2 When the amount of the loan is expressed as more than the borrower receives, the deduction being either in lieu of, or in addition to, an expressed percentage, the deduction, called discount, is interest taken in advance, and therefore is not exactly equivalent in rate to the same payment at the end of year, the time at which the usual rate is calculated; e.g., if a note for $1000 is discounted at 6 per cent the true principal is $940, and the true interest $60 at the rate of .06383. See ch. 23, sec. 3, note.
Gross interest must be distinguished from net interest. The lender does not, as in most cases of rent, have to make allow ance for repairs and for physical depreciation of the objects loaned, for the borrower is bound to return the specific stand ard of payment ; but allowance must be made first for risk, or the chance that the money will not be all returned or paid promptly. Risk and trouble are to interest what de preciation and repairs are \to rent. (Chapter 15, section 2.) Money loaned in hazardous ventures must yield a higher con tractual rate of interest to offset this, or the true rate realized will, on the average, be less than the market rate. The lender may in the end get either more or less than the usual interest, or even get negative interest through the loss of a whole or a part of his capital. A lender strives in making a number of loans to have the gains cancel the losses, so that the capital may be kept intact, besides yielding a net income (interest).
The lender mulct also count the cost of placing, supervis ing, and collectini?the loan. A pawnbroker lends only small sums and spends much time and effort to keep at interest a moderate capital. The sum of $5000 loaned for a year in sums averaging $10 represents 500 transactions, yet if placed at 5 per cent it yields an income of but $250 a year.' While, therefore, the borrower of a small sum may think he is paying an oppressively high rate of interest, the lender may find that the loan nets him a very small rate of income on the invest ment. Risk, labor, and the various costs of carrying on the business of lending money, are thus costs in exchanging things of different time-periods which are analogous to transporta tion charges in exchanging things at different places, nar 3 The Provident Loan Association of New York is a corporation or ganized as a philanthropy to release the poor borrower from the jaws of the "loan-shark"; but it is conducted on business principles to pay expenses. It finds that the minimum cost of making a loan, even the
smallest, is about 49 cents. Yet it makes a large number of loans of amounts less than $10, and for not over a month at the rate of 1 per cent per month (or 10 cents at the maximum). This loss must be made up by the larger loans.
rowing the margin of advantage and excluding many from the exchange.
§ 4. Concealed rate of interest. Interest is often con cealed under forms which make the real rate greater than the nominal, or apparent, rate. It is well known that usury laws fixing the legal rate of interest are often evaded. A simple method is for the lender to charge a commission for making the loan, or, if the lender is a bank, to charge for a pretended cost of exchange to bring the money from some other city. Sometimes the borrower is required to keep larger deposits with the bank than he voluntarily would, which he does by borrowing and paying interest on a larger sum that he is per mitted to use. Again the borrower, in periods of unusual demands for money, may be forced to make a long loan instead of a short one. When a one month's loan at 10 per cent would meet his need, he may be forced to borrow for twelve months at 6 per cent, during ten months of which time 4 or 5 per cent is the prevailing rate. In these and other ways the real amount and the real rate of interest are made different from those that are expressed.
/§ 5. Commercial paper. Interest-bearing loans may be roughly divided into short-time and long-time loans, accord ing as they run for less than a year or for a year or more. In short-time loans the creditor's claim may rest either on a verbal agreement or on a written promissory note. Short term interest contracts are implied in a large proportion of the transactions of modern commerce. A considerable num ber of short-time loans are made for direct enjoyable use to individuals whose money income is delayed or inconveniently apportioned in time. But a far larger number of such loans are made by banks on promissory notes given by manufac turers and merchants, frequently secured by bills of lading for goods that have been shipped to customers or by various other evidences of existing credits. Such documents are called commercial paper, or credit instruments.