money at maturity can get it. Similarly, some governments sell new bonds to retire old issues and never expect to be free from debt. He 87. Loans for buying, producing, and selling.Credit is most often needed for temporary investment, for seasonal use. A farmer may need funds to help produce a crop which will be marketed in six months. can borrow and pay back when he sells. Supply houses formerly sold quantities of merchandise and accepted notes in payment, but buyers soon learned that by paying cash they could get such large discounts, they could make a profit by borrowing from a bank. The local bank knows the borrower and can weigh the risk. The poorer risks are eliminated and the money is loaned for a lower rate than the seller could afford to lend his goods. A retailer buys goods on credit which he can sell in sixty days. He is offered 2% to 5% discount for cash in ten days, or by the tenth of the month. It yields a big profit to borrow the money on a sixty-day note and take the |