What is a “Heter iska”?

In the context of Jewish law, traditional interest-bearing loans can be problematic. Halacha, the collective body of Jewish laws, stringently forbids interest-bearing loans referred to as Ribbis, unless at least one party involved—the lender or the borrower—is not Jewish.

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This restriction poses a considerable obstacle for observant Jewish individuals. Without loans, commerce can't function, and without interest, lenders can't operate. So, what do you do? This is where the heter iska comes into play.

At its core, a Heter Iska alters the traditional roles of borrower and lender into those of investor and manager. In this new relationship, the lender becomes the investor, while the borrower takes on the role of a manager. This change allows for earnings in a way that is entirely permissible under Jewish law.

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The Standard Heter Iska Explained

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Heter Iska, translated as "business permit," is a centuries-old practice that redefines loans as investments. Since they're not considered "loans," one can "earn profit" by agreeing on a percentage of eventual profits from the "investment." In a Heter Iska arrangement, I don't "loan" you, for example, $100,000—I invest $100,000 in your properties or business. Similarly, when repaying, instead of receiving interest, I receive a return on my investment.

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Loan vs. Investment - The Risk of a Heter Iska

A key difference between a loan and an investment lies in the risk involved. Loans are generally considered safer because the borrower must repay the principal amount plus a fixed interest rate, regardless of their business performance. In contrast, investment earnings depend on the success of the venture, and there's a chance of losing the principal amount altogether.

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So, how can you make a Heter Iska mortgage function more like a secure loan? And how can a steady return, similar to that of loan interest, be guaranteed regardless of the investment's performance?  This is where the requirement for witnesses and a severe solemn oath becomes crucial.

 

Strengthening Repayment Guarantees in Heter Iska

A Heter Iska agreement places some of the most stringent demands, as per Jewish law, on the borrower (manager), with the aim of guaranteeing the repayment of the principal amount plus the anticipated profit.

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The agreement requires the borrower to produce two qualified expert witnesses who adhere to the rigorous criteria of Jewish law. These witnesses must confirm the borrower’s claim of loss across all their properties, businesses, or assets before any claim against the principal amount can be made. Furthermore, a severe solemn oath is required if the borrower intends to pay less than the expected interest amount. Unless these stringent conditions are met, the principal plus interest/return on investment must be returned as anticipated.

 

The implementation of these demanding conditions, which are practically improbable to meet and statistically highly unlikely (with no record of a Beth Din administering a severe solemn oath in contemporary modern history), yet still "technically" possible, ensures that the lender-investor receives the full amount anticipated. Meanwhile, the underlying transaction remains considered an investment, thereby making it kosher.

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There are several ways to structure a Heter Iska, and indeed, different situations may call for different types of Heter Iska.