Banking-friendly Heter Iska
The Heter Iska we offer is designed to work in conjunction with the primary loan documents, allowing it to be incorporated quickly and smoothly into any lending institution without extensive changes.
Problem and solution.
Jews are forbidden from borrowing or making interest-bearing loans to each other. However, a Heter Iska agreement can be entered into in conjunction with the primary loan documents (for instance, mortgage loan documentation) to redefine and convert the underlying loan (e.g., the mortgage loan) into a unique investment structure, which will ultimately produce the same economic results as the underlying loan for the lender and the borrower. However, since the transaction has been transformed into an “investment” in the mortgaged property, the lender is transformed into an investor and the borrower into a so-called “investment manager,” thereby allowing the interest to be recharacterized into a return on investment, which is allowed under Jewish law.
How the KFI Heter Iska Works.
The KFI Heter Iska comprises four main elements; the investment, conciliation, conditions and the agent.
Investment: converting a loan into an investment requires an investment structure. Therefore, the first part of the Heter Iska agreement will outline the basic terms of the investment, including the fees and responsibilities of the investment manager.
Note; Considering the investor will most likely follow the conciliation option as outlined in the Heter Iska, the percentage the manager is allowed to retain has no bearing on the outcome.
Conciliation: the conciliation or remedies section aligns the investment terms with the underlying loan documents. To make sure a borrower (investment manager) repays the funds just as he would under the underlying loan, the Heter Iska imposes stringent conditions that are highly unlikely to be followed by any observant Jew, but are still considered “possible” under Jewish law, and insists that unless the receiver follows those conditions, he or she must repay the investment principal and proceeds in accordance to the payment terms and schedule stipulated in the underlying loan agreement.
Conditions: To encourage the borrower to choose the conciliation option and pay the loan as scheduled, the Heter Iska imposes strict conditions that are very unlikely to be met.
The first condition is meant to discourage the borrower from not repaying the principal amount invested by claiming a loss in the investment property (the collateral). The Heter Iska requires that the borrower (manager) proves such a loss by adducing the testimony of two reliable, knowledgeable, and trustworthy witnesses under Jewish law, to testify to the circumstances of the loss. Because Jewish law requirements regarding witnesses are highly exacting, this standard is exceedingly difficult to satisfy. Furthermore, the receiver is given a very short time to prove such a loss at a KFI Affiliated Rabbinical Court.
The Heter Iska also requires that the borrower (manager) prove that he has no other property, business, assets, or valuable goods. The idea of someone losing everything they have, including the collateral, and being unable to repay the principal is implausible. In either case, if this happened, the borrower would likely default on their loan, regardless of whether it was an Iska loan.
To make sure that the lender (investor) is paid the anticipated Interest (return on investment) and to prevent the borrower (manager) from claiming that the investment did not yield any return, the borrower (manager) guarantees to pay a return on investment equal to the Interest outlined in the underlying loan documents, except if he or she takes a solemn oath according to Jewish law at a Rabbinical Court to testify that he made no profits.
In light of the disinclination to undergo such an oath by religious Jews, there is very little chance for such a thing to occur.
Note; There is no record of an observant Jew administering the solemn oath according to Jewish law in the United States. In the unlikely event that someone might be able to find a Jewish Court willing to administer a severe oath, it is assumed to be more costly to follow these requirements than to save on the interest due.
The Heter Iska is drafted in such a manner that the lender (investor) may sell the underlying mortgage loan in the secondary market without being subject to the Heter Iska. Once the loan is transferred to a non-Jewish third party, the original mortgage note is viewed as a new loan transaction and a new commitment from the borrower to the lender and the iska term ultimately ceases to exist.
Note; considering most loans are sold to the secondary market within a short period, the entire Heter Iska term is usually relatively short.
The Heter Iska (loan) cycle.
David, a borrower, now known as the "manager," is looking to buy a property but does not have all of the funds and turns to a bank, which now acts as an investor to provide the funding.
Instead of lending David money, the bank now invests the money in the property, with stringent conditions, to achieve the same economic outcome as a traditional loan.
David will return the invested capital and a certain return on investment instead of interest to the bank.
The question is, if the loan is converted into an investment, how can the bank (investor) be confident that David will repay as expected? After all, there are risks inherent to all investments and no guarantee that a venture will be successful, let alone profitable.
To ensure David repays just as he would under a conventional loan, the Iska imposes rigorous conditions on David as the investment manager but also offers him the alternative to avoid those strict conditions. This alternative is to repay the funds to the Bank (Investor) exactly as outlined in the underlying loan document. To the extent that David chooses to follow the repayment schedule as outlined in the underlying loan documents, it makes no difference whether the transaction is called an Iska or a loan.
So what are those conditions we impose on David that make us comfortable knowing he will choose to repay as outlined in the loan document? First, two witnesses must confirm the loss of principal (mortgaged property) according to Jewish law, and a solemn oath must verify the return on investment.
Because it is implausible that anyone will follow such conditions, the chances are they will pay as expected.
What will happen if a borrower bears a severe solemn oath? (What is the maximum loss a bank can incur?)
The fact that it did not occur in the past does not guarantee that it will not occur in the future, and a lender needs to account for the possibility that someone will take a severe solemn oath to avoid paying Interest. Nevertheless, to minimize the risk to the bank in the unlikely event that someone will exercise his right to bear a severe solemn oath, the Heter Iska requires the borrower to notify the bank along with KFI about his intention to do so within 14 days of defaulting any payment, so the bank can choose to exercise the acceleration clause as it would in any other loan. In this way, we limit the bank's loss of Interest to about two weeks.
If someone defaults on an Iska, can the lender foreclose as usual?
Yes, the iska does not limit the right of a bank to foreclose.
Does the lender have to sign a separate Heter Iska for every borrower?
To facilitate the adoption of a Heter Iska by lenders with minimal effort, the KFI designed its Heter Iska to operate as an open offer. Thus, the lender only needs to sign the Heter Iska once and provide a copy to any Jewish borrower who wishes to be bound by it, who will only have to countersign it.
Legal Disclaimer: The information provided on this page does not, and is not intended to, constitute legal advice. All information provided is for general informational purposes only.